These are perilous times for small businesses, sole proprietorships, and entrepreneurs. The COVID-19 pandemic and the attendant government shut-downs and slow-downs, combined with masking and social distancing, have changed the way we conduct business as well as the way our customers procure our products and services.
Unfortunately, not every small business has been able to adjust to the new economic climate, and many have closed their doors. If your small business is struggling, bankruptcy provides opportunities to close in an organized way or to reorganize into a leaner and meaner company.
This article comes from the office of a prominent Philadelphia bankruptcy attorney and is for entrepreneurs who are sole proprietors and single-member LLCs because they have bankruptcy options that other business entities do not.
Chapter 7 bankruptcy is available to all business entities as a way to close up shop, liquidate business assets, and distribute the proceeds of liquidation to creditors in an orderly fashion.
Because sole proprietors and single-member LLCs are “flow-through” entities for the purposes of income tax, when they file a personal Chapter 7 they can close up shop, liquidate business assets, and distribute the proceeds to creditors in an orderly fashion, and also discharge personal liability for business debts and personal debts.
For sole proprietors and single-member LLCs, they will file a Chapter 7 petition, schedules, and list of creditors in their name and in the name of their business concern, using “d/b/a.” All business and personal income, expenses, assets, and debts must be disclosed. Prior to filing, the debtor will take an online credit counseling course.
Once the case is filed, a 341(a) meeting of creditors is scheduled with the Trustee. The debtor will provide proof of identity and answer questions about their financial situation under oath. The debtor’s personal and business creditors have the opportunity to appear at this meeting and to ask the debtor questions under oath.
Following a successful 341(a) meeting, the debtor takes an online financial management course and files the certification of completion with the court. After the deadline for creditors to object to discharge has passed, the debtor receives a discharge order, and the case closes. This is typically a four- to six-month process.
For sole proprietors and single-member LLCs, the benefits of business bankruptcy include:
- Orderly cessation of business operations
- Orderly liquidation of business assets by the Trustee
- Orderly distribution of business assets by the Trustee
- Discharge of liability for personal debts
- Discharge of personal liability for business debts
- Discharge of personal guarantees for business debts
- Discharge of personal debts
There are state and federal “exemptions” that a debtor can apply to exempt their assets from the bankruptcy estate, taking them out of the reach of the Chapter 7 Trustee who would otherwise seize and sell those assets for the benefit of your creditors. Before filing, a debtor should carefully consider whether there are sufficient exemptions to exempt the assets they wish to retain following the bankruptcy.
Some sole proprietors and single-member LLCs have very little in the way of assets, such as service-based or virtual businesses. In that case, they may be able to exempt business assets as personal assets.
If you have co-signers or guarantors of any business or personal debt, you will be discharged of that debt in your Chapter 7, but the co-signer or guarantor will remain liable for that debt.
If you have cosigned any loans, or you have guaranteed any debt other than for your business, you will be discharged of those liabilities in your Chapter 7 filing. However, the other party will remain liable for that debt, and your bankruptcy filing may be an instance of default allowing the lender to call that loan.
Chapter 13 bankruptcy allows a debtor to renegotiate secured debt and catch up with past-due debt over a three- or five-year monthly repayment plan.
Chapter 13 bankruptcy has all of the steps and components of Chapter 7 with the addition of filing a proposed Chapter 13 repayment plan and a plan confirmation hearing at which the Court will confirm the plan.
A sole proprietor or single-member LLC can get the unsecured debt discharged and reorganize both personal and business debt through their Chapter 13 plan. For example, a Chapter 13 debtor can:
- “Strip off” a second mortgage or HELOC as unsecured and have is discharged if the current value of the property is less than the balance of the first mortgage;
- “Cramdown” a vehicle loan to current retail value, and pay off that amount at prime plus 1-3% interest over the plan;
- Discharge certain income taxes;
- Pay past-due secured or priority debts, such as a mortgage, vehicle loan or lease, child support or spousal support arrears, sales tax, and government fines or fees.
The one thing sole proprietors and single-member LLCs need to watch out for is whether or not they can afford their plan payments. If the debtor is continuing business operations, working a different job, or both, they must have enough disposable income to make the plan “feasible” for them and still be able to make ends meet.
About the Author
Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.