Filing for Small Business Bankruptcy | San Francisco Bankruptcy Lawyers
Many small businesses have taken a downturn in this economy. We work with small business owners to consider all the available options including negotiating debt, liquidation and reorganization.
The Type of Business Entity Matters
One of the first things to do is determine the type of business entity. Certain business entities are entitled to use particular bankruptcy chapters. A business can be one of the following:
- Limited liability company (LLC)
A corporation, limited liability company (LLC) and partnership are legal entities that can act independently from their respective shareholders, members and partners. Chapter 7 bankruptcy and Chapter 11 bankruptcy are the two types of bankruptcy available to these entities. Thus even in the typical closely held corporation where there is one or two shareholders behind the corporation, it is possible for only the corporation to file bankruptcy, and not the owners/shareholders, and vice versa.
A sole proprietorship and the owner are one entity. If Jane Doe is doing business as (dba) Juice Hut, both Jane and Juice Hut must file bankruptcy. A sole proprietor may use Chapter 7, Chapter 11 or Chapter 13.
Discuss small business bankruptcy with a San Francisco bankruptcy lawyers to understand the advantages and disadvantages of each chapter of bankruptcy.
Businesses That File Bankruptcy Must Cease Operating When Bankruptcy Is Filed – A Way To Avoid This
The trustee that administers your bankruptcy follows a manual that requires a trustee to take control and cease operations of the business if the business files bankruptcy. The reasoning is that the business’ assets and liabilities become part of the bankruptcy estate. The business must cease during the bankruptcy because continuing operations of a business runs the risk of incurring more debts and liabilities, thereby diminishing the bankruptcy estate. For example, the business may owe payroll taxes, it may be sued, its inventory damaged or other liabilities.
A potential solution is to create a new business entity before filing bankruptcy in order to continue operations during bankruptcy. For example, assume Jane Doe’s sole proprietorship Juice Hut has $250,000 in debts and liability. Jane’s assets include refrigerators, juice squeezers, a cash register, tables, chairs and other inventory worth $15,000. Jane wants to file a Chapter 7 bankruptcy, but want to keep her business, and keep it operational during the bankruptcy.
A potential remedy may be for Jane to form a corporation prior to filing bankruptcy. Jane can form Juice Hut, Inc. She can then transfer the assets into the corporation, and issue stock to herself as a shareholder worth $15,000. When Jane files bankruptcy, she will exempt the stock under the wildcard exemption. Juice Hut, Inc. as a corporation that is its own legal entity can continue to operate while Jane files her own bankruptcy.
An aggressive creditor could argue that the transfer of assets into a corporation is a fraudulent transfer. However, given that the assets could be exempted, and no new liabilities will diminish the bankruptcy estate, this claim is unlikely.
Note that if the business seeking a Chapter 7 bankruptcy is a corporation from the outset, forming another corporation and transferring the assets is more problematic. Assume that Ronald is the sole shareholder of Consulting, Inc. that has $500,000 in debts and liabilities, and $15,000 in assets. Creating a new corporation and transferring the assets is riskier because a corporation, unlike an individual, is not entitled to take exemptions. Moreover, transferring the remaining assets to the shareholder runs into issues with laws governing corporations such as shareholders raiding the assets of the corporation. A decision to transfer assets from one corporation into another is a calculated risk that should be discussed with your San Francisco bankruptcy lawyer.
Note Regarding Personal Guarantees
Many small business owners are required to personally guarantee loans and lines of credit. In this case, if a business is struggling, the business owner’s personal assets are in jeopardy. A business owner can file personal bankruptcy to sever any ties and liability that exist via a personal bankruptcy. The owner can then wind up the business through liquidation or bankruptcy.
Bankruptcy or Wind Up
A decision also needs to be made regarding whether a business should be terminated through a bankruptcy or a wind up. One advantage of bankruptcy is that a trustee will take control and handle distribution of the assets. This provides for an orderly distribution based on the priority of each creditor. It also depends on what type of bankruptcy the business uses. A reorganization under Chapter 11 or Chapter 13 may permit a business saddled with debt, bad contracts and unfavorable leases to restructure if it still has a promising future. This, however, requires an honest appraisal of the business and whether it has a viable future, including income and the necessary skills, trade and market to continue operations.
If the business has no realistic future, a Chapter 7 liquidation may be the best option. It is important to remember that bankruptcy, including Chapter 7 bankruptcy does not result in a discharge of debts. As such, a business may dissolve under the state’s law providing for dissolution.
Good reasons to file a corporation into chapter 7 might include:
- To stop a creditor from executing on valuable assets that could otherwise be utilized to pay favored creditors (e.g. trust fund taxes, wage claims or personally guaranteed debt).
- To recover preference payments that could be used to pay favored creditors.
- To help insulate the principals from allegations that the liquidation of the entity was handled improperly.
- The principals would rather turn over liquidation of the entity to a trustee rather than handle it themselves.
Good reasons to avoid a corporate chapter 7 might include:
- The assets of the corporation are very nominal.
- The time and expense of bankruptcy.
- The unwanted exposure and scrutiny of prior transactions.
Contact San Francisco bankruptcy lawyers at JC Law Group PC for advice regarding your particular circumstances.