In our day-to-day practice at Kain & Scott, our attorneys will typically field a few contacts every month from business owners who are financially stressed. The business owners typically have this, or a variation of this question: my business is in financial trouble, should the business file a bankruptcy? It’s such a simple, and such a common question. One of the reasons the United States has a bankruptcy law is to provide a safety net from small business owners - to allow the business owners to take financial risks without having to worry about financial ruin if the business experiences significant reverses. But while the question is simple, the answer is usually at least a little complicated. Let’s look at the factors that should be considered in making a decision as to whether to have a business file a bankruptcy case.
What is the business form?
The first question is whether the business is a sole proprietorship, a partnership, a limited liability company (LLC) or a corporation. If the business is a sole proprietorship or partnership, the business can’t file a bankruptcy - only an individual, personal bankruptcy will discharge the business debts of a sole proprietor or partner. Business debts are listed in the personal bankruptcy as a personal obligation of the bankruptcy debtor; it is in this way that the business financial problems are resolved.
If the business is a corporation or an LLC, then filing a bankruptcy case is possible, if it will benefit the business (or the business owner).
Are the financial obligations the sole responsibility of the business?
In almost every small business, there are bills owed by the business that are solely in the name of the business. Common examples are utility bills - or bills for the day-to-day operation of the business, such as internet support or office cleaning. Other business obligations are the responsibility of the business and the business owner(s). This is true of almost every financing agreement and lease agreement - in cases where the business has borrowed money, or if there is a credit card in the business name or if there is a commercial lease agreement or a mortgage on business real estate, the obligation belongs to the business, but also to the owner of the business who has filed a personal guarantee. If the financial problem facing the business is for these types of debts, then the question becomes which approach will benefit the business or the owner of the business more: the business filing a bankruptcy case, or the owner of the business filing a bankruptcy case, or both?
Does the owner intend to continue operating the business?
This is a key question in analyzing whether a business should file a bankruptcy case. If the owner has decided to close down the business, then the filing decision can be fairly simple: the owner needs to analyze whether the obligations are only the business’s, or the owner’s personal liability, or a joint business/owner liability. Then the question is whether there are sufficient “free and clear” assets in the business so that if the business assets are liquidated, business debt can be satisfied. If the answer to the question is that there aren’t sufficient assets, then the owner has to think about whether a short-fall with creditors will trigger personal liability for the business owner.
Things get a bit more complicated if the business owner would like to keep operating the business. Then the type of business becomes an important question. Retail businesses - that is, businesses that sell inventory, and have significant inventory on hand will find it very difficult to survive if the business files a chapter 7 bankruptcy, since a chapter 7 bankruptcy by a business will almost certainly result in the liquidation of inventory by the chapter 7 trustee. A chapter 7 filing by a service-related business is less likely to guarantee the shut-down of the business, but problems remain for a business that provides services if the creditors of the business - vendors and lenders - are subject to having the business discharge its obligations. If vendors and lenders are not going to be paid, then a service-based business owner might find it impossible to stay open, since the affected vendors and lenders will discontinue doing business with the chapter 7 business debtor.
So as you can see, it’s complicated. I’ll write more on this next week.