The Benefits of Bankruptcy for Small Business Owners in Athens, GA

Small business owners sometimes face hard times. Demand changes, the price of supplies rises, or an economic catastrophe strikes. Businesses confronting potential insolvency can either liquidate through Chapter 7 or reorganize debts under Chapter 11.

In the sections below, we outline the advantages of small business bankruptcy.

Discharge of Debts

By filing for bankruptcy, a small business can discharge many debts under Chapter 11, allowing it to survive financially. Alternatively, the owner can file a Chapter 7 liquidation and walk away from the business without any further financial obligations.

Discharge of Debts Under Chapter 7

Business owners file Chapter 7 when they decide to let a business go. They make this decision for various reasons, such as the business no longer being profitable or creditors threatening to seize essential property. Often, creditors demand that the firm sell assets it needs to function, making it impossible for the entity to remain in business.

 

A Chapter 7 liquidation is not necessary for all business closures. For example, if the business can wind down, sell its assets, pay off creditors, and leave the owner with a substantial sum, filing a Chapter 7 makes no sense. The owner can exit the business profitably or sell it at a profit.

 

This might occur if the business owner determines that the company can no longer generate a profit due to changes in market conditions. However, if the owner has equity, rather than letting it drain away from the insolvent business, the owner may close up shop, realize the profits, and move on to something else.

 

Additionally, the business owner may be able to strike a deal with creditors to repay a portion of the assets. In other cases, the owner may find a buyer interested in the business assets and confident in turning the business around.

 

However, many failing businesses lack the owner’s equity to close or sell at a profit. In fact, the business may owe money to creditors after liquidating all assets. Sometimes, the business owner may have personal liability for some loans.

 

Filing a Chapter 7 liquidation offers the business owner immediate protection from creditors. The owner can then sell off the business assets and use those funds to repay creditors partially. In addition, the debt exceeding the amount gained through the liquidation sale is discharged.

 

However, not all business debts can be discharged in Chapter 7. For instance, some tax obligations, debts incurred through fraud, and those arising from malicious conduct may be exempt from discharge.

A Note on Corporations vs. Sole Proprietorships

If the business is structured as a corporation or LLC, its assets are separate from the owner’s personal funds and property. In that case, the owner has no personal liability for debts remaining after a business liquidation. On the other hand, if the small business is structured as a sole proprietorship, the owner’s personal and business assets are combined.

 

For this reason, business owners should consider the implications of their chosen structure if the business fails.

Discharge of Debts Under a Chapter 11 Bankruptcy

Financially strapped businesses are not unsalvageable. The owner may see a way to return to profitability by restructuring debts to free up cash flow. An entity may have large debt payments eating away at its cash. With its revenue, it may be months away from becoming insolvent.

 

However, the owner may believe the business can turn a profit over the long term if it can lower the debt payments to fix its cash flow problem. The business can rebuild its balance sheet and become profitable by paying its monthly bills without the well running dry.

 

Sometimes, the owner can obtain financing and strike a deal with creditors that solves the cash flow problem and returns the business to profit. On the other hand, creditors may refuse to restructure debt, and financing may be unavailable. As a result, the owner faces the prospect of losing a business with substantial potential.

 

The owner may be able to save the company by filing a Chapter 11 bankruptcy. Chapter 11 allows the business to restructure debts to pay its bills and stay operational. Once the court approves a Chapter 11 plan, it can force creditors to accept the new terms.

 

While the reorganization plan remains in effect, the business continues to operate under court supervision. When the reorganization plan terminates, any remaining debts are discharged. At that point, the business is free from creditor pressure and can operate profitably.

 

The Automatic Stay

When a business is in financial trouble, it may need relief sooner. Creditors may hound the business, causing its credit rating to plunge. They may place liens against a property and threaten the seizure of key assets. These actions may force the company out of business.

 

Even if a drastic action, such as the seizure of plant equipment, is imminent, filing bankruptcy immediately stops it with the automatic stay. The moment the debtor-business files for bankruptcy, the automatic stay takes effect. No creditor can demand payment or accept any collection action. Temporarily, the business is safe.

 

However, the automatic stay is not forever. The court must address the creditors by granting a Chapter 7 liquidation or a Chapter 11 debt reorganization plan. Creditors must comply with the automatic stay, but at some point, the court will approve the alteration or payment terms or the sale of assets.

 

In Chapter 7, the automatic stay remains in effect while the court supervises the entity’s liquidation. Creditors cannot take independent collection activity. They must accept the settlement of their claims approved by the court, which is often pennies on the dollar.

 

In Chapter 11, the automatic stay remains in effect while the company remains under the reorganization plan. However, once the plan is complete and the remaining debts discharged, the court closes the case, and the automatic stay ceases.

 

For more information on bankruptcy, visit the U.S. Courts Bankruptcy Basics page.

Creditor Petitions for Relief from the Automatic Stay

Though the automatic stay applies to all creditors, any creditor may apply to the court for relief from the automatic stay. However, this application must cite one of the qualifying reasons for automatic stay relief. Most creditors have no grounds to protest the automatic stay, and many debtors never face one of these motions.

 

However, if a creditor has grounds and can demonstrate its case, the court may side with it. In that case, the automatic stay remains in effect, and the creditor has a special exemption to continue its collection activities. However, the creditor must abide by the terms imposed by the court. The relief may apply to all the creditor’s claims or some.

 

The bankruptcy petitioner can fight against the creditor’s motion. In that case, it is up to the judge to decide whether relief is warranted.

 

Grounds under which a creditor may seek relief from the automatic stay include the following:

 

Lack of Adequate Protection

Creditors who issued secured loans can use the lack of adequate protection argument to seek relief from the automatic stay. This concept is based on the creditor’s belief that the property that secures the loan is declining in value without adequate protection for the creditor’s interest. If granted, the court allows the creditor to take specific actions to protect its stake in the property.

 

For example, the creditor may contend that the debtor has left equipment in disrepair and without maintenance at a closed facility. Since the creditor extended a loan to the company with this equipment as collateral, it is interested in ensuring it remains in good condition. A court may allow the creditor to take action to protect its interest.

No Equity and Unnecessary for the Reorganization

A creditor may seek relief from the automatic stay to seize property in which the debtor has no equity and is unnecessary for a reorganization. Because the property is worth less than the outstanding debt and the property is not needed for the company to reorganize, the court has no reason to stop the creditor from seizing it.

 

For example, suppose the debtor company closed one of its factories. In that case, the creditor with the right to equipment inside may argue that the property is unnecessary for the company to meet its reorganization obligations and request relief from the automatic stay to seize it.

Single Asset Real Estate

In some Chapter 11 bankruptcy cases, the debtor company has a single real estate asset. When this happens, the borrower must continue making interest payments or file a feasible reorganization plan. If the bankrupt company fails to do so, the creditor may file for relief from the automatic stay.

 

For example, a debtor company may have stopped making interest payments on its sole real estate property and failed to present a realistic plan for reorganization.

Bad Faith 

Petitioners must file bankruptcy in good faith. However, a creditor can object to the automatic stay if filed under deceptive circumstances.

Lack of Progress on the Reorganization

Companies that have filed a Chapter 11 must promptly move forward with their reorganization plans. If they fail to do so, creditors may argue that the lack of progress entitles them to relief from the stay.

Serial Filings

Companies cannot abuse bankruptcy laws by becoming serial filers. The purpose of bankruptcy is to either liquidate the business or reorganize. Repeated filings to benefit from the automatic stay may result in creditor objections.

 

Ultimately, a judge decides on these motions based on the evidence and law.

 

Small business owners have options if they face business failure. When the company must liquidate, Chapter 7 winds down the enterprise and eliminates remaining debts. In other cases, the owner may be able to save the business through a Chapter 11 reorganization plan.

 

Morgan & Morgan helps small business owners stay in business through bankruptcy or liquidate an enterprise that lacks a future. If you need help with a small business bankruptcy, contact Morgan & Morgan.

 

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