Small Business Bankruptcy

07 Aug Small Business Bankruptcy

When small companies go bankrupt, you usually have to review the entire situation beforefiling bankruptcyfor the company and that means looking at the owner’s situation too.

When it’s time to shut down a small business corporation, the first order of the day is:Separating the owner from the business

Corporations are separate legal entities, which means that they exist outside of the owners. The small business owner usually owns all of the stock in the corporation, but he and the corporation are not the same “person”.

As a separate legal entity, the corporation can file its own bankruptcy, whether or not the shareholders file as well.

The bankruptcy choices for a debtorcorporation (or an LLC) are to reorganize under Chapter 11 or to liquidate underChapter 7. Corporations get a discharge only under Chapter 11. Chapter 11 reorganization is generally quite expensive and time consuming. Only the unusual struggling small business can fund a Chapter 11.

Since there is no discharge available to a corporation in Chapter 7, it is worthwhile considering why one might file Chapter 7 for the corporation. A business can cease operation, pay its bills as far as the money goes, and dissolve, outside of bankruptcy.

Reasons why you might file a corporate Chapter 7:

  1. Hand the winding down work to a Chapter 7 trustee.
  2. Stop trade creditors from levying on assets that could pay tax debts
  3. Free the owners to establish a competing business
  4. Provide credibility to claim that there is no money to pay the balance of corporate debt

The last reason has a peculiar effect of reducing the number of lawsuits against the individuals involved in a failed business.

If the corporation winds up outside of bankruptcy, some sub set of creditors will sue the corporation to collect the debt, and reflexively name the shareholders as well. In my experience, if the corporation files bankruptcy, creditors of the corporation seldom file a lawsuit just to reach the shareholders, unless, of course, they have the guarantee of the individuals.

So, just the avoided expense of defending one lawsuit in which the individuals are named as defendants along with the defunct corporation is enough to fund the filing of a corporate bankruptcy.

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Cathy Moran, Esq.

I'm a certified specialist in bankruptcy law (California State Bar Board of Legal Specialization) practicing in the San Francisco Bay Area for more than 30 years. In addition to practicing bankruptcy law, I train new practitioners at Bankruptcy Mastery.
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