Bankruptcy for Business Owners: A Guide

ByNikolina Cveticanin
September 08,2022

Many small business owners struggle to keep their business debts under control and their business on track. While a number of them have closed their businesses temporarily or permanently in the wake of the pandemic, filing for bankruptcy can help you keep your business running by providing some debt relief. Furthermore, business bankruptcy can help the business owner close up shop quickly if ceasing operations is imminent.

However, not every bankruptcy for business owners is the same. So, read on to learn what small business bankruptcy options are available for sole proprietors, partnerships, and corporations and whether you should consult a bankruptcy attorney.

When Should a Business File for Bankruptcy?

If your company has been going through a rough patch, it’s advisable to scrutinize your balance sheet and assess the extent of your debt. After a prolonged period of consistently being unable to settle its debts and expenses, a business unavoidably reaches financial status that makes bankruptcy imminent.

At that time, filing for bankruptcy helps you escape a potentially unsustainable state and protect your valuable property from being seized during the processes that accompany small business bankruptcies. 

Types of Bankruptcies for Businesses

Filing for bankruptcy under Chapters 7, 11, and 13 is available for sole proprietors, while partnerships and corporations can resort to Chapters 7 and 11.

Chapter 7 is effectively a liquidation, Chapter 11 is about reorganization, while Chapter 13 is a wage earner’s plan that pertains to individuals or sole proprietorships which are the responsibility of one individual.

Bankruptcy Options for Sole Proprietors

Sole proprietors running small businesses have a few solutions when it comes to the bankruptcy process. In sole proprietorship bankruptcy, bankruptcy law regards the sole proprietor and their business as one and the same. 

This also applies to married couples running the company together. In this case, personal and business assets are the subject of a business bankruptcy. The sole proprietor has the following solutions for filing bankruptcy.

Chapter 7 Bankruptcy for Small Business Owners

Many business owners that file for business bankruptcy resort to Chapter 7 since it doesn't require them to give up on everything they have. In that regard, Chapter 7 discharges certain qualifying debts, both business and personal. Most small business owners can expect the process to end within four months after they file bankruptcy. 

The bankruptcy process involves giving up a particular property that the trustee in charge of your case can sell and then use those funds to settle your debts toward creditors. There are exemptions in each state that allow you to keep specific business and personal assets, such as some equity in your home, car, furniture, and work tools. Consequently, you’ll be able to start afresh after you’ve regained your footing. 

Chapter 7 Bankruptcy Downside

You can bankrupt a small business with Chapter 7 and keep some necessities, but remember the following downsides of filing for bankruptcy. A Chapter 7 bankruptcy filer could lose property that is part of their estate, including their business if it is a company with valuable assets and the trustee was able to find a willing buyer. 

So, if you own an attractive ongoing operation you can't protect, being compelled to turn to Chapter 7 for personal bankruptcy might not be a good idea after all. 

Furthermore, Chapter 7 bankruptcy protection exempts small amounts of business assets. Thus, you're likely to lose most of them when you file personal bankruptcy as a sole proprietor. 

Filing Bankruptcy Under Chapter 13 or Chapter 11 Subchapter V

Chapters 13 and 11 are small business bankruptcy options for a sole proprietorship if the business owner prefers to continue operations instead of liquidating the company. Chapter 13 (or Chapter 11 Subchapter V if the business debts exceed the Chapter 13 limit) allows you to keep your business running as long as your cash flow is adequate for all monthly payments. 

In line with that, you can file for bankruptcy if your business is steady and if the bankruptcy court approves it. In turn, you'll get a repayment plan lasting between three and five years. You'll pay an assigned trustee who will transfer the funds to creditors during that time.

Chapter 13 is also a small business bankruptcy option if you have to close the company and don't qualify for Chapter 7. In this case, small businesses have three to five years to pay off business debts, and peace of mind since creditors receive financing during that time. 

Bankruptcy Options for Small Business Partnerships and Corps

Due to the various disadvantages Chapter 7 involves, small business partnerships and corporations usually opt for Chapter 11. The partnership filing for Chapter 7 bankruptcy will likely lose investments, face lawsuits outside bankruptcy court, and ultimately collapse. However, filing for Chapter 7 might benefit corporations and partnerships in some cases, so let's review both types of business bankruptcies.

Chapter 11 for Settling Business Debts

While Chapter 13 is available only to sole proprietorships and individuals, the advantage of Chapter 11 is that it’s available to general or limited partnerships and limited liability companies. 

A small business entity benefits from Chapter 11 in two ways. Specifically, it can continue operations while paying smaller amounts to creditors toward business debts, which are restructured along the way.

Before the bankruptcy filing, though, the company should contact a law firm and have a business bankruptcy lawyer evaluate its prospects and whether Chapter 11 Subchapter V will be worthwhile.

Chapter 7 Pros and Cons for Corporations and Partnerships

Unlike Chapter 11 bankruptcy, which provides a mechanism for businesses to continue operating, Chapter 7 bankruptcy results in the company's shutdown. Furthermore, the appointed trustee sells the company assets and sends the proceeds to creditors.


However, Chapter 7 bankruptcy filing may benefit a failing business if it has a substantial amount of property or a considerable number of creditors. Some related advantages are:

  • The members don't have to sell the small business's assets themselves, leaving this delicate work to the trustees.
  • This process is public, which can help prevent creditors from pursuing legal action against the company declaring bankruptcy if they assume that partners wish to keep funds instead of paying their outstanding debts.
  • By avoiding fraud litigation and related lawsuits, partners prevent exposure to significant legal expenses.


Although the trustee sells the property of the entity and distributes the proceeds to creditors, the small businesses still face some risks, including the following:

  • Chapter 7 doesn't exempt the partners from paying their business bills, holding them personally liable for the costs incurred.
  • The trustee selling company property may seek the partners' personal assets to repay the debt.
  • When corporations file bankruptcy at the federal court, creditors can initiate alter ego litigation, which leads to the personal liability of each shareholder for the corporation's debt.
  • Another potential drawback of bankruptcy for business owners is that a creditor can file complaints about inadequate handling of the small business's finances. That way, business debts can become personal debts.

Limited Liability Company Bankruptcy Filing

Filing for bankruptcy as an LLC results in a liquidation of the business's assets to pay off debts. In an LLC, the owners aren't personally responsible for company debts if they haven't guaranteed for them. Moreover, they can file personal bankruptcy to evade liability.

A struggling LLC with a plan for moving forward can file for reorganization under Chapter 11 bankruptcy. This used to be an option for large corporations only, but the Small Business Reorganization Act made Chapter 11 bankruptcy for LLC a viable alternative. It’s a good idea to consult an attorney for more information.

Bankruptcy Consultations With a Lawyer

Bankruptcies can be complicated, so the best course would be to establish a relationship with an attorney early on. That way, you get good advice and protection of your interests from the outset. Plus, it’s often a requirement that a lawyer file the case.

The business owner in bankruptcy typically receives the following services from their attorney:

  1. Situation analysis and an estimate if a bankruptcy is the right choice
  2. Bankruptcy process explanation
  3. Advice on which chapter is the best option
  4. Cost estimate and explication of the necessary steps for proceeding with the process.

Final Thoughts

In line with what we discussed in the article, Chapter 7 bankruptcy results in a company's shutdown, while Chapter 11 allows the company to reorganize and continue operating. Chapter 13 bankruptcy is for businesses with a regular income and may allow you to keep your business open while repaying your debts.

Even though these options seem pretty straightforward, they come with potential pitfalls. So, it would be best to consult an attorney to learn which bankruptcy for business debt settlement will work for your small business.

What happens when a business files for bankruptcy?

The business ceases operations while its assets are sold for settling debts to creditors and investors.

Which type of bankruptcy is available to all businesses?

Chapters 7 and 11 bankruptcy are available to all businesses. Sole proprietors can also resort to Chapter 13.

Can I keep my business if I file Chapter 13?

Chapter 13 bankruptcy for business owners allows continuous operations, provided the company can continue making regular payments. 

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By Nikolina Cveticanin · August 24,2022
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By Julija A. · October 12,2022
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By Danica Djokic · August 26,2022

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