Bankruptcy is something many businesses need to deal with, especially those that are small or just started their operations. It is quite common to see how small businesses have to close their doors after just a few years or even months of being launched to the market.

Reality has shown that small companies are the ones who usually have to face a higher risk of going bankrupt. The reason to this is rather obvious: they lack the experiences, the history and the economic muscle to face the challenges that may get in the way.

We know that even though it is hard, deciding to declare bankruptcy sometimes becomes a necessity (one that may cure many headaches). For this reason, in this article, she will explain the very basics of bankruptcy and the three options business have when they decide to file for it.

What is bankruptcy?

The easiest way to describe bankruptcy would be as the process a business has to go through in the eyes of a federal court and is created to allow a business eradicate or cover up for its debts. This process gives certain protection to the business and allows it to take care of its responsibilities without having to face further and terrible consequences.

It could be used to liquidate a business or to restructure it in order for it to solve its problems under the protection of a federal court. There are basically three different types of bankruptcy that companies could file for. Each type is meant to meet the needs of different types of businesses.

These types of bankruptcy can be taken by sole proprietors of businesses. This means that the owner of a business itself couldn’t file for bankruptcy, this process would need to be done by a figure that acts as the legal representative of the owner known as the sole proprietor.

Sole proprietors can file for bankruptcy under three different types of chapters: Chapter 7, Chapter 11, or Chapter 13. However, they are not the only ones who can file under these figures. Partnerships and corporations can also file for Chapters 7 or 11 to look for the federal court protection regarding their bankruptcy.

Below, the different types of bankruptcy under which companies can ask for protection are listed:

Chapter 7 (business bankruptcy)

Chapter 7 is the best type of bankruptcy under which companies should file when they don’t have any future. It is often used as a liquidation tool and not a restructuration one.

This chapter is used when businesses have overwhelming debts that they fail to repay. In these situations, trying to restructure a company is highly unlikely. Therefore, it is understood that the company is going to be doomed to disappear anyway.

On the other hand, this type of chapter is ideal when the business doesn’t have important assets. In other words, businesses that decide to file for bankruptcy under the Chapter 7 tend to be an extension of the owner of the company skills. For this, when these type of businesses can’t take the financial distress anymore, they choose to close their doors instead of restructuring their organization. Filing under the chapter 7 is also understood that the end of any company.

After company files for Chapter 7, a trustee is designated by the federal court to be in charge of the business’ assets. This person has the obligation to distribute the company’s assets among all creditors. Once the assets are distributed and the trustee is paid for its job, the sole proprietor, corporation or partnership doesn’t receive a discharge.

Chapter 11 (business reorganization)

Unlike the Chapter 7, the Chapter 11 is useful for businesses that actually have a future. This type of bankruptcy works as a plan for companies be restructured and continue to operate. Here, the federal courts set a trustee that sometimes could be the owner of the business. This way, the business has to give a detailed plan of its restructuration process, point out how creditors will be paid and creditors can vote if they agree or disagree with this plan.

Each restructuration plane gives companies the chance to pay their debtors during a set period of time. This period could indeed exceed a period of 20 years to repay debts.

Bankruptcy process under Chapter 11 is highly complicated and in many circumstances, it doesn’t succeed.

Chapter 13

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This type of bankruptcy is reserved for sole proprietors and consumers. It consists in filing for a repayment of every debt under the eyes of a federal court. The amount of money the sole proprietor has to pay will depend on the amount of money it is able to make monthly, the size of the debts and the proprietor’s assets.

Chapter 13 may help you avoid losing your personal properties if you declare bankruptcy under it. However, it is very important to ask an attorney before deciding under which chapter you want to file for bankruptcy.

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