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Bankruptcy Options Depend on Business Type

Oct. 28, 2019

Starting a new business is an optimistic endeavor, yet the odds are not necessarily in your favor. While approximately 80% of new businesses survive the first year, only about half reach the five-year mark, and two-thirds or so fail before reaching their 10th anniversary.

If your small business is struggling, it might be time to start thinking about filing for bankruptcy. The types of bankruptcy available to you can vary depending on the structure of your business. For example, the options available to a sole proprietorship are different than those for a limited liability company.

Bankruptcy Options for Sole Proprietors

By definition, a sole proprietorship has only one owner. The only exception, which is rare, is that sometimes a married couple can own a sole proprietorship together. While an LLC may also have only one owner, the difference between the two is that an LLC is distinct from its owner(s) from a legal perspective, while the law makes no distinction between a sole proprietor and his or her business.

Therefore, the types of bankruptcy that are available to sole proprietors are the same options available to individuals who file for bankruptcy without owning a business. As a sole proprietor, you may be able to either liquidate your assets to pay off your debts with a Chapter 7 bankruptcy or reorganize your debts to pay them off over time by filing Chapter 13.

Each has eligibility requirements to meet, however, so the type that you qualify for depends on your individual situation. If you qualify for both, you get to choose between the two. However, this is very rare.

Bankruptcy Options for LLCS

Chapter 13 bankruptcy is only available to individuals. Since there is a legal distinction between a limited liability company and its owner(s), an LLC cannot file Chapter 13 bankruptcy even if you own and operate it by yourself. However, Chapter 7 bankruptcy is available to an LLC regardless of how many owners it has.

Asset liquidation through Chapter 7 involves placing assets into a bankruptcy estate with an appointed trustee to manage them. The trustee has the responsibility to manage allowable claims from creditors and distribute assets, or proceeds from their sale, according to the bankruptcy code. Some assets are exempt, meaning that, by law, they cannot go into the bankruptcy estate.