When news broke last week that Red Lobster, home of delicious Cheddar Bay Biscuits and all-you-can-eat shrimp specials, had filed for Chapter 11 bankruptcy protection, business owners the world over were reminded how precarious business ownership can be. A few slow months, a bad lease agreement, or something completely out of your control like a downturn in the economy or decreased interest in your products or services can have massive implications for your company’s future. We’ll examine the most common types of bankruptcy that businesses file, and look at signs that your business may be headed for bankruptcy.
What Types of Bankruptcy Can Businesses Use?
The two most common types of bankruptcy are Chapter 7 and Chapter 11. We go over them here:
Chapter 7 Bankruptcy
Sometimes called liquidation bankruptcy, any business that files Chapter 7 is beyond the stage of recovery and must sell off assets to pay creditors. The bankruptcy court will appoint a trustee to ensure that creditors are paid off in the correct order.
Chapter 11 Bankruptcy
Also known as “reorganization” or “rehabilitation” bankruptcy, Chapter 11is the most complex form of bankruptcy and generally the most expensive. Chapter 11 gives a company an opportunity to reorganize its debt and try to reemerge as a healthy business.
Chapter 7 vs. Chapter 11 Bankruptcy
| Chapter 7 Bankruptcy | Chapter 11 Bankruptcy | |
| Purpose of Bankruptcy | Liquidate company assets in order to repay creditors. | Allows the business to continue operating while it reorganizes in order to pay debts over time. |
| Cost to Declare | Typically less costly than Chapter 11. | Generally more expensive due to court and other administrative fees. |
| Control of Business | Control of business changes hands from owners to a court-appointed trustee. | Owners remain in control of the company. |
| Length of Time | Usually takes a few months. | Can take several months and even years to emerge from Chapter 11. |
| Business Eligibility | Any type of business can declare Chapter 7. | Any type of business can declare Chapter 11. |
Other Types of Business Bankruptcy
While Chapter 7 and 11 Bankruptcy make up over 90% of all US bankruptcies, there are other options.
- Chapter 13: Debts are reorganized through a 3 to 5 year repayment plan. The bankruptcy trustee assigned to oversee the case sends the plan payments to creditors. After completing the repayment plan, the remaining balances of qualifying debts are “discharged” or forgiven.
- Chapter 12: A streamlined process with special provisions to accommodate the unique challenges faced by agricultural businesses. Specifically tailored for family farms and fishing businesses, Chapter 12 allows these types of business to reorganize debts while maintaining operations.
- Chapter 15: This type of bankruptcy deals with international companies that have a foothold in the US. It allows US courts to recognize foreign bankruptcy proceedings and helps to simplify the administration of assets in multiple jurisdictions.
Signs Your Business May Need to File Bankruptcy
Deciding whether to file for bankruptcy isn’t an easy decision for any business owner. But if your business is running into any of these five issues, it might be time to call up a bankruptcy attorney.
1) Declining Revenue
All business owners know that they’ll face slowdowns in the market. One month will be busy, the next super slow. But a consistent decline in revenue over an extended period can signal underlying issues within your business or industry. If you’ve exhausted all efforts to turn things around without success, bankruptcy might be necessary.
2) Legal Action
If your business faces lawsuits, liens, or judgments from creditors, it’s probably under some significant financial strain. Filing for bankruptcy can help halt legal actions and provide a structured approach to address creditor claims.
3) Cash Flow Problems
If your business is struggling to maintain positive cash flow or meet day-to-day expenses like payroll, rent, or utilities, it might be a sign of deeper financial issues that bankruptcy might help resolve.
4) Your Products or Services are Obsolete
Remember Blockbuster? They used to control the video rental market, and now there’s one left and it’s in Bend, Oregon. Netflix and other streaming companies effectively put Blockbuster out of business. If your company is selling a product or service that is more dead than the dinosaurs, it may be time to consider bankruptcy.
5) You’re Depleting Your Personal Assets
Many small business owners use their own money and assets to build their business. But if your business is failing and taking your hard fought personal assets (401k, home, investments, kid’s college savings ) with it, bankruptcy is an option.
Filing for bankruptcy isn’t an easy decision. If you’re considering it, take the time to sit down with a legal professional who specializes in bankruptcy filings. They’ll help you better understand the implications, options, and consequences specific to your business.
While Northwest can’t help your business weather a bankruptcy, we can help you save money when starting your business. For just $39 (plus state fees) we’ll help you start your business and throw in a year of registered agent service, and business identity service (domain name, website, email, business address and business phone number), and so much more.
*This is informational commentary, not advice. This information is intended strictly for informational purposes and does not constitute legal advice or a substitute for legal counsel. This information is not intended to create, nor does your receipt, viewing, or use of it constitute, an attorney-client relationship. More information is available in our Terms of Service.