Filing Bankruptcy for a Small Business: Choosing Chapter 7 or Chapter 11

Chapter 7 places estate property under a trustee’s administration for liquidation and distribution. Under 11 U.S.C. § 727(a)(1), a debtor that is not an individual cannot receive a Chapter 7 discharge.

For a corporation or LLC, Chapter 7 bankruptcy is therefore primarily a liquidation process. The analysis should identify secured assets, receivables, inventory, pending claims, and transactions subject to trustee review.

A sole proprietorship has no separate legal identity from its owner. Business assets and liabilities therefore become part of the individual owner’s bankruptcy analysis.

That distinction can affect exemptions, dischargeability, secured claims, tax liabilities, and chapter eligibility.

Chapter 7 generally fits a business entity that will cease operations and liquidate available estate assets.

Inventory, equipment, receivables, real estate, intellectual property, liens, and potential avoidance claims can affect what the trustee administers.

Chapter 11 can allow a debtor to continue operations while addressing creditor claims, financing, contracts, leases, asset sales, and a reorganization plan.

A manufacturer may consider Chapter 11 bankruptcy when machinery, customers, employees, or other going-concern value would be lost through immediate liquidation.

Subchapter V provides a specialized Chapter 11 framework for qualifying small business debtors. The current adjusted debt limit is $3.424 million in qualifying noncontingent, liquidated secured and unsecured debt, and at least 50 percent of qualifying debt generally must arise from commercial or business activities.

Debt amount, characterization, affiliates, and the nature of the business can affect eligibility.

A bankruptcy petition generally stays specified collection activity against the debtor and estate property under 11 U.S.C. § 362. It does not create a general automatic stay for a separate owner or guarantor who did not file bankruptcy.

A lender may therefore be stayed from collecting against the company while continuing an action against an owner who personally guaranteed the debt. The automatic stay, guarantee terms, collateral, and enforcement stage should be reviewed separately.

A valid lien does not disappear because the debtor files bankruptcy. Secured-creditor issues can include use of collateral, adequate protection, relief from stay, and treatment under a Chapter 11 plan.

For an operating business, the key question is whether essential equipment, inventory, or receivables can remain available on workable terms.

Tax treatment depends on the tax type, filing history, priority, liens, and taxpayer. Federal trust-fund taxes require separate attention because responsible individuals can face liability apart from the company.

A company bankruptcy therefore may not resolve tax exposure asserted against an owner, officer, or other responsible person.

11 U.S.C. § 365 governs assumption and rejection of executory contracts and unexpired leases. A debtor seeking to assume a defaulted lease generally must satisfy applicable cure and future-performance requirements.

A nonresidential lease already terminated under applicable nonbankruptcy law before filing generally cannot be assumed. Lease status can therefore affect filing strategy.

Foreclosure, repossession, lease termination, litigation judgments, or secured-debt enforcement may change the rights that exist when bankruptcy begins.

A business should identify pending creditor actions before assuming a later filing will reverse completed events.

Transfers to owners, affiliates, relatives, or selected creditors can receive scrutiny under bankruptcy avoidance rules.

Useful records include:

• Recent financial statements and cash-flow projections;
• Bank and payroll records;
• Secured loan and guarantee documents;
• Lease and default notices;
• Tax notices and returns;
• UCC records and collateral schedules; and
• Insider payments or recent asset transfers.

These records help identify assets, creditor rights, owner exposure, and whether continued operations are realistic. A related corporate insolvency review may also be relevant before filing.