Bankruptcy for Small Business

Bankruptcy is defined in our text as “when a business is unable to pay its debts as they come due.” (Daft 778) Small business owners never start their businesses with the intention of failing, however statistics show that in all likelihood they will not be successful. This fact reveals the importance of understanding bankruptcy even before a new business is formed. Small business owners who understand the bankruptcy law are better equipped when their business does not succeed, allowing them to minimize lose both professionally and privately.

Prior to the Bankruptcy Reform Act of 1978, debtors had few rights; their debt often resulted in imprisonment or involuntary servitude. When Congress passed the bill in 1978, debtors where awarded many rights including the right to petition for bankruptcy under federal law. This revised law has a two-fold purpose, first to protect debtors who have over extended themselves and secondly, to distribute the debtors assets evenly to the creditors. The Bankruptcy Act of 1978 allows failed business owners to cut their loses and continue in new pursuits, making a file for bankruptcy a strategic business decision. Small businesses normally file under three chapters including chapters 7, 11, and 13. Chapter 7 deals with liquidations, Chapter 11 allows for reorganization, and Chapter 13 provides the debtor with individual repayment plans.

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Chapter 7 is also known as straight or ordinary bankruptcy, and accounts for the majority of all filings, seventy percent. The process starts with the debtor voluntarily filing Chapter 7 and then declaring all debts, or creditors forcing an involuntary petition. All of the debtor’s assets are then transferred to a trustee who sells the assets and distributes their proceeds to creditors, hence the term liquidation bankruptcy. All debts totaling more than the money given is then counted as losses by the creditor no longer considered the debtor’s responsibility. Secured creditors are compensated first, followed by rectifying debt owed to unsecured creditors. If an involuntary petition is to be filed, the creditors must first present it to the court. The next step in the process is to determine the number of creditors. If the number of owed creditors totals 12 or over then three with unsecured debt totaling $10,000 must file the petition, however if there are less than twelve then only one with a $10,000 is required to file. Once the petition has been filed then all creditors must allow an automatic stay, claims against the debtor are suspended.

Under Chapter 7, not all property is liquidated. State law sets many of the allowances, but “Federal law allows a $15,000 exemption for ownership of a home, $4,000 exemption for household items and clothing, and a $400 exemption for other property.” (Daft 779)

Transfer of property to other individuals to avoid seizure is not allowed by the courts.

The type of bankruptcy most filed is Chapter 11, providing for reorganization.

Small businesses are extremely susceptible to weakening under economic downturns or due mistakes made by management. Often with a relief from debt they are able to regain their feet and prosper; this is the instance in which Chapter 11 bankruptcy is utilized. The result of filing under Chapter 11 is a plan formulated by both creditors and debtor to repay portions of the balances and discharging the remainder. During this period of repayment the company continues to operate under the observation of the court. Many of the same principals used in Chapter 7 bankruptcy are also incorporated in Chapter 11; involuntary or voluntary filings are possible, the order for relief follows the same principals, and the debtor is granted an automatic-stay. Sometimes such arrangements are made with court action; “creditors may prefer private, negotiated adjustments of creditor-debtor relations, also known as workouts, to bankruptcy proceedings.” (Cross 617) The benefits to the debtor company are numerous; employees are able to keep their jobs, the company can still operate, and goods and services are delivered without interruption. Despite these opportunities to continue businesses, statistics show that many companies that file for Chapter11 will eventually file under Chapter 9 and liquidate their business. The blemishes from a Chapter 11 are hard to overcome because internal and external feelings of lost confidence are incurred. Chapter 11 still provides an important last opportunity for businesses to succeed. The Hyatt Hotel Corporation is an example of numerous successful Chapter 11 bankruptcies.

The final option for filing bankruptcy is Chapter 13. This is most commonly used in the case of a sole proprietorship, because only an individual can file it. The debtor may only file this form of bankruptcy on a voluntary basis. Once a Chapter 13 petition has been filed it negates all collection attempts by creditors. The stipulations of the filing include; the unsecured debt must not total more than $250,000 or the secured debt cannot be greater than $750,000. Chapter 13 then requires the debtor to formulate a plan, considering his annual income, which repays some or all he owes within a five-year time span. Once approved by the court, the debtor pays the installments until completion, at which time the remainder is discharged.

The ability to declare bankruptcy and effectively discharge part of debts owed to creditors has many ethical implications. Many companies incur debt that they cannot cover however, by declaring bankruptcy he damage the businesses of their creditor. Examination of the bible reveals that the emphasis of the New Testament is on forgiving those who owe us but are unable to pay, stating: “Forgive us our debts, as we also have forgiven our debtors.” (‘Mt 6:12) The Old Testament also preaches the eventual discharge of debt, stating: “At the end of seven years you must cancel debts.” (Dt 15:1) The law allows for the granting of mercy to debtors, but god commands that we forgive those who are not able to repay their liabilities. The bible also contains a passage that explains the proper action for the debtor, “Let no debt remain outstanding, accept the continuing debt to love another…” (Ro 13:8) Subsequently the moral dilemma is solved, God wants us to make all efforts to rectify our financial obligations. Business decisions should be made to insure that the company does not over extend themselves, and if encouraged debt should be paid. Filing for bankruptcy should not be utilized as the easy way out of financial troubles; we are called to continue in our ventures, using bankruptcy only as a last result.

Work Cited

Scarborough, Norman, and Thomas Zimmerman. Effective Small Business Management.
New Jersey: Prentice Hall, 2000.

Cross, Frank, Gaylord Jentz, and Roger Miller. West’s Business Law. St. Paul:
West P C, 1996.

New International Disciples Study Bible. Nashville: Holman Bible Publishers, 1988.

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Bankruptcy for Small Business. (2018, Jul 01). Retrieved from