The Covid-19 pandemic has had an unprecedented effect on small businesses. With millions of small businesses at risk of closing forever and millions more facing financial devastation, a small business bankruptcy may offer a viable recovery solution. What does bankruptcy mean for your small business, and is it the best option?

New CARES Act Bankruptcy Relief for Small Businesses

In March of 2020, the CARES Act was passed to mitigate the financial strain and fallout of what was then a relatively “young” Covid-19 Pandemic. One thing included in the CARES act was the expansion and amendment of the Small Business Reorganization Act (SBRA), which had gone into effect earlier in the year.

The CARES Act raised the debt threshold of the SBRA to $7.5 million. This has enabled more small businesses and sole proprietors to qualify for financial reorganization. The SBRA makes it easier and faster for small businesses to reorganize under the Chapter 11 Bankruptcy code.

This option provides relief for any operation or individual who defines themselves as a small business, has debt that falls below the $7.5 million thresholds outlined in the CARES Act, and for whom at least 50% of that debt can be attributed to business or commercial activities.

Additionally, the CARES Act excluded any pandemic-related payments from the federal government from the definition of income for businesses looking to file either Chapter 7 or Chapter 13 bankruptcy. Debtors who are currently in the process of Chapter 13 bankruptcy may seek modification due to financial hardship directly or indirectly related to the pandemic. These are essential lifelines for struggling small businesses.

When Small Businesses Should File Bankruptcy

Millions of small businesses are currently experiencing financial hardship. They’re balancing on the line between putting everything they have into keeping their businesses open and hoping for the best, and wondering if it’s in their best interest to close up shop. This is a decision no small business owner wants to make.

Not unsurprisingly, commercial bankruptcies are up from this time last year. Given the unpredictableness of economic factors, many small businesses wonder if it’s time to add their name to the list. There is no easy answer to this question but there are a few things to consider.

First, filing bankruptcy doesn’t necessarily equate to the death of a small business. Chapter 11 and Chapter 7 bankruptcy offer two completely different solutions for financial relief. Businesses that are finding themselves drowning but hesitant to discuss bankruptcy with their attorney are suffering unnecessarily.

As a small business owner, there are two main questions you should be asking yourself. The first is whether you can see your business as sustainable once our current financial crisis passes. If you’re given the chance to recover, could your business be thriving a year from now?

The second question is whether you’re able to pay off your existing debts. Bankruptcy provides relief, but it isn’t a solution without consequences, and it isn’t an option that’s suitable for every small business.

Chapter 11 or Chapter 7 for Business

Just like personal bankruptcy, small businesses have two options for relieving themselves of business-related debt. Small businesses may file either Chapter 11 or Chapter 7 bankruptcy, each providing a different type of relief and pathway to the future.

Chapter 7 bankruptcy is reserved for businesses that are past the point of reorganization being an option. Chapter 7 bankruptcy can completely wipe the slate clean of business-related debt but also require the liquidation of any business assets you may have.

With Chapter 7 bankruptcy, all business assets are sold to repay debt, Once this has been accomplished, any remaining debt is forgiven. Unlike personal bankruptcy, businesses are not allowed exemptions for assets. Secured creditors take precedence over non-secured creditors when it comes to deciding who gets paid and who doesn’t.

If a small business owner is personally responsible for a business debt, for example, signing their name to a business loan, they will also have to file personal bankruptcy to have any personal debts forgiven. There are exceptions to this in the case of a sole proprietorship. Due to the complete liquidation of assets, it isn’t feasible for a business to remain open after filing Chapter 7.

Chapter 11 bankruptcy is a different case. Chapter 11 bankruptcy is a reorganization that offers a fresh start to financially stressed small businesses. Chapter 11 is helpful for businesses with debt to creditors who are unwilling to negotiate. Rather than eliminating debt, it is restructured into a feasible repayment plan based on projected future earnings.

Businesses that are struggling now but feel that with a little help can regain their footing can benefit from filing Chapter 11 bankruptcy.

Personal Liability for Business Debt

Small businesses and sole proprietors face challenges when it comes to securing loans or credit for the business. Learners are hesitant to extend their services, knowing that there is an absence of liability. Because of this, small business owners often find themselves in the scenario needing to sign a personal guarantee to secure loans for their business.

Small business owners may also blend their business and personal finances by offering their personal property as collateral for a business loan or signing onto a debt using their name, rather than signing as an officer of their business. Each of these scenarios, as well as using personal credit or loans to fund their business, leave a small business owner vulnerable to personal liability issues.

Personal liability is not included in commercial bankruptcy. This means that even if all business debt has been discharged or reorganized, a business owner is still personally responsible for the debt they have personally signed for in any form. It becomes necessary to file both small business and personal bankruptcy before completely recovering financially.

Benefits of Small Business Bankruptcy

Bankruptcy can feel like an intimidating process, but it’s one that offers several benefits for struggling small businesses, including:

• Elimination of unsecured debts
• Consolidation of debt with inflexible creditors
• Reorganization of financials and assets to pay off debt and run the business more efficiently
• An eventual return to profitability
• An improvement in future operating standards
• Building a more strategic approach for funding their business, rather than immediately turning to loans and debt
• The feeling of a fresh start and the chance to rebuild their dream

Credit After a Business Bankruptcy

The question of whether a business bankruptcy will affect personal credit is a common one. Unfortunately, for small businesses, personal and business finances are often intermingled, and individual credit can be affected.

The degree to which personal credit is affected depends on how much small business debt the owner or partner is personally liable. In the case of a sole proprietorship, the law considers both the owner and the business a singular entity, so yes, personal credit can be affected by filing for business bankruptcy.

For small businesses that aren’t sole proprietorships, the chance of personal credit damage depends on the degree of personal liability assumed, combined with what is owed for certain types of business taxes.

While small business owners may be hesitant to file bankruptcy for fear of damaging their personal credit history, it’s important to keep things in perspective. Small business owners’ personal credit will also take a hit if the debt remains unpaid, and creditors seek action. Bankruptcy does eventually fall off your credit report, and the path to rebuilding credit is shorter than many people realize.

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