There are three basic times of bankruptcy businesses can file.  Sole proprietorships exist as legal extensions of their owners.  Thus, the owner is responsible for all assets and liabilities of the company.  These types of companies are eligible to file for Chapter 7, Chapter 11, or Chapter 13 bankruptcy protection.  Corporations and partnerships, on the other hand, exist as separate legal entities and their owners are not personally liable for company assets and liabilities.  These types of companies can file for either Chapter 7 or Chapter 11 bankruptcy.

Chapter 7 bankruptcy is typically the best choice in situations where you know the business just isn’t going to make it out of bankruptcy intact.  Usually referred to as liquidation, most companies only use this form of bankruptcy when the business debts are just so overwhelming that there is no feasible way to restructure the finances.  Chapter 7 is also a good idea in cases where the business lacks any substantial assets.  For instance, if the company is really just an extension of the owner’s skills or services, it usually isn’t worth it to reorganize so Chapter 7 just makes the most sense.

How does Chapter 7 bankruptcy protection work?  Simply enough.  The court appoints a trustee to oversee the distribution of the assets among the creditors.  Typically this involves selling off eligible assets and then paying as much as possible to the creditors.  However the trustee distributes the business assets, once they’re all divvied up and the trustee is paid, the business receives a “discharge” and the bankruptcy proceedings come to an end.  At that point, the business owner is releases from all obligations relating to those debts.  Partnerships and corporations, however, do not receive a discharge.

Chapter 11 is more appropriate for businesses that just need some breathing room to get things back on financial track.  Under Chapter 11 bankruptcy, the company is reorganized under a court-appointed trustee and remains in operation throughout.  The business files a reorganization plan detailing how it plans to handle its debts.  Creditors get the opportunity to vote on the plan.  Should the court find that the plan is fair and equitable, the plan will be approved.  Reorganization plans provide for payments to be made to creditors over a period of time which may exceed twenty years.  This type of bankruptcy protection is fairly complex and not always successful.

Chapter 13 bankruptcy is also a form of reorganization bankruptcy, although it is usually reserved for consumers.  Sole proprietorships can also take advantage of this type of protection.  You file a repayment plan with the bankruptcy court setting out how you plan to repay your debts.  The amount you’ll be required to repay depends upon how much you earn, the amount of your liabilities, as well as the value of your assets.  In situations where your personal assets are involved with your business assets–such as with sole proprietorships–you may be better able to avoid losing your home if you file Chapter 13 bankruptcy rather than Chapter 7.

The first step to take if you think you may need to file for small business bankruptcy is to find a good, reputable bankruptcy attorney with a proven track record to consult with.  Many of them offer free consultations and can advise you on whether it’s a worthwhile course for you to pursue.