The Essentials Of Chapter 7 Bankruptcy

This article was originally published in Forbes. For the original article click here

Right off the bat, let’s dispense with bankruptcy’s stigma. While the notion of erasing valid debts and starting fresh doesn’t sit well with everyone, it’s a concept as old as Moses. More than that, bankruptcy is an essential tool for a market system that encourages taking risks such as starting a business.

And lending to one.

Lenders take risks just like business owners, and they share in a business’s success in the form of interest payments. It’s only fair that a severe business loss is shared, too, and bankruptcy is what gives the system that balance

When you or your business can no longer afford to pay your creditors, bankruptcy is an equitable option that spreads the loss out among everyone who stood to gain from the venture.

As you can imagine, this relatively simple concept quickly gets complicated when it’s put into action. The different types of bankruptcy complicate things even further. Bankruptcy can take the form of a “restructuring,” in which the court changes credit terms and a trustee is appointed to make sure the new terms are abided by. This process typically takes three to five years.

Bankruptcy can also mean a liquidation: assets are sold off, and creditors are paid with the proceeds. This process is much faster and simpler. The only downside is that it doesn’t allow the bankrupt entity to continue operating as before — though sometimes, that might not be a downside at all

Knowing when to fold ’em is an important part of running a business. If it’s time to wind up your venture but you don’t have enough to get the creditors off your back, be sure you’re making informed decisions in regards to potential bankruptcy.

Chapter 7 For Individuals And Businesses

In the U.S., liquidation bankruptcies are generally governed by Chapter 7 of the Bankruptcy Code and are thus usually called Chapter 7 bankruptcies. Both individuals and businesses can file for Chapter 7 bankruptcy. Married couples may file jointly, or one spouse can file for bankruptcy without the other

If you operate your business as a sole proprietorship, there’s no separation between your personal and your business assets, so a Chapter 7 bankruptcy will include everything. As with all personal bankruptcies, certain assets — including your primary residence and retirement accounts — are protected, meaning they won’t be liquidated to satisfy your creditors.

If your business is set up as its own legal entity (such as a partnership or corporation), then you can use Chapter 7 to declare business bankruptcy, personal bankruptcy or both. Ideally, you sat down with your accountant and lawyer when you first organized your business, taking the potential for bankruptcy into account. Now would be the time to get in touch with them again and see what steps to take before filing.

If you strike out on your own without a financial or legal advisor, you should unquestionably consult with an accountant and an experienced bankruptcy attorney before moving any assets in or out of your business.

Whether you choose to file for Chapter 7 as an individual or business, you might be able to protect more of your assets and emerge from your bankruptcy in a better position. But there are specific approved ways of shifting things around, and moving assets in any other way could only attract extra scrutiny — and potentially penalties — from the U.S. Bankruptcy Court.

The Basics Of The Chapter 7 Process

A Chapter 7 bankruptcy begins when you (or your bankruptcy lawyer) files a petition with the Bankruptcy Court. When creditors are notified of the petition, they must cease collection efforts, and you are effectively relieved from the obligation to make payments on those debts until the liquidation process.

The Bankruptcy Court will appoint a trustee, just as in a non-liquidation bankruptcy. In a Chapter 7 proceeding, however, the process doesn’t take years. Instead, the trustee meets with creditors to review the assets involved in the bankruptcy and determine how to dispose of assets and how much each creditor will get from the proceeds.

Your only role in the process is to cooperate with the trustee, providing accurate information about any income and assets you hold in your personal capacity (if filing for personal bankruptcy) or that are held by your business (if filing for a business bankruptcy).

After the assets have been liquidated, debts will be discharged, and creditors will no longer have any legal claim to any of your assets or income. However, if you reaffirm the debt by making a payment — or simply by agreeing that you still owe on the debt — you could become legally obligated to resume your pre-bankruptcy payments.

Chapter 7 can be used to discharge most but not all types of debt, so again, make sure you speak to an experienced professional before you decide to file. They can help you understand what your financial situation will look like on the other side.

I won’t lie and say bankruptcy is entirely painless. You’ve invested more than money in your business — you gave it plenty of time, energy and emotion, too. That’s equally true of any personal financial assets you hold. But bankruptcy can be far better than the alternative: years of struggling under debts that only seem to grow for a venture you’re ready to leave behind.

Chapter 7 lets you wrap things up relatively quickly, and start … well, a new chapter. When things aren’t going well, it’s an option well worth looking into.

The information provided here is not legal or financial advice. You should consult with a licensed professional for advice concerning your specific situation.