When Should A Business File For A Chapter 7 Bankruptcy?

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In order to understand the answer to this question, it helps to make a distinction between a personal Chapter 7 and a business Chapter 7. The big picture goal in a personal Chapter 7 is to discharge debts. In a personal bankruptcy under Chapter 7, there really isn’t much liquidation that happens. Occasionally, a trustee might seize a home, but for the most part, there isn’t a lot of liquidation.

In contrast, a business that files for Chapter 7 bankruptcy never gets a discharge because the Bankruptcy Code is clear that only individuals or married couples can discharge debts in Chapter 7.

Why would a business file Chapter 7 bankruptcy? Suppose the business has more debt than it can service, and it has assets that could be liquidated to pay the creditors something. If the owners agree that the business cannot be saved, they have a choice of three options:

• They can liquidate the business’s assets themselves, and use the proceeds to pay creditors. This may involve a lot of uncompensated effort;
• They can file a Chapter 11 bankruptcy for the business, and propose a liquidating plan, under which they liquidate the business’s assets and use the proceeds to pay creditors. As with the first option, this may involve a lot of uncompensated effort — and will include the cost of the Chapter 11 bankruptcy; or
• They can file a Chapter 7 bankruptcy for the business.

In option (3), after filing the petition the owners turn the business over to the Chapter 7 Trustee appointed by the Court to the case. The Trustee then liquidates the assets and pays the creditors. Thus, the business owners wash their hands of the liquidation process.

Of course, if the business has no assets, then there is no reason to file the Chapter 7 because there is nothing for the Chapter 7 Trustee to do. As a consequence, most courts frown on the idea of a business doing a Chapter 7 when there are no assets to be liquidated because it wastes the Court’s resources. In fact, a few years ago, here in the Central District of California one of the bankruptcy judges fined an attorney $30,000 for filing a business Chapter 7 when the business had no assets to be liquidated.

Can Any Type Of Business File A Chapter 7 Business Bankruptcy?

The only types of business that cannot file a Chapter 7 bankruptcy are: railroads, insurance companies, and banks. See 11 U.S.C. § 109(b) for details. If one of those businesses wants to do a liquidating bankruptcy, it can do so by filing a Chapter 11 bankruptcy, and propounding a liquidating plan.

Other than the section 109(b) exclusions, any business entity can file for Chapter 7 protection provided it has assets to liquidate.

What Debts Can A Small Business Discharge In A Chapter 7 Bankruptcy?

A small business, a big business, a mid-sized business cannot get a discharge under Chapter 7. This is because 11 U.S.C. § 727(a)(1) — section 727 is the section dealing with a Chapter 7 discharge — states, “The court shall grant the debtor a discharge [under this chapter] unless the debtor is not an individual.” Businesses are not individuals. Therefore, there are no debts that a business can discharge in a Chapter 7 bankruptcy.

Of course, if a small business wishes to deal with its debts in bankruptcy and still continue its operations, it can file under Chapter 11.

For more information on Chapter 7 Business Bankruptcy In California, a Free 20 Minute Phone Strategy Session is your best next step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.