Small business owners in Orlando frequently consult with me, many of whom are suffering from financial distress as a result of the economic downturn. Their greatest concern is often the effect that filing a bankruptcy will have on their company. Here is what the small business owner needs to know.
The effect of a bankruptcy on a small business owner will depend on whether they are filing chapter 7 bankruptcy, or chapter 13 bankruptcy. (Please see other posts and my website regarding the difference between these two solutions). If the owner files chapter 7, they are in bankruptcy, but their business in not (assuming they have incorporated, or set up a limited liability company.) The company is an entity separate from the individual who is seeking the debt relief.
However, when a small business owner files chapter 7, their stock or shares of their company are an asset that may be taken by the trustee and sold for the benefit of creditors. The trustee, who represents the creditors, will be interested if the company has hard assets that can easily be liquidated. What kind of business is it? Is it asset based (such as manufacturing, retail, equipment intensive), or is it primarily a service business (sales, professional, home based). If the company owns substantial assets that have liquidation value, the trustee will probably demand that the shares/stock of the company be surrendered for the benefit of creditors.
The trustee will then own the company and she will have the legal right to sell its assets. In most cases however, a service based business will have little value to the trustee, even if it has the potential to generate significant income to the owner. Put another way, if the trustee becomes the owner of the company, it will have little value to the creditors, because usually only the original owner can provide the service.
The trustee’s decision to demand surrender of the shares of a small business will also depend on whether the company is owned by more than one person. The trustee may be reluctant to become a business partner with other owners. Obviously, this depends on many factors, but essentially the trustee needs to determine whether there are any benefits to the creditors if she acquires the shares of the company from the owner.
In a chapter 13 bankruptcy, no property is surrendered. So the small business owner in a chapter 13 will remain in possession of their company, but the income that is generated from the company will be the subject of scrutiny by the trustee during the life of the Chapter 13 payment plan. This is the subject of another blog post.