Small Business Bankruptcy: How Does Your State Handle Debt Relief?

In 2020, COVID-19 left millions of small business owners feeling financially unstable and uncertain of their futures. As we begin to heal from last year’s crisis, the debt accrued by individuals and businesses is beginning to threaten their success. In some cases, this debt could prove unmanageable for struggling small businesses and filing for bankruptcy could be the best possible solution.

Managing your debt can make running a small business go from a passion project to a major financial impairment. With a little help, you can understand the ins and outs of bankruptcy in your state and determine if this solution is right for you.

What is bankruptcy?

Bankruptcy is a legal process that helps individuals or businesses eliminate all or a portion of their accumulated debt. If you are unable to pay back your debt in the original time frame, certain types of bankruptcy could allow you to rework your repayment plan to resolve debt more quickly. Individuals qualify for two main types of bankruptcy, while small business owners have slightly different options.

What type of bankruptcy would you qualify for?

The U.S. Bankruptcy Code outlines different types of bankruptcy in chapters, describing who is eligible for each plan based on certain circumstances and goals. For instance, the two most common types of bankruptcy for individuals are Chapters 7 and 13. Chapter 7 allows you to wipe out unsecured debts like medical bills, credit card balances, and personal loans in months. Chapter 13 helps you handle secured debt, like a mortgage or car loans, without having to surrender those assets. You may also qualify for Chapter 13 bankruptcy if you make too much money for Chapter 7.

For a small business owner, there are even more factors to consider. Here are a few of the primary options and their qualifying circumstances:

  • Chapter 11. This type allows small businesses with adequate cash flow to stay open and make lower monthly payments to resolve their debt.
  • Chapter 13. If you are your business’s sole proprietor, you may be able to keep your business open by filing for Chapter 13.
  • Chapter 7. Businesses that are no longer profitable can file for Chapter 7 bankruptcy to liquidate or close.

Does bankruptcy vary by state?

While many states have their own statutes that amend federal law, the bankruptcy process is pretty much entirely covered by the federal Bankruptcy Code. However, many states have their own property exemptions with rules that differ from the federal options.

Some states, like Kentucky, allow you to choose between the state property exemptions and those provided through federal law. Other states, like Ohio, allow married couples to double up on exemptions.

Federal exemptions aren’t even available in some states, like Montana, Mississippi, and Tennessee. State and federal property exemptions are dependent on the type of bankruptcy that you use, making the benefits for small businesses even more complicated.

How should you get started?

Considering the complexity of this process, it is essential that you seek out a lawyer if you choose to file for bankruptcy. Your lawyer will help you assess your financial situation, determine the best plan, consider state and federal guidelines, and make sense of the exemption options available to you.

Having a professional to lead you through this process will ensure not only that you file your case correctly, but also that you fully understand the weight of your decision. While it is a great solution for debt relief in necessary cases, bankruptcy is a serious process with a long-term impact on your credit and finances. Your lawyer can help you properly manage your case to prevent future issues and even suggest alternative debt management solutions if it turns out that this process isn’t right for you.

If you are considering bankruptcy as a debt management option, get informed about your own state’s practices and legislation. Take advantage of available resources for advising and representation and keep your own best interest in mind.