Business Bankruptcy Often Not the Best Solution for a Failing Firm
Many business owners ask me to take their failing business through bankruptcy when firm income no longer covers debt/expenses. I listen as they detail what contributed to declining profits and rising debt – slackening customer demand, levies from tax agencies, loss of key clients, rising supply costs, onerous legal judgment, skyrocketing rent. Then I tell most of them: “the last thing you need is a business bankruptcy.”
That because a business bankruptcy is expensive and invasive. And it’s often unnecessary because the owner’s objectives – particularly to avoid being personally hounded for the firm’s debt and to wind down the business – can be achieved more quickly and simply than in bankruptcy. How? The answer requires knowing what happens in a business chapter 11.
When an owner files bankruptcy for their business, they are legally handing over all the business’ debts and assets to a Bankruptcy Trustee. In a chapter 11, the business owner becomes the trustee – the “debtor-in-possession.” Every decision – whom to hire, what employees to pay – is subject to court approval. The business burns attorney fees the way an F-14 burns jet fuel through its afterburners. Such a business bankruptcy requires the business owner to hire an attorney to defend the owner’s interest, and few chapter 11 bankruptcies cost less than $50,000 and most cost over $100,000. Bottom line? Most business bankruptcies costs money the owner doesn’t have and leave the owner with less control over their business. However, there are alternatives to a business bankruptcy that achieve the same goals, but many bankruptcy attorneys don’t tell business owners about them because it’s not as lucrative for the attorney as filing a business bankruptcy.
Businesses can also file chapter 7, liquidating the operations. Generally, there is little benefit to filing the bankruptcy case, because the business owner can act as a bankruptcy trustee without the formal office.
Alternative to Business Bankruptcy: DIY Liquidation
The main function of all bankruptcy is to give the debtor shelter from creditors attempting to collect. The bankruptcy process determines whether the debtor has assets that can be used to repay creditors, and which creditors are repaid and how much. But if a business is so “failed” that it no longer has enough cashflow or sellable assets to repay creditors, then it doesn’t need bankruptcy to formally signal failure. The business has already failed in reality. What’s left is to liquidate the remaining assets and repay creditors to the extent possible. This approach doesn’t require a formal bankruptcy, or a Bankruptcy Trustee and a debtor’s attorney to oversee the winding down of the firm. Almost every business owner can steer the failed firm to its end themselves, perhaps with a little coaching and help, but certainly without the invasive chapter 11 business bankruptcy process.
Will creditors who get stiffed (as many surely will be) be annoyed? You bet they will be! So what? Let the creditors assert their legal right against the company and come after it with legal judgments for default on its debt. Creditors will take their winning legal judgments (after all, the firm has no defense against creditor lawsuits – it *does* owe the money), which will take at least 6-12 months to obtain, and then levy the business’ bank accounts. Who cares? Especially if there’s no money in the account and no assets to take, which there shouldn’t be if the owner has liquidated and dispersed firm assets within a few months.
Moreover, if the business is incorporated, only the business is on the hook for the debt, not the owner. That means creditors can and will call the owner on delinquent accounts, but that doesn’t mean they can collect from the owner. The company owes the money, not the owner, which means creditors can only go after the company for repayment. Not the owner. That’s one of the main reasons to incorporate: to protect business owners from being personally liable for their firm’s debts! So, when many failed firm owners come to me they don’t even need protection from creditors. They are already protected by the corporate veil, and then the firm is protected by its unprofitability. Let creditor-“vultures” swoop around the firm’s carcass, leaving threatening voicemails about how much is owed, but there’s nothing left to take. Tell them you failed, you’re sorry, you’d love to repay but there’s no money and you’re throwing in the towel. This cycle is the essence of capitalism: you used and borrowed resources for your business, for whatever reason the business failed, the creditors loaning you resources lost the bet they placed on you, and the resources get recycled by system.
Finally, file formal dissolution of the business with the California Secretary of State (or in whatever state the business is incorporated) and send a final set of tax returns for the business to the IRS and state tax authority.
So when IS it a good strategy to file a business bankruptcy? When you expect a lot of scrutiny of how your firm managed its liquidation, which typically occurs when there are a lot of saleable assets (not relevant in personal service firms like attorneys, realtors and contractors) or a lot of money in business accounts or accounts receivable with which to repay creditors. Smaller firms in dire economic straits rarely have either of these issues by the time they fold.
Alternative to Business Bankruptcy: Personal Bankruptcy to Address Personal Guarantees
Many small business owners have personally guaranteed business & SBA loans, LOCs, and business credit cards, which is a problem – and often the only one requiring an attorney to solve. When a business owner has signed a personal guarantee for their business loans or credit cards, that gives the lender the legal right to pierce the corporate veil and come after the owner personally. But this problem can be solved by filing personal bankruptcy for the business owner and is the reason I recommend filing personal bankruptcy more often than business bankruptcy for clients with failing businesses (provided the owner meets the requirements to file chapter 7 bankruptcy and wouldn’t lose assets). Personal bankruptcy is cheaper, faster and less invasive than business bankruptcy. And discharges most or even all of the business debt that was personally guaranteed by the owner.
Alternative to Business Bankruptcy: Create New Corporation
Many clients want to continue being their own boss, even after a business has failed. Does closing a prior business or filing personal bankruptcy prevent them from launching another enterprise? Absolutely not. In such cases, I recommend the owner create a new corporation for their business operations. Sometimes this will involve the sale of some of the former business’ assets to the new business (at documentable market prices), but that’s usually easily done and not a roadblock to starting over again, even in a similar business practice.
After all, the US’s bankruptcy and corporate formation laws are designed to foster entrepreneurship and innovation. We want creative people to take risks and start all sorts of businesses. Which means many will fail – and our public policy gives those entrepreneurs a way to pick themselves up, learn from past mistakes, and try again. After all, many American Presidents –Abraham Lincoln, William McKinley, Donald Trump – have made use of US bankruptcy laws. While no one wants their business to fail, erratic economic conditions, unfavorable public policies, and technological shifts hammer and destroy companies all the time. Thank goodness we live in a country that allows business owners to move on relatively gracefully and try again.
Is your firm struggling with more debt than it can reasonably repay? Give me a call so when can explore the feasible alternatives for you and your company.
July 11, 2025