Business Bankruptcy Defined
It’s an unfortunate fact of business that companies sometimes run into serious financial trouble. When a company in the United States no longer has sufficient cash flow or credit to pay its debts or operate its business, it can seek legal protection from creditors by choosing to file for bankruptcy under the US Bankruptcy Code. There are several types of business bankruptcies, but the general idea is to give a distressed business – or the owner of a failed business – a financial “fresh start” in exchange for some adjudicated level of orderly debt repayment.
Why Business Bankruptcy Matters
When a major corporation goes belly up, it makes the news, and the signs of financial distress have usually been apparent for a while. But in other cases, a company’s troubles aren’t obvious until the bankruptcy notices go out, leaving its creditors to wonder if, when, and how much of their money will be repaid.
By watching for signs of declining financial health in the businesses a firm may partner with, vigilant credit and collections professionals may be able to help identify businesses within their portfolio that may be on the verge of bankruptcy, indicating a need to stop shipping products and services and turn to collecting outstanding invoices. A credit risk management software solution, such as D&B Credit, can help you manage and monitor customers’ business credit accounts and provides email alerts about changes to companies’ legal events, including bankruptcy filings.
“Understanding how bankruptcy trends ebb and flow in accordance with the wider economy – as well as the specific implications of distinct bankruptcy types for debtors – can enable government, private enterprise, and individuals to better prepare for and insulate themselves against potential financial shocks in the case of a downturn or slowing economy,” says Cyndi Festa, Leader, Global Registry and Ownership at Dun & Bradstreet.
Bankruptcy Statistics by Industry
Certain industries have higher bankruptcy rates, which can be attributed to many economic factors that can influence credit risk. Dun & Bradstreet collects data from all 275 bankruptcy courts across the US in order to provide useful insights to our customers. Understanding bankruptcy trends can help a credit professional make more informed decisions about the amount and type of credit to extend. The chart below shows business bankruptcy statistics by SIC code in the US from 2014–2018.
|2-DIGIT SIC Code||Total Bankruptcies by Industry||Percent of Bankruptcies by Industry|
|50-51 Wholesale Trade||3,837||3.12%|
|52-59 Retail Trade||15,688||12.76%|
|91-97 Public Admin||48||0.04%|
Bankruptcy Filing Statistics by Year and Chapter
Business Bankruptcy Definitions
There are many different types of business bankruptcies in the US, and it’s important to understand the differences between them to help you determine the likelihood of recouping the loss or the potential impact to your business if it goes bankrupt. You should always consult with an attorney to understand more about bankruptcy and what filing bankruptcy can mean for you and your business.
Chapter 7 – Liquidation
Chapter 7 bankruptcy is the most common type of filing in the US. If you’re a sole proprietor, Chapter 7 bankruptcy allows you to wipe out all of your dischargeable debt – business and personal – in exchange for turning over all nonexempt assets – business and personal – to an appointed bankruptcy trustee for liquidation. The trustee sells off those assets and divides the proceeds among the creditors. Also, once the petition is filed, some creditors are at least temporarily stopped from collection actions (including wage garnishment). Some debt, such as certain tax obligations and alimony, is non-dischargeable – which means you’re still on the hook for it. Chapter 7’s big benefit for a sole proprietor is that it gets rid of all your dischargeable debt and protects your exempt assets (exemptions vary by state). But there are a number of downsides: You may lose property, and your personal credit score and ability to get a mortgage or a car loan may be negatively affected for many years.
For a corporation or an LLC, Chapter 7 shutters the company and any employees get dismissed. Your business gets fully liquidated, with the court-appointed trustee selling off all the saleable assets to pay back creditors to the extent possible. Unlike the situation in the sole-proprietor case, however, the business’s remaining debts after liquidation are not dischargeable. And these undischarged debts can become relevant in cases where you are held personally liable for business debts (such as if certain taxes remain unpaid or you at some point signed a personal guarantee to cover your business debt). Consequently, it is not always advisable to wind down a corporation or LLC under Chapter 7 – always discuss these matters with your bankruptcy attorney.
Chapter 9 – Reorganization (for Municipalities)
Chapter 9 is specifically designed to protect a financially distressed municipality from creditors’ collection efforts while it negotiates a debt restructuring. “Municipality” includes counties, taxing districts, hospital taxing authorities, municipal utilities, and school districts. Chapter 9 does not involve asset liquidation, and it allows for extending the repayment timeline, the refinance of debt through new loans, or the reduction of principal or interest on existing loans.
The four requirements for filing Chapter 9 are as follows:
- A debtor must be authorized to file for Chapter 9 under state law.
- A debtor must be insolvent.
- A debtor must have a desire to adjust its debts.
- A debtor must attempt to obtain agreement of the majority of certain types of creditors (or show they can’t in good faith do that).
Chapter 11 – Reorganization (for Larger Debt Filings)
Chapter 11 is designed to allow a troubled business to restructure its debt such that creditors are repaid over time and the business remains a going concern. (Sole proprietors may be better off filing under Chapter 13, if their debts fit under the allowable limits. See below.) Once the petition is filed, the business becomes a “debtor-in-possession,” meaning it retains property and continues as a going concern. Also, a temporary stay usually stops collection attempts and provides relief for the debtor while it negotiates the repayment plan with its creditors. All creditors generally need to agree to the plan, and it must be approved by the bankruptcy judge.
A debtor-in-possession generally acts as its own case trustee and carries many of a trustee’s rights and responsibilities. The debtor-in-possession can file lawsuits to avoid transfers of money to creditors, obtain loans for the debtor, and accept or reject contracts. Any creditor or the court, on its own, may seek the appointment of a case trustee to replace the debtor-in-possession if they believe it’s in the best interests of the bankruptcy estate and creditors (e.g., if the debtor-in-possession is mismanaging its assets).
A Chapter 11 bankruptcy can be very expensive, depending on how complex the reorganization needs to be, your attorney’s fees, how many creditors file disputes, and how long the case lasts.
Chapter 12 – Reorganization (Predominately for Farmers and Fishermen)
Chapter 12 bankruptcy is only available to family farmers or family fishermen. Designed as a response to difficulties suffered by farmers and fishermen in the 1980s, it is similar to Chapter 13 but provides more flexibility in making periodic payments to accommodate the seasonal nature of many farming and fishing operations. The farmer or fisherman proposes a repayment plan that lasts three or five years. Chapter 12 is less expensive and less complex than other chapters.
Chapter 13 – Reorganization (for Individuals)
Chapter 13 is designed to help individual debtors with regular income restructure (and repay) their debts while still keeping property such as their house. It’s not a forced liquidation like Chapter 7. But to qualify, their debts must fit inside certain limits (currently, unsecured debts less than $394,725 and secured debts less than $1,184,200). If you’re a sole proprietor, your personal and business finances are considered the same for tax purposes, so you can file under Chapter 13 as long as you (or your spouse) has income and your debts are under the prescribed limits.
The debtor is protected from most collection actions and typically repays creditors according to a three- or five-year repayment plan that has been approved by the creditors and the court. You usually pay a single monthly payment to the bankruptcy trustee, who divides payments among creditors and sends out the necessary payments. At the end of the plan, most remaining unsecured debt is discharged.
Chapter 15 – Cross-Border Insolvency
When a foreign debtor files bankruptcy in another country, Chapter 15 gives the foreign debtor a way to gain access to the US. Bankruptcy Court for the purpose of administering assets or taking action for the debtor in the US. A Chapter 15 proceeding is usually to secondary the main proceeding, which typically takes place in the foreigner’s home country. The US Bankruptcy Court in these cases is generally limited in scope and power to affect only the assets of the foreign entity or persons that are within the US; many actions are therefore deferred to the foreign court. A foreign company may choose to file a case under Chapter 7 or Chapter 11 of the U.S. Bankruptcy Code if its assets or relationships in the US are sufficiently complex.
Chapter 7 vs. Chapters 11 or 13: Which One Is Right for Me?
Bankruptcy can have long-lasting consequences for you and your business, and it is advisable to consult a bankruptcy attorney before taking action. Each chapter has different implications for your business and your credit.
If your business is failing and better terms from your creditors won’t really help turn things around, then Chapter 7 liquidation allows you to wipe the slate clean: no more business, sadly, but also no more creditors and no more burdensome debt. If your business is a sole proprietorship, your personal credit rating will be negatively affected for a long time, but you’ll probably be able to protect some of your assets.
On the other hand, if better terms from your creditors would give you a fighting chance to save your company and keep it operating, a Chapter 11 or 13 bankruptcy may be worth trying. Both chapters allow your business to continue operating while you pay off your newly restructured debts according to a court- and creditor-approved (and, ideally, less burdensome) repayment plan. Broadly speaking, incorporated businesses file under Chapter 11 and sole proprietorships usually file under Chapter 13.
What Can Happen to Your Credit When Your Business Files for Bankruptcy
Filing for bankruptcy is a big decision, and it is generally recommended – if not required – that an attorney be consulted before filing. You should fully understand what it can mean for your business. For a sole proprietor, a bankruptcy can also affect your personal credit. For an LLC or corporation, the bankruptcy can linger on the business’s credit report for many years and can reduce its ability to acquire funding at a reasonable cost. Furthermore, if you have signed a personal guarantee for any of the business’s debts, your personal assets may be used to pay back those debts and your personal credit can be affected by any unpaid remainder.
A business’s Dun & Bradstreet credit report displays how many times a company has filed for bankruptcy and the date of last filing. A bankruptcy can severely impact the company’s scores and ratings. The report’s Legal Events section features full details of a company’s bankruptcy filing, which can include whether the filing was voluntary, the name of the judge presiding over the case, the chapter of bankruptcy filed under, and the status of the filing. In the case of a Chapter 7 bankruptcy, the company’s business credit report will be labeled Out of Business, as the company will no longer exist. However, if a company files for Chapter 11 and successfully emerges from bankruptcy, the filing will remain on a D&B business credit profile for 25 years.
How Dun & Bradstreet Can Help
Business credit professionals need to keep an eye on their customer accounts and can use monitoring tools like those found in Dun & Bradstreet’s Finance Solutions to help understand the financial health of their customers.
The habits that you develop to raise your own business credit score or get your business credit back on track, such as making on-time payments and monitoring your financials closely, can also help keep you in good financial shape. If you find your debt burden again becoming a problem, you can consider:
- Settling or negotiating debts
- Selling property or assets you don’t need
- Minimizing non-essential expenditures
- Prioritizing debt repayments
- Facing bad habits or troubling circumstances head-on, seeking outside counsel if necessary