When a small business is drowning in debt, bankruptcy is not the end -- it is a federal process with specific rules for each business structure. The right chapter depends on whether you want to close or keep operating, how your business is organized, and how much you owe. This guide covers every option.
In This Guide
Small business bankruptcy is not a single process. The Bankruptcy Code (Title 11 of the United States Code) provides multiple chapters, and the right one depends on two threshold questions: how is the business organized, and what is the goal -- winding down or continuing operations?
The three chapters most commonly used by small businesses are Chapter 7 (liquidation), Chapter 11 (reorganization), and Chapter 13 (individual repayment plan). Each serves a different purpose and has different eligibility requirements.
Before diving into each chapter, it helps to understand the landscape. According to federal court data, sole proprietorships make up the vast majority of "business bankruptcies" in the United States. Most of these are filed under Chapter 7 or Chapter 13 because the owner and the business are legally the same person. Separately organized entities -- LLCs, S-corps, C-corps, and partnerships -- account for a smaller share but tend to involve more complex proceedings.
The 2019 Small Business Reorganization Act (SBRA) changed the calculus significantly. Before SBRA, Chapter 11 was effectively out of reach for most small businesses because the process was too expensive and complicated. Subchapter V created a streamlined path that has made reorganization viable for businesses that would have previously been forced into liquidation.
If you operate as a sole proprietor -- no LLC, no corporation, no partnership -- you and your business are legally the same entity. There is no legal separation between your personal assets and your business assets. When you file bankruptcy, it covers everything: your house, your car, your business equipment, your personal credit cards, and your business debts.
This is the simplest structure for bankruptcy purposes, but it comes with a tradeoff. Because there is no separation, personal assets are exposed to business creditors and business assets are exposed to personal creditors. The bankruptcy estate under Section 362 includes all of it.
The means test under Section 707(b) applies to individuals filing Chapter 7 with primarily consumer debts. If your debts are primarily business debts (commercial lease obligations, supplier invoices, business credit lines), the means test does not apply and you can file Chapter 7 regardless of income. This is a significant advantage for sole proprietors whose debts are business-related.
If your business is organized as an LLC, corporation, or partnership, it is a separate legal entity from you. This has two important consequences for bankruptcy:
There is a critical limitation for business entities in Chapter 7: they do not receive a discharge. Under Section 727(a)(1), a discharge is only granted to individual debtors. When an LLC or corporation files Chapter 7, its assets are liquidated, proceeds are distributed to creditors, and the entity simply ceases to exist. Any remaining debts technically survive, but since the entity is dissolved, there is no one to collect from.
This means that for an LLC or corporation, Chapter 7 is purely a closing mechanism -- an orderly wind-down supervised by a court-appointed trustee. There is no fresh start because entities do not get fresh starts. They get dissolved.
If the LLC or corporation has no assets worth liquidating, filing Chapter 7 may not make sense. The filing fee is $338, and if there is nothing to distribute, the practical result is the same as simply closing the business through state dissolution procedures. Many attorneys advise "walking away" from a no-asset LLC rather than spending money on a Chapter 7 filing. However, a formal Chapter 7 can be useful if you want a trustee to handle creditor claims and potential litigation in an orderly process.
Limited liability is only as strong as how well you maintained the separation between yourself and the entity. If you commingled funds, failed to observe corporate formalities, or used the entity as an alter ego, creditors may attempt to pierce the corporate veil and reach your personal assets. Bankruptcy does not change this analysis -- if the veil can be pierced outside of bankruptcy, it can be pierced inside of bankruptcy.
Chapter 7 bankruptcy is liquidation. A court-appointed trustee takes control of the debtor's non-exempt assets, sells them, and distributes the proceeds to creditors according to the priority scheme in Section 507. For businesses, this typically means the business stops operating.
Can a sole proprietor keep operating a business after filing Chapter 7? Technically, yes -- there is no law that says you cannot start a new business after filing. The discharge eliminates the debts, and you can begin again. However, during the case itself, the trustee controls business assets, and the business as it existed typically ceases. Many sole proprietors file Chapter 7, discharge their debts, and then restart a similar business immediately after, free from the weight of old obligations.
Chapter 11 is the reorganization chapter. Unlike Chapter 7, the goal is not to close the business -- it is to restructure debts so the business can survive. The debtor typically remains in control of the business as a "debtor in possession" (DIP) and proposes a plan of reorganization that modifies the terms of its debts.
Traditional Chapter 11 was designed for large corporations, and it shows. The process is expensive, slow, and complicated. Key features include:
For small businesses, traditional Chapter 11 was often a death sentence. The legal fees, the creditors' committee costs, the administrative burden -- many small businesses burned through their remaining cash just trying to get through the process. Nationally, Chapter 11 success rates for small businesses have historically been low.
The Small Business Reorganization Act of 2019 (SBRA) created Subchapter V of Chapter 11, and it fundamentally changed small business bankruptcy. Subchapter V is designed specifically for small businesses, with streamlined procedures that reduce cost and complexity.
Subchapter V has been widely praised by bankruptcy practitioners and judges. It has made Chapter 11 accessible to businesses that previously had no viable reorganization option. If your business has debts under $7.5 million and you want to keep operating, Subchapter V should be your starting point.
Chapter 13 is the "wage earner's plan" -- but it is not limited to traditional employees. Sole proprietors with regular income can file Chapter 13 and continue operating their businesses while making payments to creditors over a 3-to-5-year plan period.
Chapter 13 is available only to individuals (not LLCs or corporations) who have:
These debt limits adjust periodically and include both personal and business debts. If your total debts exceed these limits, Chapter 13 is not available and you would need to look at Chapter 11.
In Chapter 13, you propose a repayment plan that pays creditors from your future income over 3 to 5 years. The plan must pay priority debts in full (taxes, employee wages owed), must pay secured creditors at least the value of their collateral, and must pay unsecured creditors at least as much as they would receive in a Chapter 7 liquidation.
The key advantage for sole proprietors is continuity. You keep your business assets, you keep operating, and you make plan payments from business revenue. The plan confirmation requirements under Section 1325 ensure creditors receive fair treatment while giving you breathing room to restructure.
Your plan payment is determined by your "disposable income" -- the difference between your income and reasonably necessary business and living expenses. If your income is above the state median, the plan must run for 5 years. If below, it can be as short as 3 years.
This is where many small business owners get an unwelcome surprise. You formed an LLC to protect your personal assets. The LLC files bankruptcy or simply closes. You assume the business debts go away. They do not -- if you signed personal guarantees.
A personal guarantee is a separate contract between you and the creditor. It says: if the business cannot pay, you will. The LLC's bankruptcy addresses the LLC's obligations, not yours. Even if the LLC's Chapter 7 case discharges every penny the LLC owed (which it does not, because entities do not get discharges), your personal guarantee survives.
Before making any decisions about business bankruptcy, pull every loan agreement, lease, and credit application the business has. Read the guarantee provisions. Determine your total personal guarantee exposure. This number -- not the business's total debt -- is what matters to you personally.
Choosing the right bankruptcy chapter is the most important strategic decision a struggling business owner makes. Here is a framework organized by business structure and goal.
| Situation | Best Option | Why |
|---|---|---|
| Sole proprietor, want to close | Chapter 7 | Fastest path. Discharge personal liability for business debts. Restart later. |
| Sole proprietor, want to keep operating, debts under limits | Chapter 13 | Keep assets, keep operating, repay over 3-5 years. Lowest filing fee. |
| Sole proprietor, debts exceed Chapter 13 limits | Subchapter V | No debt limits for the individual debtor path (if business debts are over 50%). |
| LLC/corporation, want to close | Chapter 7 or state dissolution | Chapter 7 if assets need orderly liquidation. State dissolution if no assets. |
| LLC/corporation, want to reorganize, debts under $7.5M | Subchapter V | Streamlined, affordable, owner keeps control. No creditors' committee. |
| LLC/corporation, debts over $7.5M | Traditional Chapter 11 | Only option for large reorganizations. Expensive but no debt ceiling. |
| Owner with personal guarantees after business closure | Personal Chapter 7 or 13 | Business bankruptcy does not discharge personal guarantees. Separate filing needed. |
Not every struggling business needs to file bankruptcy. An assignment for benefit of creditors (ABC) is a state-law alternative that achieves a similar result to Chapter 7 liquidation without the cost and complexity of a federal bankruptcy case.
In an ABC, the business assigns (transfers) all of its assets to an independent third party called an assignee. The assignee liquidates the assets and distributes the proceeds to creditors, similar to what a Chapter 7 trustee does. The key differences:
ABCs are most commonly used by technology companies, startups, and other businesses with limited assets, few creditors, and a desire to wind down quickly without the expense and public scrutiny of a bankruptcy filing. They are not appropriate for every situation -- particularly if the automatic stay is needed to stop aggressive creditors or if preference actions would recover significant assets for the estate.
The cost of business bankruptcy varies dramatically depending on the chapter and the complexity of the case. Here are the baseline costs:
| Chapter | Court Filing Fee | Typical Attorney Fees | Total Estimated Cost |
|---|---|---|---|
| Chapter 7 (individual) | $338 | $1,000 -- $3,500 | $1,338 -- $3,838 |
| Chapter 7 (business entity) | $338 | $1,500 -- $5,000 | $1,838 -- $5,338 |
| Chapter 11 (traditional) | $1,738 | $25,000 -- $100,000+ | $26,738 -- $101,738+ |
| Chapter 11 (Subchapter V) | $1,738 | $15,000 -- $50,000 | $16,738 -- $51,738 |
| Chapter 13 | $313 | $3,000 -- $6,000 | $3,313 -- $6,313 |
| ABC (state law) | Varies / None | $5,000 -- $20,000 | $5,000 -- $20,000 |
Employees are often the first concern for a business owner facing bankruptcy. What happens to them depends on the chapter and whether the business continues operating.
When a business files Chapter 7 and ceases operations, employees are laid off. However, the Bankruptcy Code provides important protections for employees:
In a reorganization, employees typically continue working. The business continues operating, payroll continues, and the goal is to emerge from bankruptcy as a going concern. Current wages and benefits are treated as administrative expenses and must be paid as they come due.
However, the debtor may seek court approval to reject burdensome contracts, which can include collective bargaining agreements (under Section 1113) and retiree benefit obligations (under Section 1114). These provisions have specific procedural requirements and are heavily litigated.
Business owners should be aware that unpaid payroll taxes (the employee portion of FICA that was withheld but not remitted to the IRS) are priority claims that must be paid in full in any bankruptcy chapter. They are also nondischargeable under Section 523(a)(1). Additionally, the IRS can hold responsible persons (typically the business owner or controller) personally liable under the Trust Fund Recovery Penalty (IRC Section 6672) for the employee portion of payroll taxes. This liability is not dischargeable in the individual's personal bankruptcy.
Understanding the distinction between business debts and personal debts is critical because it affects multiple aspects of the bankruptcy process.
The line between business and consumer debt is not always clear:
The classification is determined at the time the debt was incurred, based on its purpose. Keep records of how you used borrowed funds -- this documentation can make the difference between passing or failing the means test.
Yes, but the process depends on your business structure. Sole proprietors file personal bankruptcy (Chapter 7 or Chapter 13) that covers both personal and business debts. LLCs and corporations are separate legal entities that can file their own Chapter 7 or Chapter 11 cases. Only individuals receive a discharge -- business entities in Chapter 7 simply liquidate and dissolve. Small businesses with debts under approximately $7.5 million may qualify for Subchapter V of Chapter 11, a streamlined reorganization process enacted in 2019.
Subchapter V is a streamlined version of Chapter 11 created by the Small Business Reorganization Act of 2019 (SBRA). It is available to businesses (and individuals with business debts) with total debts under approximately $7.5 million. Key advantages include no creditors' committee (saving tens of thousands in fees), the debtor stays in possession of the business, a Subchapter V trustee facilitates rather than controls, and the plan can be confirmed without creditor consent if it commits all projected disposable income for 3 to 5 years. Filing fees are $1,738.
If you signed personal guarantees on business debts, yes -- you remain personally liable regardless of what happens to the LLC. The LLC's bankruptcy only addresses the LLC's obligations. Your personal guarantee is a separate contract between you and the creditor. Many small business loans, commercial leases, and credit lines require personal guarantees. If the business cannot pay, the creditor will come after you personally for the guaranteed amount. You may need to file your own personal bankruptcy to address those guaranteed debts.
It depends on the chapter. In Chapter 7, the business typically shuts down and assets are liquidated. In Chapter 11 (including Subchapter V), the debtor usually remains in possession and continues operating while reorganizing. In Chapter 13 (sole proprietors only), you can keep operating your business while making plan payments over 3 to 5 years. Chapter 13 requires regular income and is limited to individuals with secured debts under approximately $1,395,875 and unsecured debts under approximately $465,275.
Court filing fees are $338 for Chapter 7, $1,738 for Chapter 11, and $313 for Chapter 13. Attorney fees vary significantly: Chapter 7 business cases typically cost $1,500 to $5,000; Chapter 11 cases range from $15,000 to $100,000 or more depending on complexity; Chapter 13 attorney fees typically range from $3,000 to $6,000. Subchapter V cases tend to cost less than traditional Chapter 11 because there is no creditors' committee and the process is more streamlined, but fees of $15,000 to $50,000 are common.
In Chapter 7 liquidation, employees are typically laid off as the business winds down. Unpaid wages and benefits (up to $15,150 per employee earned within 180 days before filing) receive priority treatment under Section 507(a)(4), meaning they are paid before general unsecured creditors. In Chapter 11 or Subchapter V, employees usually continue working as the business reorganizes. The automatic stay prevents disruption of operations, and the business continues to pay current wages. Employee benefit plans can be assumed or rejected as part of the reorganization plan.
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