When Is Bankruptcy the Answer to Your Freelance Business Woes?

small business bankruptcy

How Much Is Too Much With Your Freelance Business?

I used to be a bankruptcy lawyer in a former life, so anyone asking questions about when it’s a good time to file, is asking the right guy. And especially in what has been a tough economy, this is a question I am hearing more and more lately.

Bankruptcy is the big bad monster of your business movie, I get that. But you should know up front that, in reality, the bankruptcy monster is more like that big, sweet blue thing in Pixar’s movie Monsters, Inc. than that mean, scary thing in Alien.

What the heck are your talking about, Steve?

Look, almost every area of the law is about revenge, except for bankruptcy.

Criminal law is about putting people behind bars; lawsuits are about getting money. But not bankruptcy. Although the rules were recently toughened (more on that bonehead idea in a minute), the basic tenet behind bankruptcy is about forgiveness, not revenge. It’s about helping you start over.

Understanding How Bankruptcy Changes Can Impact Your Business Decisions

When the bankruptcy laws were greatly restricted in 2005, the idea was to cut back on bankruptcy fraud, that is, to prevent people who were not really in over their heads from legally escaping their debt.

But bankruptcy fraud was never a big problem. Anecdotally, I can tell you that of all of the many bankruptcies I handled over the years, only one or two cases of fraud were possibly at play.

Most people want to pay their debts, but because of business problems, or divorce or illness, or something, things changed and now they can’t.

So should you file bankruptcy if your freelance business is in trouble? Well, I hate to sound like the lawyer I am, but it depends.

Understand that there are three types of bankruptcies, one being far more preferable. A Chapter 7 (desirable) wipes out your unsecured debt. A Chapter 13 (less desirable) is a three-to-five year repayment plan for individuals. A corporate repayment plan is called a Chapter 11, and works well in the certain situations.

The Difference Between Chapters 7, 11 and 13

Chapter 7: If your freelance business is a sole proprietorship, then you and it are one in the same, legally speaking. You could file a Chapter 7 and possibly wipe out your unsecured debt and get a fresh start.

I say “possibly” because the 2005 changes to the law made filing for a Chapter 7 much harder. You will have to check with a lawyer to see if you qualify, and these days not a lot of people do. But if you do, that’s good news because it really is a chance to wipe the ‘ol financial slate clean. And you will be getting credit again within a year or two.

It’s not so bad, really. In fact, the only thank-you cards I ever received when practicing law were from former Chapter 7 bankruptcy clients because their life was so much easier afterwards.

If your business is a corporation, then a Chapter 7 would act as a liquidation: that is, your business would have to close its doors and all business assets would be sold to pay off creditors.

Chapter 13: Unfortunately, as I said, not many people these days meet the new stringent Chapter 7 requirements and therefore end up having to file a Chapter 13 repayment plan. The amount you repay may be anywhere from, say, 10% to 100%, it just depends on the facts.

I also say unfortunately because a lot of people have a difficult time finishing their Chapter 13 repayment plans. If they could have paid off their debts, they would have, right?

S corporations cannot file Chapter 13 bankruptcies; only individuals can.

Chapter 11: If you want to keep the doors of your corporation open and have the debt restructured, you would file a Chapter 11. Here, you propose a plan of reorganization that needs to be accepted by a majority of your creditors and confirmed by the court.

The bottom line is that if you think you can get rid of enough debt to warrant a BK filing, then it might be a good idea.