4 Reasons a Corporation Should File for Bankruptcy

Corporations can file for bankruptcy just like individual households, but they typically file for a different form of bankruptcy. Corporations choose between Chapter 7 bankruptcy, which is a liquidation of assets, and Chapter 11 bankruptcy, which is a reorganization of debts. Depending on the financial situation of the corporation at the time it declares bankruptcy, each organization will make a different election. It is preferable to file for Chapter 11 when possible. Bankruptcy is a legal protection from creditors, and a corporation should elect this option if any of the following is true.

Industry Changes Result in Lack of Productivity

Most corporations will attempt to avoid bankruptcy by making spending cuts and increasing profitability in the short-run. Once the corporation is "back in the black," meaning it has paid off debts, the business owner can either sell or dissolve the company without a loss. This is the first choice when a corporation faces challenging financial times. However, this is only an option if there is potential business to be done. At times, and industry change results in little potential for profit. Continuing to run a company at a high cost without profits coming in the door will only result in larger debts.

A Corporation Faces Lawsuit

Lawsuits are costly, and the personal assets of a business owner may come into risk in the course of a costly lawsuit. Filing for bankruptcy prior to facing a lawsuit can be one way to protect the company and its owners in the future. Of course, filing for bankruptcy in an effort to hide assets from the plaintiff is illegal. However, if bankruptcy is chosen because the corporation will have little chance of surviving after the lawsuit and is already suffering from debt, bankruptcy offers explicit legal protections for the owners of the corporation.

Personal Assets are at Risk

Many small business owners make the mistake of placing their personal assets on the line in order to attempt to avoid business bankruptcy. Financial experts agree a business owner needs to make a definitive separation between the two. Getting an initial small business loan with personal collateral is sometimes necessary. As soon as a business is profitable, the personal collateral should be removed from all loans. When a business fails, declaring bankruptcy is a more practical option than continuing to collateralize personal assets in order to try to turn a profit.

A Corporation Qualifies

Ultimately, the greatest indicator of if bankruptcy should be pursued is simply qualifying. Bankruptcy protections were designed to provide legal protections to those who truly need the assistance. Any business that meets the court's definition of bankrupt really needs the assistance. Choosing to forgo bankruptcy to continue attempting to survive as a business rarely results in a positive profit. Instead, electing for the less harmful form of bankruptcy, Chapter 11, before total liquidation is necessary can help a business and its owners preserve the possibility of future success while providing legal assistance in eliminating current debts. Waiting until there is no option but Chapter 7 can be detrimental.


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