What Happens When a Small Business Files for Chapter 7 Bankruptcy?

Chapter 7 bankruptcy can affect small businesses in radically different ways. Especially if the owner has a personal guarantee in the company’s debt, then the filing could trigger the pursuit of said person’s personal assets. 

Although big business bankruptcies get much of the fanfare and press coverage, the majority of business bankruptcies affect small businesses and the fallout is typically more significant. Small business owners feel the effects of bankruptcy in a more personal way. They’ll typically have much more involvement in the process than large companies, who may leave it mostly up to the attorneys. In the circumstances of Chapter 7 bankruptcy, the goal is to wipe out most of the businesses’ debt, and continuous operation will depend on the individual circumstances of the company.

Why Small Businesses Choose Chapter 7 Bankruptcy

Sole proprietors tend to choose Chapter 7 as it erases most personal and business debts with one filing. If the company’s debt exceeds the filer’s personal debt, then the filer does not have to meet the income requirements of the Chapter 7 means test (a determination of monthly income to decide if there’s enough “disposable income” to enter Chapter 13 instead).

Additionally, sole proprietors will use bankruptcy exemptions to protect personal and company assets. This is a viable option for some service-oriented businesses that don’t have many physical assets and can continue operating while wiping out debts. However, the appointed bankruptcy trustee will determine which assets can be sold, which could put the company out of business if those assets are vital to the operation. Any uncollected receivables as of the date of the case filing would likely become payable to the Chapter 7 trustee for creditors’ benefit.

Drawbacks for Small Businesses Using Chapter 7

Unless you’re a sole proprietor as described above, the company won’t be able to receive a discharge of its debts in Chapter 7. If the business is a partnership, corporation, limited liability company, or other legal entity, it will not receive a discharge of its debts in Chapter 7. If you’re responsible for the company’s debts (e.g., through a personal guarantee), you’d still be responsible for the debts unless you filed an individual Chapter 7 bankruptcy.

Lastly, sending a business into bankruptcy opens the books to creditors to potentially lodge objections or raise claims to assets. This could result in a ruling that members or shareholders should resolve business debt with personal assets. Obviously, this would be a much more significant liability for small business owners as opposed to a bigger corporation.


If you’re considering bankruptcy to resolve the debt of your small business, it’s vital to consult a qualified bankruptcy attorney before making the formal filing. Natural State Law, PLLC is a trusted source for Arkansas businesses and is here to help you as well. Call 501-916-2878 today to learn more and schedule a free consultation.