How to Avoid Small Business Bankruptcy

Megan Simonsen | Sep 30, 2022

Avoiding an Involuntary Bankruptcy

Business owners know that strategically choosing to file a business reorganization bankruptcy can be beneficial. It can eliminate debt and force creditors to the negotiating table, which allows owners to remain in control of their own destiny. On the flip side, being forced or “put into” bankruptcy by a powerful and hostile creditor will result in a serious loss of control and oftentimes a total disaster.

Unfortunately, life-altering and unexpected situations arise, and your business may find itself backed into a corner with less cash than it needs. If cash flow is a problem or debt is piling up fast, it's important to be proactive when trying to avoid a forced bankruptcy of your business. We can help.

First, let’s discuss what an involuntary bankruptcy is, and the requirements to be pulled into one. It’s exactly what it sounds like, a bankruptcy that creditors can bring against a debtor. This type of bankruptcy is typically put in place when the creditor has determined there’s no way for the debtor to pay back the amount they owe through the traditional avenues, or original payment plans. While rarely enacted and often used only as a scare tactic, this is unlike voluntary bankruptcies where the debtor files for themselves to either liquidate or reorganize. These bankruptcies are also entirely initiated by creditors, which puts debtors on their back foot.

The requirements according to the bankruptcy code are as follows:

  • The debtor must be able to be considered a debtor under whichever chapter of bankruptcy the creditor is attempting to force the debtor into.
  • The case must be a Chapter 7 or Chapter 11.
  • The debtor must have debts that, overall, add up to at least $18,600.
  • The potential creditor must show that the debtor is not paying debts as they’re due, and that a custodian, receiver, or agent has taken control of the debtor’s property with a lien within the last 120 days.

Note, if a debtor has more than 12 unsecured creditors, then at least three of them must join the petition. Adding onto that, those three creditors must have at least a total of $21,050 of unsecured outstanding debt owed to the three of them combined. (Effective from April 1, 2025, through March 31, 2028) Also, involuntary bankruptcies cannot be brought against insurance companies, nonprofit organizations, credit unions, farmers, or family farmers.

Are there ways to avoid being pulled into an involuntary bankruptcy?

Involuntary bankruptcies are, as mentioned above, entirely initiated by creditors, and largely used as a scare tactic, so besides the obvious “never fall behind on your payments or accrue debts” there’s no exact formula to avoid an involuntary bankruptcy.

But what could pull you into an involuntary bankruptcy, and how do businesses end up in this situation? The most common reasons an involuntary bankruptcy is filed are the business is behind on payments, is insolvent, or the debtor and creditor don’t agree on the amount owed. Businesses often get to this point because they’ve done any or all of the following:

Leveraged their Equity in Assets

Most businesses have some machinery. Whether it's a piece of manufacturing equipment, a heavy-duty vehicle, or even a suite of expensive computers, these high-value, tangible items are often leveraged by business owners to help their business get back on its feet. This can be a temporary fix but does create more secured debt that can be held against the business at a later date.

Failed to Avoid Overhead Increases

The phrase "you have to spend money to make money" is too often used when a business is going through financial hardship. If your business is struggling to make payments on existing loans and debts, it’s generally considered a good idea to try and avoid an overhead increase.

Now might not be the best time to upgrade the office, purchase new machinery, or hire a large crew of team members. Instead of spending money on an expensive new team member who you hope could "right the ship," focusing on your business's most profitable services could be a better option. Singling out services that are profitable and cost little in overhead can also be worth optimizing until you can get the business back on its feet.

Taking Out an MCA

Merchant cash advance (MCA) lenders know that when a business is experiencing financial difficulties, owners often borrow without counting the cost. Sadly, they or a broker may take advantage of your difficulties for their own gain. Avoid their debt consolidation trap, and stay as far away from MCA lenders as you can. Unfortunately, they’re very good at convincing business owners that a small or "affordable" merchant cash advance is exactly what's needed to get back on track, and The Lane Law Firm has seen firsthand that it doesn't work as promised. If you're being pursued by an MCA lender, it’s in your best interest to connect with an experienced business debt relief attorney. They know exactly how to deal with predatory MCA lenders as well as what type of financial solutions will support your business rather than entrap it.

Failed to Connect with a Reputable Business Debt Relief Attorney

The previous point is a perfect example of why it's always a good idea to consult with a business debt relief attorney if you feel your business is at risk of being forced into an involuntary bankruptcy, or a voluntary one. A business debt relief attorney can help you stand up to MCA lenders, and stop their predatory actions, as well as listen to your small business' situation and provide both financial and legal options that suit your business' needs.

Looking for a business debt relief attorney in Texas? Contact The Lane Law Firm. Our lawyers are well-versed in various types of business debt relief and bankruptcy approaches. We’re here to help you figure out a plan to move forward, restructure, and become profitable once again.


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