When is Bankruptcy Actually the Smart Move?

Business bankruptcies are rising, and it’s not just the big names making headlines. We’re seeing small businesses get squeezed by higher borrowing costs, inflation-driven expenses, and customers who simply aren’t spending the way they used to. When cash gets tight, owners often feel forced into quick-fix financing like merchant cash advances, and that can turn a temporary slowdown into crushing monthly debt service.

We sit down with JoAnn Falgout, an experienced bankruptcy attorney, to walk through what actually happens when a business considers bankruptcy and why the answer is often more nuanced than “close the doors.” We talk about personal guarantees and the hard truth that many owners have signed onto business debt with their own credit, their home equity, and their future on the line. JoAnn explains why draining a 401k or IRA to save the company can be a tragic mistake, since retirement accounts are often exempt in bankruptcy, and why early pre-bankruptcy planning can prevent avoidable problems like preferential transfers.

We also dig into Subchapter V Chapter 11, a streamlined reorganization option built for small businesses, including what makes it cheaper, faster, and more realistic than a traditional Chapter 11 for many mom-and-pop operations. Along the way, we compare Chapter 7 liquidation, Chapter 13 repayment plans, and Chapter 11 reorganization, plus what “exemptions” mean in real life for everyday assets.

If you’re a business owner, creditor, or just trying to understand small business bankruptcy and debt restructuring, this conversation gives you a clear framework for choosing next steps. Subscribe, share this with a business owner who needs it, and leave us a review.

Transcript

Why Bankruptcy Hits Everyone

Bob Sewell 0:04

Is that even legal? It's a question we ask ourselves on a daily basis. We ask it about our neighbors, we ask it about our elected officials, we ask it about our families, and sometimes we ask it to ourselves. The law is complex and it impacts everyone all the time. And that's why we are here. I'm attorney Bob Sewell, and this is season five of the Worldwide Podcast that explores that one burning question is that even legal? Let's go. Today's guest in the show is JoAnn Falgout. JoAnn is an experienced attorney in bankruptcy and other areas of the law. She has been practicing law since 1993. Uh worked as a clerk for the Court of Appeals. She's she's a fantastic attorney. JoAnn, welcome to the show. Thank you. Happy to be here. I wanted to have you on the show because there's something that's interesting happening. It's a little scary too, actually. And what's

Business Bankruptcies Are Rising

Bob Sewell 1:05

going on is uh business bankruptcies are on the rise. Since 2000, January 1st, 2026, to the first quarter, they've been up 12 percent. And a disproportionate of those numbers is in the small business. It's not just large businesses, it's small business, the moms and the pops, the companies that uh that are really the lifeblood of the middle class, the lifeblood of our country, those are the ones that are getting hit the hardest. And there's a lot of reasons for that, from what I could tell in the news. And I want to hear your perspective. For some, it might be uh it might be the tariffs created an uncertain environment, uh, inflation, the borrowing cost costs have increased uh because of the interest rates have gone up. All these things have made, you know.

JoAnn Falgout 2:03

I would I agree, Bob. A lot of a lot of these issues are are real for small businesses. Costs are up, you know, uh customer purchasing is down a little bit. Um, and it's hitting every aspect of our economy, everything from healthcare to shipping industries to restaurants, anything you can think of, it's having an impact. And I think probably disproportionately for the small businesses, in part because they may struggle more to find sources of funding when they need additional cash. You know, a large business has no trouble going to a bank and getting a loan at a reasonable interest rate. But many times small businesses struggle to get any kind of funding. And so then they end up, you know, much like individuals who take out those payday loans just to be able to pay their mortgage, the small business might take out a cash advance from a merchant cash advance uh provider and just so they can make payroll. And then next thing you know, that debt service is really just eating up all of their income and makes it hard for them to survive.

Bob Sewell 3:04

Right. And a large business will have different sectors that we expose to different sectors of the industry. And and the the result is if a large business wants to keep keep functioning, and they have a sector that's not doing well, they riff that they rift that portion of the business. They just say, well, we'll get rid of that.

JoAnn Falgout 3:27

It is much harder for a small business to completely pivot like that. Absolutely.

Bob Sewell 3:31

Yeah, but it's yeah, they don't they don't pivot, right? I mean, if I'm a roofing company and there's you know, people need to be able to take loans and seconds on their house in order to put on new roof, right? And the borrowing costs are extreme. Right.

JoAnn Falgout 3:49

The customers are hiring less, and the and the business itself may have difficulty as well getting those bridge loans in order to finance the some of the construction until they get paid by the customer. Um, and then sometimes the customer defaults can can really um impact a smaller business in a way that you know one or two defaults by customers wouldn't impact a larger company. So, yeah, it really is a big problem for small businesses right now. The the economy has just um really been difficult for the small businesses. You know, fuel costs are up, and I know that hits larger businesses as well. But again, they have more options for funding and more options for um diversifying. A lot of times the small businesses are mom and pop operations, like you said, where you know they know how to do one thing and they do it really well, whether it's roofing or or preparing meals for a restaurant or or providing health care for individuals, whatever their specialty is, that's what they do. It's much harder for them to just change and do something else.

Bob Sewell 4:49

Yeah,

Why Small Businesses Get Squeezed

Bob Sewell 4:50

I have a uh particular I'm an avid uh cyclist. And uh there's a cycling company that uh Buddy and I and I uh have bought bikes from, and it's a small company. Yeah, it filed for bankruptcy. And and uh we hope it comes out of bankruptcy because it produces an interesting product, but it's a small business and it's trying to do everything here in the United States and it's sourcing, you know, it's sourcing product from outside the country, and you know, tariffs are are hitting that and you have market forces beyond its control, you know. It's it's a challenge. But what do businesses do if they're a business? If you if I you know, if I own a construction company, that does the business owner file bankruptcy or does the business file bankruptcy? How does it work?

JoAnn Falgout 5:45

So that's another aspect that makes it difficult for small business owners. You know, most corporations, when they go to get financing from a bank or wherever they're getting their financing from, typically the bank isn't asking the corporate CEO to sign off on a personal guarantee of that loan. Um, but for small businesses, very frequently the business owners are asked to co-sign the loans and to personally guarantee them, sometimes even asked to put up their very own houses as collateral for the loan. And so, yes, very frequently when you have a small business that needs to file for chapter 11 reorganization, um, this the business owners are gonna need to file too. And whether they file under chapter seven or chapter 13 or their own subchapter five bankruptcies, depending on their income and debt amounts, um, you know, they they frequently are gonna need to file their own bankruptcy as well. Sometimes those can be jointly administered, and that can help keep the costs down, especially if um both the business and the individual are filing under subchapter five. Um, but other times they can't, they just can't manage that. They the business owners may have to file first, um, or the business might need to file first, and then the business owners followed up later. Um, there's lots of ways that can play out. One of the things that really breaks my heart is to see business owners who have literally drained their 401ks, their IRAs, all of their savings. They've taken out a second mortgage on their house to try to keep the business afloat. And then they come to me and want to do a reorganization and they have nothing left. I would encourage anybody, any small business that is struggling at all, to consult with a bankruptcy attorney. It may be possible to do a reorganization of the business before it gets to the point that you are destitute and have liquidated your retirement accounts. When you file bankruptcy, go ahead.

Bob Sewell 7:35

Yeah, go ahead. Yeah, keep going.

JoAnn Falgout 7:37

Yeah, when you file bankruptcy as an individual, those retirement accounts are exempt from creditor claims. You get to keep them. So to liquidate those retirement accounts in order to try to pay for the business, when instead you could take out a different loan or file for reorganization and streamline some of that debt that you have and make your payments more manageable. Um, just please, I encourage anyone who's listening, consult with a bankruptcy attorney long before you think you might need it. Um, we can do what's called pre-bankruptcy planning. We can advise you on things that you should and should not spend your money on. So make sure that you're not committing any kind of um any kind of thing that would be considered a preferential transfer, a fraudulent transfer under the bankruptcy code. We can advise you on how to make the payments that you need to make while making sure that you're doing things that are going to be acceptable for the bankruptcy trustee.

Bob Sewell 8:30

Okay, let's let's talk about that for a second because you said business bankruptcy or business bankruptcy planning or bankruptcy planning generally. This is important. And and the reason why it's important is certain money is special under the bankruptcy code. Certain money is special. And we, for example, you mentioned a 401k, right? And correct me if I'm wrong because you're the expert. A 401k is special money, an IRA is special money.

JoAnn Falgout 8:59

Absolutely. It is exempt from your credit. Why is it special claims? In a bankruptcy, it is exempt from your creditors' claims as an individual. So if you have a 401k or an individual retirement account, any kind of retirement savings like that, 403B, there's a bunch of them that qualify that are listed in the statute. Um, you can file bankruptcy and you get to keep that money, just like your homestead exemption. Under Arizona law, you get a certain amount of equity in your home that is exempt from your creditors' claims, and you get to keep that. So if you're taking

When Owners Must File Too

JoAnn Falgout 9:30

out a second mortgage on your home and eating up that equity with secured debt, now you don't have any equity in your home. And instead you have this money that you have to pay. And the bankruptcy doesn't really help a lot with that. Um, if instead you had filed bankruptcy sooner and kept that equity in your home and kept your 401k in your retirement account, you would be in a much better position moving forward to, you know, A, retire at some reasonable time. And B, if you did need extra money during the bankruptcy for any reason, you would still have a source for those funds, which can be a very helpful thing. So I do encourage people to really think, you know, if you're if you're struggling financially, don't be afraid to consult a bankruptcy attorney. You may not end up filing. A lot of times the bankruptcy attorney, um, one thing that we do is we often can help people to negotiate with their creditors and get more reasonable terms for that debt. Um, one of the one of the things we can do is help analyze how much you can really afford to pay. And we can reach out to the creditor and say, look, you know, if you're not willing to settle on some terms that my client can actually afford, then my client may end up filing a bankruptcy. And here we filled out our bankruptcy statements and schedules. We can show you here's how much you're going to get up in a bankruptcy. And it's, you know, 38 cents, right? And here's how much you'll get if you settle with us, and it's a lot better. So that can be helpful.

Bob Sewell 10:51

And that's really helpful, especially. I mean, from the business owner standpoint, if I'm if I have a 401k or a 403B or whatever my retirement savings, and I got equity in my house of $350,000 or whatever the equity is, what I want to do is look at that in advance. If I see where my business is going, before I start dipping into it, talk to you. Right. And go talk to us. And the thing that's interesting about that is let's say I have a million dollars in my uh 401k and I have, you know, another half a million or another 400,000 in my equity in my home, I got $1.4 million. I could be filing bankruptcy and keeping it.

JoAnn Falgout 11:41

Well, that's correct. And um, and especially, you know, depending on your situation, if you've personally guaranteed some of the loans on the business, yes, you want to maintain those exempt assets. On the other hand, if you have excess equity in your home, then we may be advising you to do something with that that is that is useful. Um, and and you have to be careful. You don't want to be preferentially paying certain creditors while not paying others and wind up in trouble if you do end up filing bankruptcy in the future. You don't want to be spending that money on things that the bankruptcy trustee might uh might raise some red flags for them. You want to be spending that money on like a vacation. Yeah, right. You don't want to you don't want that round-the-world trip that cost you, you know, $500,000 and now you just ate up all the excess equity in your home. Um you're a killjoy kid. I know, right? No, no, but what I'm trying to do is is not killjoy, right? I want people to be prepared for the future so they can have fun in the future as well as in the present. Um, and so yeah, we we want to look at how we can salvage the business. And sub chapter five is really great for those small businesses. It's one of the few things that Congress has gotten right. They rolled it out. Tell me about it.

Bob Sewell 12:54

Why is it so good?

JoAnn Falgout 12:55

They rolled it out in February 2020, just uh coincidentally, I believe, right before the pandemic began. So it really was uh put to the test right away and has demonstrated to be very successful. It has a much higher success rate for planned confirmations than a chapter regular chapter 11 for small businesses. The problem with a regular chapter 11 for a small business is that it's expensive.

Protecting 401k Equity And Avoiding Mistakes

JoAnn Falgout 13:20

You have um US trustee fees, you have creditor committee attorney fees, you have your own attorney fees, and it can take, you know, a long time, years even to get a plan confirmed in a regular chapter 11. And most small businesses just could not afford those administrative expenses that went along with that. And so under subchapter five, it's a streamlined process and much shorter timelines, which all equals less expense. You also have in subchapter five, a um subchapter five trustee gets appointed. But he's not, I don't know why, it's almost a misnomer to call him a trustee. He doesn't take over the business the way that you think of a chapter seven trustee would do.

Bob Sewell 14:03

And instead, for those who hang on, for those who don't know, every bankruptcy names a trustee, and that trustee is to manage the credit rather to step in the shoes of the creditor and try to get money out of the debtor, which is the person going bankrupt. Do I got that right?

JoAnn Falgout 14:24

Pretty close, yeah. They don't necessarily step into the shoes of the creditors, but they do assist the creditors in in trying to maximize recovery under the under the um under the bankruptcy code. Um in a regular chapter 11 and in a subchapter five, um, you can file a bankruptcy for your company and you can be what is called the debtor in possession, under which um situation you have the same obligations as the bankruptcy trustee to try to make sure that the creditors get paid. That's your goal. Um, in a regular chapter 11, though, um you they have this thing called the absolute priority rule, which means all of the creditors have to get paid in full before the equity owners can keep their interest in the company. Um and there is a new value exception to that, but let's not let's not get too too deep into the weeds here. Um but in a subchapter five, they have done away with that absolute priority rule, which means that the small business owner gets to keep their interest in the business and continue operating it as long as the treatment to the unsecured creditors is quote, fair and equitable, and as long as the unsecured creditors get more than they would get in a regular if we had filed a chapter seven and liquidated the company. So there's a couple of criteria that have to be met. But I think it was wise of Congress to recognize that unlike, you know, a publicly traded corporation that has, you know, hundreds of thousands of shareholders and has lots of options and money, nobody's really interested in buying the mom and pop operation. In fact, most people couldn't potentially buy the mom and pop operation. Why not? They may not have the expertise to run it. They, a lot of the goodwill is tied up in that owner's personal relationships with the vendors and the and the other people that they're working with and their own customers. And if somebody were to come in and try to buy that business, the chances of it being successful are pretty slim. And then plus, you're looking at a huge, often debt ratio that the company has. And so there aren't going to be a lot of interested buyers, unlike with a publicly traded corporation. So it can be a lot harder to get that new value or to get somebody to purchase the company out of bankruptcy. And so instead, they've they've come up with this way of trying to maximize the recovery for the unsecured creditors by having certain requirements about how much has to be paid, um, but also allowing the business owners to continue operating their business. I think there's also a recognition that, you know, to for somebody who's operating, say, a restaurant or, as you mentioned, a bike shop, you know, they are experts in how that restaurant works and how that bike shop works. And so it's in everybody's best interest to let that business keep operating, keep those 20 or 30 employees or whatever it is, let them all keep their jobs and keep those things operating rather than require it to shut down just because the owners can't come up with enough money to pay all the unsecured debt that is currently accruing interest at sometimes ridiculous rates such as 175% interest.

Bob Sewell 17:24

Oh my gosh.

JoAnn Falgout 17:25

Yeah.

Bob Sewell 17:26

Okay. So here are my options, right? If I'm a small business owner and I'm looking at an unfavorable business environment and I'm sitting on some cash, I'm sitting on uh that like in form of retirement funds, I'm sitting on some maybe a little bit of savings. Um but I'm seeing my my savings dwindle, I'm seeing my jobs dry up, I'm looking at this issue, I'm seeing my creditors get more and more anxious. I come to you, I start to discuss what my options

Why Subchapter V Works

Bob Sewell 18:05

are. Well, one option is a chapter five. How small do I have to be? Sub chapter five. How small do I have to be before I'm qualify for that?

JoAnn Falgout 18:17

Right. So the debt limit currently is 3.42 million. So you have to have debt under that amount. Um, and it has to be primarily business debt. And um, and so uh both for individuals and for the company itself, above that amount, and you would be sending the company to a regular chapter 11, and you yourself could either do a regular chapter 11, um, or depending on what your income is, potentially even a chapter seven, and that's gonna depend on income and assets and all things to to you know could to be considered.

Bob Sewell 18:48

But um chapter seven, that's liquidation, right? Sorry about that.

JoAnn Falgout 18:54

Yeah, so in a chapter seven, basically you uh you marshal all your assets, you list all of the assets that you own, and you list all of the debts that you owe. And basically, if it's a company, it gets liquidated, all the stuff gets sold off, and the creditors get paid. The company does not get a discharge in a chapter seven, unlike an individual. Um, for individuals, you also have the option for a chapter 13, under which you can do a three or five-year payment plan to pay back creditors. That also has debt limits, 1.5 million, and um also uh, but doesn't have the income limits that chapter seven has. And then again, sub five if your debt is up to 3.5 million, and then regular chapter 11 if you're over that. So there's lots of options. And what we would do if you come talk to us is evaluate what is the best for the company. Does the individual also need to file or not? And I have had clients that come to me with their small businesses in some financial peril, but they themselves have not guaranteed the debt, and they themselves don't end up needing to file bankruptcy. So that is also a total possibility. So, but get it evaluated before you before you liquidate that 401k.

Bob Sewell 20:06

But but all of it, all of these these uh bankruptcies, it's we're gonna require that I give up my Pokemon collection, right?

JoAnn Falgout 20:15

Well, not necessarily.

Bob Sewell 20:16

Um, it's I mean I joke, I joke, right? I mean, I don't have a Pokemon collection, but it's it's gonna require that I give up everything that I want, every in my life, all the good stuff, you know, all my my bicycles and which I have too many. And uh according to my wife.

JoAnn Falgout 20:36

Yeah, there certainly are some yeah, there certainly are some assets that are not going to be exempt under the under the bankruptcy code. Under the bankruptcy code, you could you look to Arizona statutes to determine what your exemptions are. And Arizona's exemptions are pretty reasonable. You can have a vehicle with equity up to 16,000 house, equity up to 450,000 or so. Um, various household goods have you know your clothing. Most people, all of their stuff is exempt. Um, if you own some Picasso paintings or other super valuable things, perhaps not. If you own things like recreational vehicles, those may not be exempt. But you know, all the normal stuff that you need for living life is pretty much exempt. So you don't have to give up everything in the bankruptcy. But yes, you may have to give up some of those fancy toys. Your yacht may not sail through the bankruptcy. Um, the flip side of that though is if you do have some post-petition income, the the trustee often will let you purchase your own stuff, right? So, you know, if you have some non-exempt asset and you can afford to pay for it from the trustee, then often the trustee will let you keep it as opposed to selling it to a stranger.

Bob Sewell 21:44

I'm keeping my Pokemon collection, then.

JoAnn Falgout 21:46

There you go. Absolutely. I know, I know I want to keep mine.

Bob Sewell 21:53

So um if I'm going to um File. I wanna I wanna point something out. It is the great American way to have the bankruptcy statutes and the bankruptcy code. And it sounds insane, but it's one of the things that makes our our economy vibrant and better than a lot of other economies because we have this way to get a fresh start.

JoAnn Falgout 22:30

Absolutely. And and I'm it's in the constitution. It's it is absolutely a beautiful thing. And and there's two two things I want to say about that. First is that many times it really is true that uh almost ever, I mean, every time, in fact, by by design in a subchapter five, the unsecured creditors are going to come out better than they would if the company were liquidated.

Chapter 7 Chapter 13 And Exemptions

JoAnn Falgout 22:55

So it's to everybody's interest to let that reorganization go forward and let the company maximize the payout to the unsecured creditors. Because the idea is, you know, you look at the assets of the company. If you liquidate today, you know, the building is probably secured, and so that goes to the secured lender. The um the equipment in the kitchen is not worth anywhere near what was paid for it. And again, secured claims, right? So that goes to those creditors. And then the unsecured creditors essentially get nothing. But if you allow the business to keep operating, then the unsecured creditors get paid something, maybe not as much as they were hoping to get paid, but they get paid something, and that's better than nothing, right? So that's a great thing. The other thing I would point out is that this idea of the bankruptcy fresh start goes back to, you know, biblical times with the Jubilee and the forgiveness of debt every seven years, right?

Bob Sewell 23:48

Yeah, I forgot about that. You're right there.

JoAnn Falgout 23:50

I mean, this is like this is not just an American thing. This is, you know, a human thing. Everybody deserves a fresh start once in a while. And so many of my clients, you know, they've been hit by some tragedy. Frequently, the business owner maybe got sick for a while, couldn't operate the business, and now the business is in financial trouble. I've had clients who had situations where their bookkeeper, you know, um embezzled a bunch of money and now they have no more money. And so those kinds of tragedies really can strike. And it really is to everybody's benefit to give that debtor a fresh start, let them keep operating, let them do the best they can to pay Mac as much as they can while being forgiven the crushing debt that otherwise is simply gonna put them out of business.

Bob Sewell 24:34

So if I want to have a good meeting with you, okay, I I'm a bit my my business is struggling, or my personal, you know, that situation is not doing well. Um I come, I want to have a productive meeting with you. I set my appointment. What am I gonna bring? What are you gonna want to look at?

JoAnn Falgout 24:54

So for a business, we definitely want to see some financial statements, profit and loss, cash flow statements, things like that. For a business, a good candidate is a business that if it weren't crushed by the unsecured debt payments, it actually would have enough cash flow to make its payroll, make a little bit of a profit, service some of the debt, right? Pay its administrative expenses for the bankruptcy. If it's making enough money to pay those ongoing expenses plus a little, it's a great candidate for a bankruptcy. But if even if we got rid of all of the unsecured debt, the company still isn't making enough money to turn a profit, then it's probably best to just shut that down and try again with something else, right? Um, so we we would want to evaluate the company's long-term viability, basically. And the other thing to bring is a sense of

Fresh Starts Prep And Next Steps

JoAnn Falgout 25:45

complete honesty, transparency, disclosure, because that's what bankruptcy is all about. Disclosing everything to the creditors. Here's what we have. You lay all your cards on the table, here's what we have, and here's our plan to try to pay back, you know, all of the secured debt, all of the administrative claims, make sure we're paying our operating expenses and as much of the unsecured debt as we can. And look, you can see everything right here on the table. We are paying as much as we can. And if you can get to that point, often you can get a consensual plan. You get the creditors all voting in favor of your plan, and everybody moves forward with the knowledge that they're getting the best deal they can get.

Bob Sewell 26:23

Okay, so I want to point something out. As if it's not obvious already. You're not telling anyone to do anything right now. You're not consulting about their personal debt situation. They need to talk to you first.

JoAnn Falgout 26:37

Absolutely.

Bob Sewell 26:38

Absolutely. This is just generalizing.

JoAnn Falgout 26:40

Every situation is different. And um, sub chapter five can be a great answer for one company and the complete wrong answer in a different situation. So definitely you want to consult an attorney.

Bob Sewell 26:52

How do I get a hold of you?

JoAnn Falgout 26:54

Call Davis Miles and set up an appointment. Um, and and I'm happy to meet with you. Uh, we also have Preston Gardner, he's the other partner in our section, and he is also an excellent attorney. We either one of us would be happy to meet with you and discuss your options, whether it's going to be chapter 11, chapter 7, or an individual bankruptcy as well. We're happy to meet with you.

Bob Sewell 27:15

JoAnn, thanks for coming on the show. I really appreciate it. And thanks, Bob, for having me.

JoAnn Falgout 27:21

I look forward to it. Thanks a lot.

Bob Sewell 27:23

Thanks for listening to the podcast. Is that of illegal is now listened to in a hundred countries and available on virtually all podcast platforms. Leave us a review, send us some show ideas, and do so at producer at evenlegal.com. Don't forget, as smart as we sound and as lovable as we are, we are not your lawyers. And we are not giving you legal advice. But if you need some legal advice, get stuck. There's some great lawyers out there, and we are always ready to help. See you next time.