So what are the laws governing nonprofit organizations who are seeking to file bankruptcy?
First, the organizer(s) of the nonprofit can only file a Chapter 7 or Chapter 11 bankruptcy. This decision is important because the nonprofit must determine if they are able to pay their debt and remain business or close their doors.
Next, a good understanding is needed of the bankruptcy laws governing nonprofits. While new laws have not been changed since 2005, the Bush Administration paid special attention to give bankruptcy laws an overhaul. In the case of a not for profit entity (an “NFP"), the ability of a debtor to sell its assets in a bankruptcy often overlaps with various state laws and regulations governing NFP asset sales (Kannel and Walker, 2005). This means that pursuant to the Bankruptcy Act, the sale of a NFP debtor’s assets pursuant to Section 363 must now be “in accordance with non-bankruptcy law that governs the transfer of property by a corporation or trust that is not a moneyed, business, or commercial corporation or trust." 11 U.S.C. § 363(d)(1). Basically, individuals who are selling assets from their nonprofit cannot knowingly engage in illegal practices or position themselves to make money off the sale of any assets.
It is always a sad case when a nonprofit organization has to file bankruptcy, but in times of economic crisis or stresses many givers pull their purse straps closed and nonprofit organizers close. Unfortunately, there are no clear bankruptcy laws for nonprofits to protect them but there are options instead of closing.
Finally, when forming a nonprofit, it's best to determine if the business has to dissolve how the process will work via the guidelines in the original nonprofit bylaws.