For a struggling small business owner, filing for Chapter 7 bankruptcy may help save your business or help you liquidate it. A personal Chapter 7 bankruptcy can also help you get rid of your personal liability for company debts. Let’s discuss when you may be personally liable for business debts and when it makes sense to file a business or personal Chapter 7 bankruptcy.
Are You Personally Liable for Business Debts?
The answer mostly depends on your business structure. If you did not form a specific business entity and you are the sole business owner, then you are a sole proprietor. A sole proprietorship is not a discrete legal entity, which means you are personally responsible for all business debts and when you file for bankruptcy, you are filing a personal bankruptcy.
If your business was formed as a partnership, corporation or limited liability company (LLC), your liability for your company’s debts depends on other factors. In a partnership, you are liable for business debts if you are a general partner but not if you are a limited partner. If your company is a corporation or an LLC, you are usually not liable for your company’s debts unless you cosigned or personally guaranteed the debt.
How Does Chapter 7 Bankruptcy Work?
When a Chapter 7 is filed, an automatic stay goes into effect and prohibits most collection activities. A bankruptcy trustee is appointed and charged with selling off the nonexempt assets to pay off creditors according to their priority.
In a personal bankruptcy, all dischargeable debts are wiped out so the debtor is no longer required to pay them. In a business bankruptcy, there is no discharge and no exemptions. As a result, all business assets are sold and the proceeds are distributed among creditors.
How Can Chapter 7 Bankruptcy Help Small Business Owners?
The answer again depends on business structure. Let’s discuss how Chapter 7 bankruptcy affects each type of business and its owners:
Because a sole proprietorship is not a discrete legal entity, it cannot file a Chapter 7 bankruptcy. When a sole proprietor files a personal Chapter 7 bankruptcy, the business also files. All business debts are treated as personal debts and are eliminated by the discharge. You can protect the assets of the business by using your exemptions. So with a Chapter 7 you can wipe out your debts and continue operating the business.
A partnership is a discrete legal entity and is allowed to file a Chapter 7 business bankruptcy. Remember: in a business bankruptcy there is no discharge or exemptions. So if your partnership files a Chapter 7, the trustee will close and liquidate the business, selling all assets to pay creditors.
The partnership’s bankruptcy does not impact the personal liability of its partners. If there weren’t enough assets to pay off the creditors, they can come for your personal assets if you were personally liable for the debt. The trustee can also sue the general partners to pay remaining creditors. So if you were responsible for the partnership’s debts, you will likely have to file a personal Chapter 7 bankruptcy to discharge your obligations.
Similar to a partnership, a corporation can also file a Chapter 7, but it does not receive a discharge. The benefit of a business Chapter 7 is an easy and orderly liquidation by placing the burden of selling assets and paying creditors on the trustee instead of the owners. Also, if you had cosigned or personally guaranteed a corporate debt, then you are still responsible for it unless you file a Chapter 7 personally.
Limited Liability Company (LLC)
An LLC is almost exactly the same as a corporation when it comes to bankruptcy and personal liability for debts. You can liquidate the business by filing a business bankruptcy but you must wipe out your own liability for business debts through a personal bankruptcy.
Next week, we will take a closer look at Chapter 13 bankruptcy for small business owners.
For a more detailed explanation of your small business bankruptcy options, let’s schedule a consultation today.
Moshier Law Office, PLLC
St. Paul, Minnesota