Small Business and Bankruptcy
Posted Jan 25 2010 in Wink and Wink by @winkhesaid
As a personal bankruptcy lawyer in today’s economy, I am increasingly encountering small business owners facing bankruptcy. These business owners are usually considering bankruptcy because their business income is down and they have some combination of personal debt and personally guaranteed business debt which they cannot repay. I generally see the goal for these owners as wiping out business debt as well as personal liability for those debts, while keeping business assets. While achieving this goal in bankruptcy is not always not possible, bankruptcy can wipe out personal liability for business and personal debts, and can be the best option for business owners in financial distress.
Owners of Sole Proprietorships can wipe out business debt while keeping business assets in bankruptcy
Sole proprietorships are not business entities but are essentially part of the business owner. While these businesses do not give their owners limited liability (i.e., if someone sues the business, they are suing the owner personally), they generally give their operators the most options in bankruptcy. This is because the business debts are generally wiped out along with personal debts when the operator files for personal bankruptcy. Additionally, under the Colorado Law (where I practice), the owner can claim up to $20,000 worth of business assets as exempt and keep them through the bankruptcy.
Owners of Business Entities are often NOT able to wipe out business debt and the assets of entity can be lost in bankruptcy
Most business entities, such as LLCs and corporations, offer their owners limited liability (i.e., those wanting to sue the business usually cannot sue the owner personally). However, lenders typically require the owners to sign personally as a condition of extending credit to the entity. For these debts, liability is not limited to the business, but extends to the owner. This situation is very common.
In general, the business owner can wipe out personal liability for the guaranteed business debt by filing personal bankruptcy. However, that debt remains on the business because business entities cannot get debts wiped out in Chapters 7 and 13. Business entities can pursue debt relief in Chapter 11, but that is generally too costly a process for the typical small business.
Additionally, assets of the business entity are NOT exempt under Colorado law. This means that the business owner may lose the assets of the business entity in bankruptcy, or pay to keep them. For these purposes, the value of corporate assets is their sale value minus corporate debt.
I know – it seems crazy that you can keep $20,000 worth of assets as a sole proprietor but not through a business entity. It has its reasoning in the fact the entity provides limited liability to the business owner. OK – you don’t have to like the reasoning, just know the distinction is real.
So, what should the owner of a business entity do if they are in need of debt relief?
Chapter 13 can wipe out personal debt while enabling the business owner to keep the business entity
If the business owner is struggling primarily with personal debt, Chapter 13 can enable the owner to wipe out personal debt while giving him or her time to pay the value of any assets held by the business entity. This is because Chapter 13 will put the business owner in a three to five year payment.
Chapter 7 can also wipe out personal debt, but assets of the business entity may be tougher to keep
Chapter 7 can enable the business owner to wipe out debt without a payment plan. However, the value of assets held by the business entity can be more problematic in Chapter 7 because the business owner will have to forfeit those business assets or pay for them without the benefit of a three to five year payment plan.
Business owners may have to close down business entities with significant debt or assets
If the business has significant debt, personal bankruptcy is likely not enough save the business because personal bankruptcy will not remove the debt from the business entity. Similarly, if the assets of the business entity are too much for the debtor to pay in Chapter 7 or Chapter 13 bankruptcy, the business owner will have to give up the entity either before or during bankruptcy. Business owners should consult an attorney prior to shutting down a business entity in anticipation of filing personal bankruptcy. You may be able to go into business as a sole proprietor.
For business owners in financial distress, personal bankruptcy presents an opportunity to remove debt and gain a fresh start. However, personal bankruptcy cannot remove debt from a business entity and you may not be able to keep assets of the entity in bankruptcy. While these facts may be harsh, facing them may be the only way to get out of a bad financial situation.
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