How to Protect Personal Assets During a Small Business Bankruptcy

Despite their best efforts, small business owners may be pushed into insolvency by economic downturns, unexpected events. They can seek relief under bankruptcy laws, including Subchapter V of Chapter 11, which provides a streamlined process for seeking debt protection and restructuring. 

The owner of a closely held business facing the prospect of bankruptcy may worry about whether it might imperil their personal assets, such as homes, retirement accounts and savings. Careful planning and concerted action before and during a case can be vital in protecting them. Here are positive steps:

• Structure the business effectively — Operating as a sole proprietorship leaves an owner personally liable for business debts and obligations. By contrast, forming a corporation or a limited liability company (LLC) creates a formal legal barrier between the business and its owners, shielding personal assets from most business liabilities. However, this protection is effective only if the business maintains its separate legal identity.
• Observe corporate boundaries — Owners must act as if the business truly is a separate entity, not merely an extension of themselves. To maintain limited liability, small business owners must meticulously follow corporate rigors. These include keeping separate records for business decisions, holding required meetings (even if informal), maintaining minutes and complying with all required filings. Failing to observe these boundaries, even for a single-member LLC, can result in a court “piercing the corporate veil,” exposing personal assets to creditors. 
• Keep funds separate — A common and costly mistake is commingling personal and business funds. Mixing money, such as paying personal bills from a business account or vice versa, makes it difficult to prove the separation between owner and entity. In bankruptcy proceedings, such confusion can lead to allegations of fraud or result in the loss of limited liability protection. Use separate bank accounts and always document every transfer between them.
• Avoid risky personal guarantees and new debt — While sometimes unavoidable, personal guarantees of business loans, leases or lines of credit increase risk to personal assets. Also, taking on debt while already insolvent, especially by using personal credit, may be considered fraudulent and could leave the owner liable for repayment, with no discharge available. 
• Use available exemptions —Personal asset exemptions are powerful tools in bankruptcy. Federal and state laws allow for certain categories of property to be protected from creditors. To maximize these protections, owners should organize their personal financial affairs well in advance of filing. Also, avoid converting non-exempt assets into exempt ones immediately before bankruptcy, as this can be seen as a fraudulent transfer.

Protecting personal assets as a small business owner requires foresight, meticulous separation between personal and business affairs and careful navigation of legal requirements. Above all, retaining an experienced small business bankruptcy attorney early in the process will help you understand your options, maximize exemptions and avoid missteps that could jeopardize the process.

The Law Offices of Michael Jay Berger in Beverly Hills helps small businesses dealing with excessive debt obtain the benefits of bankruptcy protection and reorganization. Please call 310-271-6223 or contact us online to schedule a free consultation.