Using Chapter 7 to Wipe Out Personal Liability for Business Debt

Many small businesses struggle to stay afloat and eventually reach the point where debt becomes unmanageable. If you are an owner or part owner of a business in that situation, you may be wondering whether you are liable for your company’s debts and whether filing a Chapter 7 bankruptcy can protect you and your personal assets. The answer depends mainly on how your business is structured.

If you are a sole proprietor, you are personally responsible for your business’s debts. The good news is that you can file a Chapter 7 in your own name to discharge all qualifying unsecured debt, both personal and business. This can erase debts such as back rent, loans, utilities, lease and contract obligations and personal loans.

Because a sole proprietor is treated as an individual in Chapter 7, you can declare exemptions to protect both personal and business property. If you run a service business, you might be able to continue operating if you want to. But if your business has used expensive equipment and supplies, those items probably won’t qualify for an exemption and would be sold by the trustee, which might mean you can no longer operate.

Bankruptcy law applies differently to small businesses other than sole proprietorships, such as these:

• General partnerships — Filing for Chapter 7 does not discharge the business debt, for which all partners are personally liable. The Chapter 7 trustee will liquidate the business assets to repay creditors and can go after the partners’ personal assets as well. However, the partners can each file their own personal Chapter 7 bankruptcy case.
• Limited partnership — These are treated the same as general partnerships, except that the limited partners are safe from personal liability.
• Limited liability partnership — This structure eliminates personal liability for business debts of all partners.
• Corporation or LLC — These entities can file a business Chapter 7, under which the company is liquidated by the trustee and ceases to exist. Owners are not liable for business debts unless they signed a personal guarantee or failed to follow certain legal formalities that would hold them harmless from the company’s creditors.

If you run your company as anything other than a sole proprietorship, then you will need to determine if you personally guaranteed any business loans. For example, a lender may have required you to co-sign for a business loan, thus making you personally liable if the business fails to pay. Certain personal guarantees can be eliminated in Chapter 7, and that is a subject that your lawyer will need to analyze.

Every small business bankruptcy situation is different, and the Law Offices of Michael Jay Berger in Beverly Hills is experienced in handling a wide range of business debt workouts. My team offers a free initial consultation and can explain whether a business and/or personal bankruptcy would benefit you. Call 310-271-6223 or contact me online to arrange your consultation.