What Chapter 11 Filers Should Know About Personal Liability

Unless a business is established as a sole proprietorship or general partnership, owners typically can avoid personal liability for most business debts. If a corporation or limited liability company (LLC) files a Chapter 11 bankruptcy, owners generally do not put their personal assets at risk.

There are exceptions, however. Personal liability may still attach in the following circumstances:

• The owner has guaranteed loans, lines of credit or leases. Personal guarantees are common in commercial lending and leasing. These obligations survive even if the business seeks Chapter 11 protection. In fact, some guarantees spring into effect only upon default or bankruptcy.
• If an owner guaranteed a secured loan and the collateral sells for less than the debt, the lender can pursue the owner for the deficiency. In addition, many cross-collateralized loan agreements tie multiple debts together, so that a default on one can trigger personal liability on others.
• Business owners may also face personal exposure if they commingle personal and business assets or liabilities, engage in fraudulent transfers, intentionally move assets to keep them away from creditors or otherwise breach fiduciary duties owed to the company or its creditors. 

Another potential liability is the Trust Fund Recovery Penalty (TFRP). Employers withhold what are known as trust fund taxes from employees’ paychecks, including Social Security and Medicare taxes. These funds must be remitted to the IRS. If a business fails to pay these taxes when due, the TFRP may be assessed against corporate officers, directors, partners and other responsible parties. 

California Labor Code section 558.1 creates another possible source of personal liability, since it allows employees to recover unpaid wages, accrued vacation pay and certain benefits directly from owners and other responsible parties, along with penalties for wage-and-hour violations.

Before filing Chapter 11, business owners should take practical steps to protect themselves and the company. These may include separating personal and business finances, reviewing any personal guarantees, avoiding transfers of business assets outside the ordinary course of business and ensuring payroll taxes and employee wages are paid to the extent possible. 

For certain small businesses, filing a Subchapter V — a streamlined version of Chapter 11 — may be a more effective path for owners to reduce personal liability. If the owner has personally guaranteed business debt, Subchapter V may help by reducing the guaranteed debt, stretching payments and preventing aggressive collection.

Seeking experienced legal advice early can help business owners evaluate their exposure and make informed decisions before filing for bankruptcy relief.

The Law Offices of Michael Jay Berger in Beverly Hills helps business owners throughout Southern California avoid personal liability through Chapter 11 bankruptcy. Schedule a free initial consultation by calling 310-271-6223 or contact us online.