Filing for Chapter 7 bankruptcy is a valuable option for corporations and limited liability companies (LLCs) that are going out of business. Read on to learn more about how Chapter 7 bankruptcy can help corporations, LLCs, and their owners.
Corporation and LLC Basics
In order to form a corporation or an LLC, you must file certain documents with the secretary of state and pay registration fees. When you incorporate your business or form an LLC, it becomes a separate legal entity. As an owner, you are considered a shareholder of the corporation or a member of the LLC. This means that the company has its own assets and debts that are separate from those of its owners.
(To learn more, visit Nolo's Business, LLC & Corporations Center.)
Liability for Corporate and LLC Debts
Since both corporations and LLCs are separate legal entities, they are liable for their own debts. The owners of the company are usually not personally on the hook for the obligations of the business. As a result, forming a corporation or an LLC is a common way to shield your personal assets from business debts.
However, you may still be held liable for corporate or LLC debts under certain circumstances. You can voluntarily make yourself responsible for business debts by cosigning or personally guaranteeing the loan or by providing your personal assets as collateral. Alternatively, a creditor can go after personal assets by proving that the corporation or LLC was a sham or an alter ego of its owners. This is known as piercing the corporate veil.
How Can Chapter 7 Bankruptcy Help a Corporation or LLC?
Corporations and LLCs do not receive a discharge by filing Chapter 7 bankruptcy. A business Chapter 7 is designed to liquidate the company’s assets and pay its obligations. Since exemptions are not available in a business bankruptcy, all assets of the corporation or LLC are sold and the proceeds distributed among its creditors according to priority.
The benefit of a Chapter 7 bankruptcy is the easy and orderly liquidation of the business. When the corporation or LLC files for Chapter 7, it becomes the duty of the bankruptcy trustee to sell off its assets and pay its creditors. This means that the owners don’t have to go through the hassle of settling up with the company’s creditors.
What If You Were Personally Liable for Corporate or LLC Debts?
Your corporation or LLC’s Chapter 7 bankruptcy does not change your obligation to pay the debts you were personally on the hook for. If a business debt you were liable for did not get paid off in the bankruptcy, that creditor can now look to your personal assets to satisfy the obligation.
Usually the simplest solution to this problem is to file a personal Chapter 7 bankruptcy yourself. Since you can discharge your debts in a Chapter 7 personal bankruptcy (unlike a business bankruptcy), your personal liability for business debts will be wiped out by the bankruptcy.
To learn more, check out Nolo's article, When You Might Be Personally Liable for LLC or Corporate Debt.
Disadvantages of Chapter 7 Bankruptcy for Corporations and LLCs
Filing a Chapter 7 means the end of the business. You will no longer be able to operate it or negotiate its sale to a third party under more favorable terms. Further, you can usually sell your company's assets at a better price than the bankruptcy trustee. So if you were personally liable for the company’s debts, you may be left with a larger personal liability than if you had negotiated with the creditors and sold the assets yourself.