Chapter 7 Bankruptcy for Partnerships
Learn about Chapter 7 bankruptcy for partnerships and how it may affect you as a partner.
If your partnership can no longer stay in business, filing Chapter 7 bankruptcy may provide an orderly way to close and liquate the business. Read on to learn more about Chapter 7 bankruptcy for partnerships and how it may affect you as a partner.
What Is a Partnership?
A partnership is an unincorporated business entity created when two or more individuals agree to jointly own and carry on a business. There are several types of partnerships that affect each partner’s personal liability for partnership debts.
(To learn more about partnerships, see the articles in our Partnerships area.
Who Is Liable for Partnership Debts?
A partnership is a separate legal entity responsible for the debts it incurs. However, depending on the type of partnership, each partner may also be held liable for the debts of the partnership.
If two or more individuals agree to jointly start a business but do not set up a particular type of partnership or entity, the result is a general partnership. In a general partnership, all partners are called general partners and they are all personally liable for the partnership’s debts. If the partnership can’t pay its debts, creditors can go after the partners’ personal assets to satisfy them.
A limited partnership is created by filing the necessary forms with the secretary of state. It requires at least one general partner but may have multiple limited partners. The general partner is fully responsible for the partnership’s debts. But limited partners are not personally liable for partnership debts.
Limited Liability Partnership (LLP)
An LLP also needs to be registered with the secretary of state by filing the required documents. In some states no partners are personally liable for the LLP’s debts but in others there must be at least one general partner who is liable. Further, certain states only extend limited liability protection to partners for negligence claims but not for contractual debts such as loans.
Can Partnerships File Chapter 7 Bankruptcy?
Yes. Partnerships are allowed to file a business Chapter 7 bankruptcy. However, unlike a personal bankruptcy, partnerships cannot receive a discharge and there are no exemptions. All partnership assets are liquidated and distributed to creditors. After everything is distributed, the bankruptcy is closed.
What Happens to the Partners’ Liability for Business Debts?
If a partner was personally liable for the partnership’s debts, his or her liability is not affected by the partnership’s bankruptcy. If the partnership did not have enough assets to pay off all of its creditors, they can go after the partner’s personal assets if he or she was also personally liable. However, partners can discharge their own liabilities by filing a personal bankruptcy.
Advantages of Chapter 7 Bankruptcy for Partnerships
Even though a partnership cannot receive a discharge, filing for Chapter 7 bankruptcy still provides many benefits. A partnership usually has multiple assets and creditors. When a Chapter 7 is filed, a bankruptcy trustee is appointed and charged with liquidating all assets and distributing the proceeds to creditors based on priority. As a result, this makes the process a lot simpler and more orderly for the partners because they do not have to worry about selling the assets and dealing with creditors.
Drawbacks to Partnerships Filing Chapter 7 Bankruptcy
When a Chapter 7 bankuptcy is filed, the partnership is closed and liquidated. There is no opportunity to continue the business or sell it to someone else. Further, the trustee will usually sell the assets for less than what you could have gotten for them. So if the partnership has a significant amount of assets that may be enough to pay off all creditors, it may be more advantageous to try to sell them yourself.
Also, if the partnership’s assets are not enough to cover its liabilities, bankruptcy law gives the trustee power to sue the general partners to recover the difference. So if you are a general partner you may find yourself the subject of a lawsuit by the trustee if the partnership files a Chapter 7.
To learn more about your bankruptcy options as a business owner, see Nolo's section on Small Business Bankruptcy.