If you are a struggling small business owner, filing for Chapter 7 bankruptcy may help save your business or provide a simple way to liquidate it. A personal Chapter 7 bankruptcy can also help you get rid of your personal liability for company debts. Read on to learn more about when you may be personally liable for business debts and when it makes sense to file a business or personal Chapter 7 bankruptcy.
(To learn about other types of bankruptcy for small business, see our Small Business Bankruptcy area.)
Are You Personally Liable for Business Debts?
The answer depends largely on the structure of your business. If you did not form a specific business entity and you are the only owner of the business, you are probably a sole proprietor. A sole proprietorship is not a separate legal entity -- which means you are personally responsible for all business debts and when you file for bankruptcy, you are really filing a personal bankruptcy.
If your business was formed as a partnership, corporation, or limited liability company (LLC), whether you are liable for your company’s debts depends on more factors. In a partnership, you are liable for business debts if you are a general partner but not if you are a limited partner. If your company is a corporation or an LLC, you are generally not liable for your company’s debts unless you cosigned or personally guaranteed the debt.
(To learn more, see Are You Personally Liable for Business Debts?)
How Does Chapter 7 Bankruptcy Work?
When a Chapter 7 is filed, an automatic stay goes into effect and prohibits most collection activities. A bankruptcy trustee is appointed and charged with selling off the debtor’s nonexempt assets to pay off its creditors according to their priority.
In a personal bankruptcy, all dischargeable debts are wiped out so the debtor is no longer required to pay them. In a business bankruptcy, there is no discharge and no exemptions. As a result, all business assets are sold and the proceeds are distributed among creditors.
(To learn the ins and outs of Chapter 7, see our Chapter 7 Bankruptcy area.)
How Can Chapter 7 Bankruptcy Help Small Business Owners?
The answer again depends on business structure. Below, we discuss how Chapter 7 bankruptcy affects each type of business and its owners.
Since a sole proprietorship is not a separate legal entity, it cannot file a Chapter 7 bankruptcy on its own. When a sole proprietor files a personal Chapter 7 bankruptcy, the business also files as a result. All business debts are treated as personal debts and get wiped out by the discharge. You can protect the assets of the business by using your exemptions. So with a Chapter 7 you can wipe out your debts and continue operating the business.
(To learn more, see Chapter 7 Bankruptcy for Sole Proprietors.)
A partnership is a separate legal entity and can file a Chapter 7 business bankruptcy. As we discussed, in a business bankruptcy there is no discharge or exemptions. So if your partnership files a Chapter 7, the trustee will close and liquidate the business by selling all its assets to pay creditors.
The partnership’s bankruptcy does not affect the personal liability of its partners. If there weren’t enough assets to pay off all creditors, they can go after your personal assets if you were personally liable for the debt. The trustee can also sue the general partners to pay any remaining creditors. So if you were on the hook for the partnership’s debts, you may have to file a personal Chapter 7 bankruptcy to discharge your obligations.
(To learn more, see Chapter 7 Bankruptcy for Partnerships.)
Similar to a partnership, a corporation can also file a Chapter 7 but it does not receive a discharge. The benefit of a business Chapter 7 is the simple and orderly liquidation it provides by placing the burden of selling assets and paying creditors on the trustee instead of the owners. Also, if you had cosigned or personally guaranteed a corporate debt, then you are still on the hook for it unless you file a Chapter 7 yourself.
Limited Liability Company (LLC)
An LLC is almost exactly the same as a corporation when it comes to bankruptcy and personal liability for debts. You can liquidate the business by filing a business bankruptcy but you must wipe out your own liability for business debts through a personal bankruptcy.
(To learn more about what happens when your business files for Chapter 7, see our Chapter 7 for Small Businesses area.)