Many debts that might drive a business owner to file for bankruptcy can be erased by filing an individual Chapter 7 case. Filing will effectively discharge your personal liability for a business debt, but not the business debt itself.
If you’re wondering why, it’s because unless the business is a sole proprietorship, a business can’t discharge debt in Chapter 7. The business remains responsible for the obligation.
unsecured debts owed by a sole proprietor (such as debts to suppliers, consultants, and professionals like accountants or architects)
obligations under leases and contracts entered into by a sole proprietor (including commercial and residential property leases and leases to rent equipment), and
personal loans and promissory notes.
You might notice that none of the above debts are secured debts—debts for which you have pledged property as collateral. Secured debts get handled differently.
The lender can take back the collateral securing the loan if you don't make your payments, even if you file for bankruptcy. If you owe more on a secured debt than the collateral is worth, the difference (called a deficiency) becomes a debt that can be discharged in bankruptcy. You can learn more about how this works by reading Secured Debts in Chapter 7 Bankruptcy: An Overview.
Debts That Survive Chapter 7 Bankruptcy
Some types of debt aren’t dischargeable in Chapter 7 personal bankruptcy. Unless the trustee sells your property and uses the proceeds to pay nondischargeable debt, you’ll still owe it when your case is over, just as if you hadn't filed.
Some common types of nondischargeable debt include:
back child support, alimony, and other domestic support obligations
court-imposed fines, penalties, and restitution
certain tax debts—including recent back taxes, any back taxes for which you didn't file a tax return, trust fund taxes (the employee's portion of Social Security and Medicare taxes), and debts you took on to pay nondischargeable taxes (for example, if you took a cash advance on your credit card to pay your most recent tax bill)
presumptive fraud—debt for a luxury item purchased during the 90 days before you file or a cash advance taken within 70 days before you file (over a certain amount)
loans owed to a pension plan, such as money you borrowed from your 401(k)
student loans unless repaying them would constitute an extreme hardship
You can use Chapter 7 bankruptcy to wind down a business in a transparent manner, but better options usually exist. Not only does Chapter 7 bankruptcy hold special problems for partnerships, but filing Chapter 7 for a corporation or LLC might not be a good idea, either.
Instead, consider retaining a bankruptcy attorney or business lawyer. A lawyer is in the best position to advise you about your options when dissolving the business.
If you think a personal Chapter 7 bankruptcy might be the right option for you, you might want to pick up a copy of How to File for Chapter 7 Bankruptcy, by Attorney Cara O’Neill and Albin Renauer, J.D.
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