When You Can't Pay Your Business Debts: Personal Liability and Bankruptcy Options

If your business is in the red, take steps to protect your personal assets.

By , Attorney

If your business is in distress -- you owe a lot of money but you can't pay -- your creditors will probably threaten legal action against you personally. How much your creditors can collect will depend on how your business is organized (for example, sole proprietorship or corporation), whether you personally guaranteed any repayments, and whether you decide to file for bankruptcy. Learn which debts you are personally liable for. If you have personal liability for some of your business debts, this will influence your decision whether to close your business and/or file for bankruptcy.

The Bankruptcy Option

If your business bank account is empty and you're in a lot of debt, you might be considering bankruptcy. Although it won't guarantee you'll get to keep your house or other property, it can at least give you some breathing room. And you'll be able to keep the basic necessities of life (clothing, furniture, and so on), as well as some or all of your equity in your house and car.

Business vs. Personal Bankruptcy

If you're a sole proprietor, you can file for either Chapter 13 or Chapter 7 bankruptcy. Either can be used for personal debts or business debts.

If you're a corporate shareholder, LLC owner, or partner in a partnership and you've signed personal guarantees or pledged collateral for business loans, putting your business through bankruptcy won't protect your personal property.

So let's assume you want to file for personal bankruptcy, either using Chapter 7 or Chapter 13. In a Chapter 7 bankruptcy, your assets (except for property that's exempt under state or federal law) can be sold to pay off your creditors. At the end, all your debts that are eligible for discharge in bankruptcy will be wiped out.

In a Chapter 13 bankruptcy, you propose a repayment plan where you repay part or all of the debt over three to five years. You don't lose any property in a Chapter 13 bankruptcy; instead, you pay off your debts using your income. (For more information on the differences between Chapter 7 and Chapter 13 bankruptcy, see Bankruptcy FAQ.)

How Bankruptcy Might Help

When you file for bankruptcy, something called an automatic stay immediately stops your creditors from foreclosing on your house or any other personal property. This can buy you time, if nothing else.

Beyond this, the type of debt you have will affect how and whether bankruptcy can help you. Bankruptcy wipes out most unsecured debts (for example, credit card bills and lawsuit judgments), but secured debts are a bit different. If you pledged property -- such as your home -- as collateral for a loan, the creditor is entitled to take the property, even if you file for bankruptcy. Although you may not have to pay back what you owe on the loan, even if it's more than your home is worth, you will lose your home. You may have the right to keep some of your equity in the home, however.

Filing for Chapter 13 might be a better option if you're faced with losing property you really want to keep. In Chapter 13, you can include the debt in your repayment plan, spreading the payments out over five years. This gives you a better chance of making good on the debt, which will allow you to keep your property.

If you're in imminent danger of losing your family's home or livelihood, get in touch with a knowledgeable small business attorney with bankruptcy experience.

Further Information

For more information, see Nolo's section on on small business bankruptcy. Alternativey, if you're considering selling most or all of your business assets, see Selling Your Business: Eight Steps. When everything else has failed, see Closing Your Business: What You Need to Do.

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