Whether you can be held personally liable for the debts of your business will depend on the business structure and whether you agreed to be personally responsible for any business debt. Read on to learn more about when you could be held personally liable for the debts of your business.
(You’ll find more helpful information in Small Business Bankruptcy.)
You’re probably aware that the type of business dictates whether you can be forced to use your personal assets to pay the business debt. Specifically, a sole proprietor will be responsible for business debts, as will most partners in a partnership.
By contrast, the purpose of a corporate structure is to shield those with an ownership interest (such as a stockholder) from personal liability. For instance, those with ownership interests in a corporation, an LLC, and certain other hybrid entities aren’t personally responsible for paying business debt.
Of course, exceptions apply. For instance, certain tax obligations must be paid by interest holders if the business fails to fulfill its responsibilities. And, creditors can “pierce the corporate veil” and seek payment from shareholders when certain corporate formalities aren’t observed. (You’ll find more information below under “Types of Business Structures.”)
There’s another way that any business owner can end up liable for a business debt—signing a personal guarantee. This happens when a new business, or an established business without much in the way of assets, ask for credit.
A bank, lessor, or supplier knows that if the business fails—which can be common—the business won’t pay the debt. So, before agreeing to financing or entering into a lease, the creditor requires the business owner to agree to be personally liable for the debt if the business fails to pay. Such agreements are called “personal guarantees.”
You’ve likely signed a personal guarantee if your business has:
Personal guarantees should be taken seriously. Because a business owner usually must provide proof of assets before entering into a personal guarantee, a failed business can be costly.
It’s rare for a business that’s closing to file for bankruptcy. (You can find out why in Will Bankruptcy Help If I Want to Continue My Business?) However, it’s fairly common for someone liable for a business debt, or who has signed a personal guarantee, to wipe out it out by filing individual bankruptcy, such as in a Chapter 7 case.
Although most people must meet certain income requirements to qualify for a Chapter 7 discharge (the order that wipes out dischargeable debt), if your business-related debt is more than your consumer (personal) debt, you’ll qualify even if you have significant income. Why? Because someone who files a “business bankruptcy” can avoid taking the income-qualifying Chapter 7 means test.
Keep in mind that you’re only allowed to keep so much property in Chapter 7 bankruptcy. So if you own more property than you can protect with bankruptcy exemptions, you’ll want to be sure that the value of the property you’ll lose is less than the total debt you’ll wipe out. Of course, another approach is to retain an attorney to negotiate down the business debt or personal guarantee.
(Find out about keeping nonexempt property in bankruptcy.)
A sole proprietorship isn’t a separate legal entity. You’re likely a sole proprietor if you’re the only owner of your business and you haven’t incorporated or set up a specific form of business entity. You and your business are equally liable for debts incurred by the business.
Since a sole proprietorship does not offer limited liability to its owner, creditors of the business can go after your personal assets in addition to business assets. This means that if the business does not have sufficient assets, creditors may sue you and try to collect the debt by taking your house, car, or other personal property.
A partnership is a business entity that’s owned by two or more individuals. In many respects, liability is more like that of a sole proprietor than a corporation, with some exceptions for hybrid versions.
A corporation is an incorporated entity designed to limit the liability of its owners (called shareholders). Generally, shareholders are not personally liable for the debts of the corporation. Creditors can only collect on their debts by going after the assets of the corporation.
Shareholders will usually only be on the hook if they cosigned or personally guaranteed the corporation’s debts. However, shareholders may also be held liable if a creditor can prove corporate formalities weren’t followed, shareholders commingled personal, and business funds or the corporation was just a shell designed to shield liability. This is called piercing the corporate veil.
Similar to a corporation, an LLC offers limited liability to its owners (called members). Generally, members are not liable for the debts of the LLC unless they cosigned or guaranteed the debt personally. However, like a corporation, creditors may also be able to go after the members’ personal assets by piercing the corporate veil.