Does Business Bankruptcy Eliminate My Personal Liability?

Northern California is filled with hard-working people. Many of those folks are small business owners. But running a small business can be a struggle, especially in a volatile economy. It is a great thing that inhabitants of the Sacramento Valley are proactive entrepreneurs. From general contractors to orthodontists, there are examples of what makes the Sacramento community great. However, when business wanes or taxes get out of hand many small business owners are left looking for solutions. Bankruptcy may be that solution.

Sole Proprietorship

Depending on the structure of the business, the owner may or may not be personally liable for the debts of the business. Sole proprietorships do not create a separate legal entity from the owner. Therefore, the business cannot file a bankruptcy by itself. The owner and business are one in the same. When the owner files Chapter 7 bankruptcy, the business does as well. Business debts and personal debts are treated the same and may be discharged. Depending on the value of the assets of the business, they may be protected by using exemptions. This may allow the owner to wipe out the overbearing debt, but still continue to operate the business.

One recent bankruptcy in the Eastern District of California was filed by a doctor whose sole proprietorship included multiple offices. One particular office was underperforming and forced him into the bankruptcy. Through the process of the bankruptcy, however, he will likely be able to shed the burden of the office that is losing money and refocus on the thriving locations.

Partnerships, Corporations, Limited Liability Companies

Unlike a sole proprietorship, a partnership is a separate legal entity. That means the partnership itself can file Chapter 7 bankruptcy. Also unlike a sole proprietorship Chapter 7, there is no discharge and no exemptions available. Therefore, if the partnership files a Chapter 7, the trustee will shutter the business and sell all the assets to satisfy the creditors. Depending on the type of partnership, the partners may be personally liable for some or all of the remaining debt after liquidation.

A Limited Liability Company, or LLC, and a Corporation are very similar for the purposes of filing Chapter 7 bankruptcy. A business Chapter 7 is beneficial because it is a fairly simple way to liquidate a business. This is mostly because the burden of selling assets and satisfying creditors is shifted to the trustee. Be warned, though: if the owner personally cosigned for a business debt, she will likely still be personally liable for that debt. In that case, the business bankruptcy may need to be followed up with a personal Chapter 7.

The Means Test

The “Means Test” is part of the Bankruptcy Code that determines whether the debtor has enough disposable income to pay back some of the creditors. Basically, the test compares the debtor’s average income during the six months prior to filing bankruptcy with the median income in the state where the bankruptcy is filed. In a business case, meaning that the debt is primarily business debt, the debtor doesn’t need to complete the means test at all. This allows a debtor who would otherwise be ineligible for Chapter 7 to qualify for one.

The Bottom Line

Small business owners know that there are ups and downs when running a business. Sometimes that means bankruptcy. In that case, it is important to consult a bankruptcy attorney who has experience with business bankruptcies, because they tend to be more complex than most personal bankruptcies. Don’t feel guilty because your business is having a rough time. Get some help and get back on your feet.