Whether you or your business needs to file for bankruptcy is not always clear cut? There are a number of factors that can affect whether you or your business should file for bankruptcy. These include the business form, liability for business debts, and assets owned. So it’s certainly understandable that there is much misunderstanding as to what type of bankruptcy you should file.
One of the main areas of misunderstanding involves the most important benefit of bankruptcy, the discharge of debts. More specifically what debts get discharged in a business bankruptcy and which do not?
WHY IS IT CRUCIAL TO DISTINGUISH BETWEEN DEBTS OF THE BUSINESS vs. DEBTS OF THE INDIVIDUAL?
A necessary starting point in dealing with which type of bankruptcy to file is to know exactly who is legally liable on the debt. If you are contemplating bankruptcy to get rid of a liability, you first need to know who is legally liable on it. Otherwise the bankruptcy case may discharge one person’s or entity’s liability but leave some other person or entity still liable.
This is especially true with business debts, because of the distinction between the potential liability of the business and that of the business owner. There can be many misconceptions about this, which is a further source of confusion about what business debts can be discharged and which can’t.
In a nutshell, if your business is in the form of a sole proprietorship, you are personally liable for all of the debts of the business. For debt liability purposes the sole proprietorship is not a separate legal entity, therefore it cannot be liable for any debts of itself. If on the other hand your business is in the form of a corporation or limited liability company (LLC)—or limited liability partnership (LLP) or other legally recognized type of business entity—the corporation or other type of business entity can itself be liable for the business’ debts. Whether or not it is depends on whether it contracted to be liable—whether it was a party to the debt agreement with the creditor. Whether the individual owner is also personally liable (or is liable instead of the business) also depends on whether he or she is a party to the debt agreement, either directly or as a guarantor.
CAN THE BUSINESS OWNER’S INDIVIDUAL BANKRUPTCY DISCHARGE THE DEBTS OF THE BUSINESS?
If the business is a sole proprietorship, as just mentioned, the business itself cannot be separately liable on the debts, so the discharge of the owner’s personal liability wipes out the debt for all purposes (assuming that no one else co-signed or guaranteed the debt).
If the business is a corporation or some other type of legal entity, AND if that business entity is contractually liable on the debt, then the owner’s individual bankruptcy would NOT discharge the business’ separate liability.
So, whether the owner’s bankruptcy leaves the business itself still owing the business debts depends on the type of business entity and whether it’s contractually liable on the debts.
CAN THE BUSINESS ENTITY’S SEPARATE BANKRUPTCY DISCHARGE THE INDIVIDUAL DEBTS OF THE BUSINESS OWNER?
No. A bankruptcy case can only discharge the legal liability of whichever person or entity that is filing that case. If a business corporation files a bankruptcy, that case does not affect the liability of the business owner (or anyone else) who is also liable on the debt.
DOES THIS MEAN THAT IF MY NOW-CLOSED BUSINESS WAS NOT A SOLE PROPRIETORSHIP THAT I HAVE TO FILE BOTH A BUSINESS BANKRUPTCY AND A PERSONAL ONE AS WELL?
Often you only need to file an individual bankruptcy to deal with whatever personal liability arose out of your closed business—debts you are directly liable on because they were taken out in your own name, or were co-signed together with the business entity, or were guaranteed on its behalf. The business entity often has no need to file its own bankruptcy—in spite of debts that it owes—if it no longer has any meaningful amount of assets. The separate liabilities of the business entity essentially die with the business.
If the business entity DOES still hold assets in its name, talk to a competent business bankruptcy attorney about whether those assets would best be liquidated through a Chapter 7 bankruptcy case filed by that entity, or through some other appropriate means.