Bankruptcy is a great way to reorganize your financial life and have a fresh start. One of the primary purposes of filing for bankruptcy is to help individuals or businesses with overwhelming debts to eliminate liability over these debts. While bankruptcy is beneficial, it can have adverse and long-lasting negative effects. Business bankruptcy is separate from personal bankruptcy. However, if you are actively involved in running your business, it could suffer when filing for personal bankruptcy.
In this case, the effect on your business will depend on whether it is a sole proprietorship, partnership, or a limited liability entity. Bankruptcy is a complicated and unusual process since the qualifications are essential. Therefore, before you decide to take this route, you must understand both the benefits it offers and the adverse effects that could result from this action. Bankruptcy law is challenging to understand, and the process may be complicated. Therefore, enlisting the services of a bankruptcy attorney is vital.
Effects of Personal Bankruptcy on your Business
Unfortunately, owning a business does not mean that you cannot accumulate debts in your personal life. When you have too much debt to handle, you can seek relief through bankruptcy. Although this will help you reorganize your finances, it could impact your ability to retain ownership of your business. The effects of a bankruptcy on your business will vary significantly depending on the type of business. Small businesses are structured in four main ways:
- Sole proprietorship. A sole proprietorship is a business owned by one person. You and your business are considered a single entity for this type of business. If you pay your taxes using the business proceeds and fail to pay business taxes, you will be liable for business expenses. The bankruptcy trustee can come for your business assets to pay the creditors when you file for personal bankruptcy. Ultimately, one of the biggest factors will depend on how much the business assets are worth and whether you can properly exempt them using the given exemptions.
- Partnership business. This type of business is run by two or more owners, with all partners contributing money and paying taxes for their portion of income on the business. Depending on what type of partnership it is, you are either liable for business debts only up to your investment amount or possibly the entire amount.
- Limited Liability Company. An LLC is an entity that is independent of its owners. If you own this type of business, you are not liable for the business debts unless you sign a personal guarantee. Doing this authorizes the creditor to come after you personally if the entity is unable to pay the debt.
- Corporation. A corporation is a separate entity that shareholders own. Like the LLC, shareholders in a corporation are not responsible for business debts unless they sign personal guarantees on the debt.
The Fate of your Business in Chapter 7 Bankruptcy
Chapter 7 bankruptcy involves liquidation of your assets to pay back your creditors. The court-appointed bankruptcy trustee is responsible for selling your non-exempt assets. You will keep your exempt assets for this type of bankruptcy and all your other dischargeable debts are forgiven. If you own a sole proprietorship, the business assets are not treated differently from your assets. If the assets are non-exempt, the trustee can sell them to pay some of your debts.
While your business is considered the same entity in a partnership, you share the business assets with other partners. While the results are the same----the trustee sells the non-exempt assets to pay the creditors---it is a more difficult task since a third party (i.e., your partner) is involved.
Filing for personal bankruptcy as an LLC owner is complicated. Although the business assets are safe from liquidation by the trustee, your equity and interest in the business could often be at issue. If you cannot protect your LLC with an exemption, the trustee may be able to take the following actions:
- Sell the business assets to pay off your debts. There is no distinction between business assets and personal assets during bankruptcy. Therefore, any property that is not protected can be used to pay your personal debts.
- Sell your ownership interest in the business.
- The bankruptcy trustee can seek permission from the court to continue running your business so they can sell it as a going concern.
- Abandon the business. If the bankruptcy trustee finds your business assets not valuable to cover payments for your creditors or there are no buyers, they could abandon them back to you.
If you own 100% interest in an LLC or corporation that is unsellable, you can exempt your shares from the ownership interest. However, it may be challenging finding a specific exemption under bankruptcy laws. When a trustee has to go through court to acquire a business asset that is not very valuable, they may decide to let it go.
If your business lacks liability insurance, filing for liquidation bankruptcy could result in its closure. To understand whether the bankruptcy trustee will sell part or your entire business, you need to understand the basics of chapter 7 bankruptcy. When you file for this type of bankruptcy, the property rules apply for business and personal purposes. The following are some typical chapter 7 bankruptcy basics that could determine the fate of your business:
- You can protect some of your property through the bankruptcy exemptions. If the property is exempt, it cannot be part of the liquidated assets to pay your creditors.
- Some business exemptions are not common, and the state will be responsible for deciding whether the property is under state or deferral exemption.
- Any property you cannot protect with a bankruptcy exemption will be lost in the liquidation.
- If you feel that liquidation bankruptcy will affect your business, you can opt for other categories of bankruptcy.
Selling of Business Assets in Chapter 7 Bankruptcy
When you decide to file for liquidation bankruptcy, you must consider the fate of the business assets you can’t protect. The bankruptcy trustee deals with your non-exempt assets by either selling them to pay creditors or abandoning them when they are not valuable. Some of the factors that the trustee may consider when coming for your business assets after a personal bankruptcy include:
- Whether or not your stocks can be transferred freely
- The nature of your businesses. Often, a business that majors in personal service will require the primary owner to function. In this case, the bankruptcy trustee will not have anything to sell and recover money from creditors.
- The amount of effort required to sell your business or the assets
- Whether or not you can buy back the business from the trustee
Your Business in Chapter 13 Personal Bankruptcy
Unlike chapter 7, chapter 13 bankruptcy does not prompt liquidation of your assets. Although your debts may be overwhelming, filing for this type of bankruptcy means that you have to pay at least some of your creditors. However, the court allows you to create a three to five-year repayment plan depending on your income. Such an arrangement will enable you to make more manageable monthly payments.
Chapter 13 bankruptcy does not affect the ownership of your business. However, if you own a partnership or sole proprietorship, you and your business are inseparable. Your income and assets are scrutinized when the court grants your chapter 13 bankruptcy. Any income you accrue from the business is expected to be part of the repayment plan.
Although Chapter 13 is a safe type of bankruptcy for your business, it may not be available for everyone. Chapter 13 is for individuals with a regular income. If you cannot show to the Court that you have regular income, you cannot seek bankruptcy relief under this chapter. Additionally, your repayment plan must result in your creditors recovering a certain percentage of what you owe them. Therefore, if you do not have enough money to pay that percentage of the debts you owe, you may have to deal with the repercussions of liquidation bankruptcy.
Many issues surrounding personal bankruptcy and your business depend on how liquid your business assets and ownership are. Mostly, liquid assets are easy to dispose of and recover the amount you owe to creditors. However, qualifying for chapter 13 bankruptcy will ensure that you don’t close your business for financial troubles in your personal life.
Saving your Business from Personal Bankruptcy
If you own a sole proprietorship business, you and your business are viewed as one entity. Therefore, any effects of personal bankruptcy could impact your business. As a result, the bankruptcy trustee could sell your business assets to cover your secured debts. You can avoid losing your business by considering the following alternatives to bankruptcy:
- Debt settlement. If you do not want to undergo all the inconveniences that accompany bankruptcy, you can negotiate with your creditors, allowing you to pay less than you owe. In this case, a creditor must be willing to accept partial payments. Debt settlement works when you are in default. A creditor cannot forgive your debt if you can pay minimum monthly installments. Before proposing debt settlement, you must consider how the forgiven debt will affect your credit score. Also, this can sometimes result in a taxable event occurring based on how much debt was forgiven.
- Debt consolidation. Credit consolidation involves taking out a loan to pay your debts. You must have access to a credit line to take out a loan from a credit union or a bank for this to work. Most lenders will allow you to borrow against your house. However, seeking financial advice is crucial before you decide to consolidate.
- Sell your assets. If your debts are overwhelming and you are afraid that bankruptcy will affect your business, you can sell your assets to cover the debts. When you file for bankruptcy under chapter 7, the bankruptcy trustee will liquidate your assets to pay creditors. Therefore, you can opt to do it without dealing with the negative consequences of bankruptcy.
- Credit counseling. If negotiating worth your creditors and talking about additional loans to pay your debts does not work, you should consider seeking the services of a non-profit credit counseling firm. Credit counselors help you develop a debt management plan which you can afford. If the credit counselor can convince the creditors to lower your interest rates, you can avoid bankruptcy and the consequences that accompany the decision.
If bankruptcy is your only option out of your debts and financial turmoil, you can consider other options for protecting your business, including:
- Partner with more than one person. When your business is a sole proprietorship, your finances and business are considered a single unit. By partnering with multiple individuals, you can potentially avoid the effects of a personal bankruptcy on the business entity because you have additional resources (i.e., your partners) to help.
- Corporations. If your business is a corporation, the business can go bankrupt without the involvement of your personal assets. However, oftentimes the situation comes up that the person actually personally guaranteed the corporate debts. If this is the case, a personal bankruptcy could often be necessary as well.
Whether you file for bankruptcy under chapter 13 or Chapter 7, a trustee is appointed to oversee the bankruptcy. The role of the trustee is to investigate your financial life and make decisions that are aimed at ensuring that creditors are paid. If you have a business with valuable assets and file for bankruptcy, the bankruptcy trustee will make legitimate steps towards liquidating your business assets if you file Chapter 7. This could eventually lead to the closure of the business.
Find a Skilled Bankruptcy Attorney Near Me
Starting and running a business is not an easy task. After putting in all your effort and resources to the business, you want to protect it as much as possible. State and federal laws provide bankruptcy as a remedy for unmanageable debt. While declaring bankruptcy will help eliminate your liability to some of your debts and allow you to reorganize your financial life, this relief comes with a steep price. In addition to lowering your credit score, personal bankruptcy can impact your business significantly.
The specific effect of a bankruptcy on your ability to continue running your business depends on the type of business and the category of bankruptcy you file. There are many consequences caused by bankruptcy for business owners, management, and shareholders and may even result in business closure.
If you are considering personal bankruptcy and are worried about how the action will impact your business, it would be wise to consult with a skilled bankruptcy lawyer. At Sacramento Bankruptcy Lawyer, we offer legal guidance and representation for all our clients to navigate bankruptcy proceedings in Sacramento, CA. Call us today at 916-800-7690 to schedule your free consultation. In the alternative, please click HERE to be able to conveniently schedule your free consultation online.