What Happens If I Own a Business And File a Personal Bankruptcy?

Posted by Wesley Scott on February 3, 2017 at 11:30 AM
Wesley Scott

after_business_failure.jpgThis is a source of great confusion in the marketplace. If you own a business, does the business need to file bankruptcy or you? Can I just file on business debts and not my personal debt? These are all great questions.

SOLE PROPRIETORSHIP

Filing bankruptcy is the opposite of poker. In poker, you get to hide your cards from everyone else, including the dealer. You don’t show your cards to anyone else right? Well, when you file bankruptcy it is just the opposite. When you file bankruptcy, you must show all your cards to the bankruptcy trustee and your creditors.

If you are operating as a sole proprietor, you are liable for all of the business debts. There is no shell that protects you from the business debts. Yes, I realize you are in debt because of the business, but you are the one liable for the debt at the end of the day.

So, if you are filing a chapter 7 or chapter 13 bankruptcy in Minnesota, you must disclose all of your assets, including your business assets, and you must disclose all of your debt, including business debt- since you are the one ultimately responsible for the debt.

Again, while the reason for the bankruptcy might be your business, the bankruptcy filing requires you to disclose it all. I always tell clients, the person you are trying to protect is you!

CORPORATIONS

What if you own a corporation (like an LLC or S or C corporation)? Again, if you file bankruptcy, you must disclose all of your assets. So, if you own 75% of ABC LLC, you must list your ownership of those shares. Corporations, unlike a sole proprietorship, is a different entity unto itself.

A corporation can file a bankruptcy- a sole proprietorship (the business itself) cannot. When you own a corporation, the issues can get tangled because often the corporation will owe a creditor money but so will the shareholder. How is this so? Well, most corporations are mom and pop type corporations. They are smaller in size and typically have very little in the way of assets.

If you own ABC CONSULTING INC, the company may own some accounts receivable and a computer or two but the business is really you! Do you think a lender would lend money to this business without you, the consultant, personally guaranteeing the debt too? Doubtful. And that is why the issues become tangled.

Let’s take an example to illustrate the point better. Suppose Carl owns 100% of ABC CONSULTING INC.

ABC CONSULTING INC. owns no real estate, has a small balance in the check book of $300.00, owns two computers worth $500.00 and has accounts receivable of $10k. So, the business has a value of $10,800.00. Often, the “blue sky value” or the equity a business like this has is limited because presumably Carl’s customers like Carl not you or me.

So, if Carl quits the business, or sells the business, there is no guarantee Carl’s customers would stay with you or me. So, much of the time there is little other value to the business.

For these reasons, banks are reluctant to lend the corporation money itself. If Carl quits, the bank is left with maybe $10,800.00 in value. If the bank lends the corporation 50k the bank would stand to lose close to 40k in money.

Because of this, the bank will often want the shareholder of the corporation to pledge his personal liability for the debt too. That way, if the corporation fails, the bank can pursue the shareholder too. Instead of recovering $10,800.00 in value, the bank has a chance of collecting the balance of what is owed to them through the shareholder.

ONE CORPORATION AND ONE PERSON- BUT TWO SOLUTIONS

Because the shareholder will often pledge their personal liability on corporate debts, two decisions must be made. One, does the individual shareholder need to file bankruptcy? Often the answer is yes. The second, question is, assuming the corporations debts exceed the value of the corporation, what do you do with the corporation?

If the shareholder wants to continue the business, it will be hard to use the same corporate shell because the corporate creditors can sue the corporation and levy on the corporation’s bank accounts. Well, that sucks. So, what do you do?

Often, the shareholder will file a bankruptcy and then let the corporation go defunct (stop operating the corporation and either dissolve it by statute or stop paying the registration fees and the state will administratively close the corporation.)

In most instances, the shareholder lets the corporation go defunct and then starts to operate under a different name. The shareholder may start a new corporation or operate as a sole proprietor. If there are assets that remain in the old corporation, you will want to meet with a business lawyer to make sure any asset sales to a new corporation pass state and federal laws regarding the transfer.

In many cases, there is so little in the way of assets, there is not much to be transferred anyway. Some shareholders choose to file a bankruptcy for the corporation too. Often, it is easier to operate as a different entity than it is to file a bankruptcy for the old corporation. I have been practicing law for nearly 20 years and I might have filed one chapter 7 bankruptcy for a corporation. In most cases, dissolving the old corporation or letting it go defunct is the way to go.

CONCLUSION

It can be a bit confusing to own a business entity that has caused you to incur debt and wonder how the strands of bankruptcy law intertwine with the realities of a broken business. Much of the time, it comes down to you, the person who has signed the personal guarantees.

At the end of the day, the usual result is the owner files a bankruptcy and the shell of the entity, the corporation, usually gets dissolved or goes defunct. The owner/debtor, if they want to continue in business, will usually operate as a different entity.

Of course, if there is value to the corporation- in other words, the corporation’s assets exceed the liabilities, the trustee may then take over as shareholder and liquidate the shares of the company. By liquidate, I mean reduce the shares to money by selling the corporation to someone else. This does not happen very often.

Topics: Bankruptcy

Take the first step toward  getting your life back  Let us help you get started on your road to a debt-free life Sign Up for a Free Consultation