In the course of handling many personal bankruptcy cases for small business owners over the years I’ve often run across clients who misunderstand the dynamic between their debt, their business’s debt and how the two are treated in a personal bankruptcy case.
In most instances the great majority of small business owners have personal liability for their business debt. The majority of lenders want someone on the hook especially in small business situations as most small companies or small business enterprises are under capitalized. The lender will take personal guarantees in order to minimize the risk.
In a personal chapter 7 bankruptcy case any business debt that the debtor is personably liable for is discharged or wiped out in the personal bankruptcy case. This is in regard to any unsecured debt. Any debts that are collateralized are, of course, subject to the terms of the security agreement as those debts are not discharged in bankruptcy cases. While a debtor’s personal liability is discharged the business entity itself is still liable for the business debt whether the business is a sole proprietorship, a corporation, an LLC, a partnership…whatever. Some have assumed that once they did a personal business case that the debt was discharged in it’s entirety as to both them personally and to the business entity itself. Not so. One cannot file a bankruptcy case and absolve anyone or anything else of it’s liabilities. In order for the business enterprise to shed it’s debt the business must file bankruptcy as well. There are a couple of schools of thought on whether that makes any sense.
Some would say that if it is a business that is no longer functioning and has no assets to speak of…why bother? Let the creditors pursue a defunct business all it wants. They will still come up empty. Others would say it makes sense to file a bankruptcy for the defunct business for a couple of reasons. In Minnesota, the state that I practice in, there is a statutory framework for dissolving a corporation I think it expensive and cumbersome. I am assuming other states also have a similar statutory process for that as well. In my estimation a bankruptcy filing does everything we need to do in order to close it up and settle the creditor claims quicker, easier and cheaper. Second, although the business may not have any assets and it would be fruitless for creditors to pursue the business there is always the problem of who the creditors are going to be hassling while they and their lawyers are going through what they think they need to do in order to do what they think will help them in the collection process. The business owner is usually the registered agent for the business. That person is the person who is going to get the dunning letters, the collection calls, etc. He or she is also going to be the one being served the summons and complaints to initiate a lawsuit and will be the one who is tapped on the shoulder when the creditor is engaging in discovery to determine whether there are assets that they can execute on in order to satisfy their claims…which means attending depositions, answering interrogatories, etc. None of which is very comforting or a good use of time.
Most of my clients choose to file both personal and business bankruptcy cases. They do so in order to put all of the stress and troubles related to the business debt issues behind them. A bankruptcy filing for a failed business is a relatively seamless and orderly way to put all creditors on notice that there are no assets as all the business’s assets (if any remain) are scheduled on the paperwork filed with the bankruptcy court for all to see. If the creditors have claims they file those with the bankruptcy court and will take part in the distribution of any remaining assets (again…if there are any) under the supervision of the interim trustee appointed by the United States Trustee’s Office to adminster the case. It is a nice, clean and tidy way to clear up the debt and take care of any remaining creditor issues. Generally speaking it is a matter of money. Those that can afford to file both cases generally will do so. In my opinion it is a good expenditure….lots of bang for the buck considering the peace of mind that it will bring.