Should You Use Personal Credit Cards to Prop Up a Struggling Business?

My colleague, Kurt O’Keefe, recently wrote a post on this blog about tools available to small business owners that can be used to avoid bankruptcy.   Like Kurt, I frequently speak to small business owners who find themselves out of cash, out of inventory and facing huge personal liability from shopping center landlords, equipment vendors and credit card lenders.

Often I have to advise these small business owners not to file right away because of the risk of challenges from one or more creditors.  Specifically, business owners who use personal credit cards to prop up a failing business are at great risk for dischargeability complaints under Section 523 of the Bankruptcy Code.

As Kurt writes, careful planning and cash reserves can improve the chances at business success, but what about those times when your market changes or some unexpected event causes a drop in revenues?

Business owners are optimists by nature.   If you own a small office supply store, it is easy to discount the risk posed when a Staples and an Office Depot both open within a few miles of your store.   Your customers are loyal and will gladly pay a little more for supplies because they know you, trust you and appreciate superior service.  Right?

In my experience small business owners will hang on for months or even years after an objective observer would have concluded that the owner’s business model no longer works.  I recently filed a Chapter 7 case for a retail business in which the owner had racked up over $500,000 in credit card debt used to keep his business afloat.  In his case, the drop in sales occurred first after the “dot com” crash in 2000 and secondly after September 11, 2001.  He had been hanging on ever since, using his personal credit cards to finance his business.

In cases like this, there is a good chance that one or more of the credit card lenders will object to the discharge of some or all of the debt to that particular lender.  The lender will argue that the debtor knew or should have known that he would not have the resources to pay back this debt.  My client may very well walk out of bankruptcy still owing $100,000 or more.  $100,000 is better than $500,000, but it is still a lot of money.

So, if you find yourself tapping into personal credit cards to cover business expenses, it may be time to seriously look at the viability of your business.  No one wants to admit failure but you are better off cutting your losses rather than delaying the inevitable.