Business bankruptcy: whose debt is it?

21 Aug Business bankruptcy: whose debt is it?

Small business owners feel as though they and their business are one. Before we can assess whether a bankruptcy filing is advisable for the owners or the business, we have to separate the business from those who operate the business .

When the business is a sole proprietorship, the owner’s feeling is also legally correct. There is no legal distinction between the enterprise and the person who owns it. They are one, in law.

It’s different when the business is a separate legal entity, a corporation or an LLC. These entities are their own legal “persons” who can incur their own debt. Generally, the owners of one of these entities are not automatically liable for the entity’s debts. After all, if you own shares in General Motors, you aren’t personally liable for GM’s debts.

So, if the debt stands in the name of the entity and the owners haven’t guaranteed the debt in writing, the entity’s debts don’t impact the owners.

It’s usually the reverse pattern that I see: the entity may be liable for very little debt because the owners have financed business operations with the owners’ credit cards. Credit card companies have elaborate marketing campaigns to promote use of their brand of plastic for business .

My clients often assume that the “business credit card” is a debt of the entity, because the entity’s name is embossed on the card. Not necessarily.

The entity is liable only if it signed the credit agreement. We often find that the corporation’s name is only there to make the card holderlook and feel ” businesslike.”

When the debt is largely the responsibility of the owners, we can file a bankruptcy case for the owners and the entity business goes right on operating, now freed from servicing the credit card debt of the owners. The shares of stock in the entity are an asset of the owner’s bankruptcy estate, but they usually have no market value.

Many small, incorporated businesses can survive as a result, while the owners get a fresh start. And the deciding factor was knowing just exactly who was liable for the debt.

See also:

The trouble with small businesses

Can the corporation file Chapter 7

Image courtesy of Leo Reynolds.

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Cathy Moran, Esq.

I'm a certified specialist in bankruptcy law (California State Bar Board of Legal Specialization) practicing in the San Francisco Bay Area for more than 30 years. In addition to practicing bankruptcy law, I train new practitioners at Bankruptcy Mastery.
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