Types of Bankruptcy
Businesses can file several types of bankruptcy, depending on the business structure. Corporations and limited liability companies can file Chapter 11 bankruptcy, which is a reorganization of the business. All types of businesses can file Chapter 7 bankruptcy, which is a liquidation, or sale, of assets to pay debts. Owners of sole proprietorships and partnerships can file Chapter 13 bankruptcy to create a repayment plan for their debts.
Sole Proprietorships and Partnerships
Sole proprietorships and regular partnerships do not offer liability protection to their owners. Legally, there is no distinction between the business and the owner or partner, so the owner or partner is personally liable for the debts of the business. Consequently, if the business files Chapter 7 bankruptcy, both personal and business assets are available for the court to liquidate to pay business or personal debts. If an owner or partner chooses Chapter 13, he must create a repayment plan including business and personal debts. However, Chapter 13 does not involve liquidating any assets, so it is unlikely that he will lose his home simply because he filed for Chapter 13 bankruptcy.
Corporations and LLCs
Corporations, LLCs and other similar businesses that must register with the state typically offer liability protection to the owners. Generally, the owners are not responsible for the debts of the business since the business is considered a separate legal entity. Thus, the bankruptcy court cannot take the owner’s personal assets to pay the business’s debts, regardless of the type of bankruptcy the business files. If the business files under Chapter 7, the court can only liquidate business assets.
Crossing Corporate Lines
In some cases, however, owners can make themselves liable for business debts even though the business structure should protect the owner from liability. When the owner personally guarantees a loan, provides personal assets as collateral for a business loan or personally cosigns for a loan, he is exposing himself to liability. In such cases, the business’s bankruptcy can affect the owner’s personal finances to the extent the owner made himself personally liable. If the corporation or LLC is a sham created to protect the owner’s assets, rather than a legitimate business, a creditor can go after the owner’s personal assets. This is called “piercing the corporate veil,” and requirements vary by state law. Generally, if the owner has not maintained corporate formalities or has used the corporate structure fraudulently, a court can pierce the corporate veil and make the owner’s personal assets available to satisfy business debt.