How Does Chapter 11 Business Bankruptcy Affect Personal Assets?

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When an entrepreneurial venture fails or begins to struggle, the small business owner may start to consider bankruptcy as an option to right the financial ship. However, as you consider those options, you may worry about the impact a Chapter 11 business bankruptcy will have on your personal assets and affairs. Understanding what a Chapter 11 business bankruptcy is can help you decide whether it is the right choice, and determine if your family is protected.

What is a Chapter 11 Business Bankruptcy?

A Chapter 11 business bankruptcy allows a company to reorganize under a new name, as a new legal entity, and create a confirmable plan of reorganization that resolves outstanding creditor claims according to the U.S. Bankruptcy Code. The company reorganizes as the “debtor in possession” and then creates a plan for the financial future of the company. A “confirmable” reorganization plan accounts for the business’s ongoing secured debt payments and tax obligations, while treating unsecured creditors fairly, usually satisfying their debts for substantially less than the amount owed on the balance sheet. Reorganization under a Chapter 11 business bankruptcy can be technical and often complicated, but it can allow business owners to carry on with their business while getting out from under certain debts.

Does Business Bankruptcy Affect Personal Assets?

Many small business owners, especially solo entrepreneurs and sole proprietors, never formally incorporate their business. That means you and your business are the same legal entity. When a sole proprietorship struggles, it can affect the business owner’s credit directly. If that business owner files for a Chapter 11 reorganization (individuals do qualify for this form of bankruptcy protection), it will apply to their personal assets and debts, as well as those related to the business.

Partners in an unincorporated business face similar challenges. General partners are personally liable for the business debts of their partnership. If you have a partnership agreement, the extent of that liability could be tied to your ownership interest. However, creditors can still sue you for money your business owes. Any partnership bankruptcy will apply the same way.

If you are doing business as a corporation or under a Limited Liability Corporation (LLC), your personal assets will have more protection. LLCs and corporations are separate legal entities from their owners. That means the contracts they enter are between vendors, lenders, and creditors and the company, rather than the people running it. If a corporation or LLC institutes a Chapter 11 business bankruptcy, the creditors involved are generally not allowed to attempt to collect from the business’s members or shareholders. Instead, they must work with the bankruptcy trustee to reach a fair settlement of the company’s assets. In this setting, a business bankruptcy does not affect the members’ or shareholders’ credit or personal assets.

Business Debts That Affect Personal Credit

There are some exceptions to the general rule that incorporation protects business owners’ personal assets from collections. You may be personally liable for a business debt if:

  • You signed a guarantee or cosigned on a loan to the company.
  • Your business fell behind on transmitting tax collected to the government, such as employees’ salary withholdings or retail sales tax collected.
  • You put up personal assets as collateral for a loan to the business (this liability is limited to the loss of the specific collateral involved).
  • You failed to treat your business as a separate entity, allowing creditors to “pierce the corporate veil” and collect directly from the business owners.

If your company has large business debts that affect you personally, a Chapter 11 business bankruptcy may not be enough to protect your assets. If you file for a Chapter 11 reorganization as a business entity, it triggers an “automatic stay” that puts a pause on any efforts to collect debts against the company. However, if you signed on as a guarantor or put up collateral on a secured debt, the creditors can still attempt to collect from you personally based on those contracts. In that case, you may also need to file a personal Chapter 7 bankruptcy to address your personal liability on the business debts, and there may be other options, depending on the situation as a whole

Should You Start a Chapter 11 Business Reorganization?

There are many options available to business owners who are falling behind on their company’s debts. A Chapter 11 business bankruptcy is one powerful tool to erase unsecured debts and give your company a new chance to make its mark in your industry. Chapter 11 bankruptcies are even available to unincorporated small business owners who need to renegotiate their contracts and start fresh. However, a Chapter 11 reorganization isn’t right for every company, and it won’t protect every entrepreneur’s personal assets. If you want to stay in business, a Chapter 11 bankruptcy may be the best option, but if you simply want out, either dissolving and winding down the company or filing a chapter 7 bankruptcy for the company may be better alternatives. Which option is best for you depends on your priorities, whether you have personal liability for the business’s debts, and your goals for the company going forward.

At Lawrence & Jurkiewicz, we focus our practice on helping people. We know how to help entrepreneurs and small business owners resolve their debts, and make the right decision for a company that is struggling. We will meet with you to review your financial circumstances and help you decide whether to file a Chapter 11 business bankruptcy. We want to help you make the right decision for you, your business, and your family. Please call (860) 264-1551 or contact us for a consultation.