When business owners face financial difficulties, one of their biggest concerns is, does business bankruptcy affect personal assets? The answer depends on the kind of bankruptcy filed, the structure of the business, and whether personal assets or credit are involved with the business. In this blog post, we explore how business bankruptcy can affect personal assets and offer insights to minimize its potential personal impact.
Types of Bankruptcy Available to Businesses
Businesses can file designated types of bankruptcies in the United States. This blog covers the two options available for businesses who want to reorganize and remain operational:
- Chapter 11 Bankruptcy: This type of bankruptcy is commonly used by large corporations and allows the business to restructure its debt and operations while remaining open. The company must create a reorganization plan and obtain approval from creditors and the bankruptcy court.
- Chapter 11 Subchapter V Bankruptcy: Subchapter 5 was added to Chapter 11 Bankruptcy to offer small businesses an affordable and streamlined restructuring option. Subchapter V provides for the restructuring and elimination of unaffordable debt while keeping the business up and running. One of Subchapter V’s best features is that the court only considers the business owner's plan; creditors cannot put forth a competing plan.
Does Business Bankruptcy Affect Personal Assets?
Whether or not business bankruptcy affect personal assets depends on the business structure. The two types are a sole proprietorship operating under a DBA (doing business as) and a business entity such as a Limited Liability Company (LLC).
Sole Proprietorship vs. Limited Liability Company
A sole proprietorship may not appear any different to its customers than an LLC or other legal entity. However, from a legal perspective, a sole proprietorship means the business owner and the business are one and the same. Since a sole proprietorship is not a separate legal entity, there are no legal protections. This means debts cannot be reorganized under bankruptcy without impacting the owner's personal finances, and in these situations, business bankruptcy does affect personal assets.
Sole Proprietorship: Yes, by default a business bankruptcy will affect personal assets since the business owner and business entity or DBA are legally viewed as one. In other words, business debts are treated as personal debts. Consequently, when a sole proprietorship files for bankruptcy, even if they aim to continue the business, they cannot protect their personal assets from being used to settle business debts.
Limited Liability Company: No, by default personal assets are not affected. When properly established and maintained, an LLC is a separate legal entity that provides protection for its owners. When an LLC files for Chapter 11 bankruptcy, the LLC seeks protection from its creditors, not the individual owners. The homes, vehicles, and personal bank accounts of the LLC owners are typically kept separate from the assets and liabilities of the LLC. As a result, they are generally shielded from direct impact during the bankruptcy proceedings of the LLC.
In certain circumstances, there can be some indirect impacts on the personal assets of the LLC owners, depending on the specific circumstances and factors involved. These can include:
- Personal guarantees: If the LLC owner personally guaranteed loans or obligations of the LLC, the owner's personal assets could be at risk if the LLC cannot fulfill its obligations under the new bankruptcy plan as confirmed by the court.
- Commingling of assets: If the LLC owners have commingled their personal assets with the assets of the LLC, it can be challenging to distinguish between personal and business assets. In these instances, creditors may petition the court to pierce the corporate veil, potentially enabling them to transfer liabilities to the owners and thereby gain access to their personal assets.
- Fraudulent or improper behavior: If the LLC owners have engaged in fraudulent or improper activities, such as using the LLC to shield personal assets or defrauding creditors, a bankruptcy court may disregard the separation between personal and LLC assets and hold the owners personally liable.
How To Ensure Chapter 11 Doesn't Affect Personal Assets
It’s important to note that bankruptcy laws are complex and the specific circumstances of each case varies. Therefore, it is advisable to consult with a qualified bankruptcy attorney who can provide guidance based on the particular details of each individual situation.
That being said, here are some practical steps to take to help ensure that Chapter 11 business bankruptcy doesn't affect personal assets:
1. Maintain proper separation: Keep personal assets separate from those of the LLC. Maintain a separate bank account, keep accurate records of financial transactions, and avoid commingling funds between personal and business accounts.
2. Avoid defaults after confirmation: Once the Chapter 11 plan is confirmed, the business must meet its new obligations. Failing to do so may trigger personal guarantees. Wherever possible, try to minimize or avoid personally guaranteeing any loans or obligations. This will reduce the risk of being held personally liable for a business's debts.
3. Operate by legal requirements: Ensure that the LLC complies with all legal requirements, including maintaining proper corporate formalities, filing necessary tax returns, and adhering to applicable regulations. This helps establish the separation between personal and business assets.
4. Seek professional guidance: Consult with a bankruptcy attorney who specializes in Chapter 11 bankruptcy. He or she can provide specific advice tailored to your specific situation and help you navigate bankruptcy while protecting personal assets.
5. Consider alternative solutions: Depending on the financial circumstances of a business, there may be alternative solutions to Chapter 11 bankruptcy that can help address debts without jeopardizing personal assets. Exploring options such as negotiation with creditors or debt restructuring may be worth considering.
Protecting personal assets from business bankruptcy requires careful planning and consideration. Engaging the services of a skilled attorney experienced in assisting financially distressed businesses is crucial to safeguarding both your business and personal assets to the maximum extent possible.
The Lane Law Firm Can Help Keep Assets Safe
The Lane Law Firm provides valuable guidance and support when navigating business bankruptcy while protecting personal assets. They will carefully examine personal finances, assist with bankruptcy filings, negotiate with creditors, represent you and your business in court, and provide ongoing support throughout the process. Contact our team today to learn more.