If you are a business owner dealing with business debt, you may be considering whether to file a bankruptcy or some other solution for your business, or for yourself, or for both. Before you make this decision, it’s important to first understand the distinction between your personal debts, your business debts, and those debts that are actually the obligations or both you and your business. While dealing with business debt, it is also important to understand the kind of business that you’re operating so that you can understand the different bankruptcy and other bankruptcy alternatives that may be available to that particular kind of business. Where you and your business share most of the same debts, liquidating or reorganizing your business alone is unlikely to help your situation. This article may assist you in understanding how to navigate these decisions.

Bankruptcy for Sole Proprietorships – Dealing with Business Debt

In dealing with business debt, many business owners have formed a separate entity in order to operate their business while limiting their personal liability exposure. Examples of these separate entities include limited liability companies and corporations formed under state law. However, some business owners have never formed a separate entity for their business.  These people are operating their business as themselves in their personal capacity, but simply using a business name, which is referred to as a trade name. 

These individuals are called “sole proprietors.” They operate “sole proprietorships.” Sole proprietors can file any kind of bankruptcy available to individuals. These kinds of bankruptcy include Chapter 7 liquidation bankruptcy, Chapter 13 reorganization bankruptcy, and Chapter 11 reorganization bankruptcy. Because a sole proprietor is really just an individual, and is not two (2) separate entities, that individual is not separate or distinct from their own business. A bankruptcy for that sole proprietorship is the same as a bankruptcy for the individual.

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Bankruptcy for Corporate Entities 

As stated above, many business owners dealing with business debt take the steps necessary to form a separate entity under state law, and through which they operate their business. These entities are generally limited liability companies, or for-profit corporations. Business owners hold membership interests in limited liability companies, and they hold shares in corporations. These equity interests are personal property of business owners. In dealing with business debt, many businesses entities are closely held by their owners, and are effectively extensions of their owners, these entities can provide a higher level of protection for business owners. These protections are generally limited, however, and do not always provide 100% protection for a business owner. Nor do limited liability protections guarantee that a business owner will not be liable for some or all of their entities’ debts. This is especially true where a business owner personally guarantees its business entity’s debts.

In our experience dealing with business debt, personal guarantees on business debts are a major cause of individual business owners seeking bankruptcy protection. This is because many lenders require personal guarantees from business owners when lending money or otherwise extending credit to a business. As a result, when a business is in distress, and cannot pay back its loans, and do not have enough assets which may be sold to pay off those loans, business owners can find themselves more concerned about their personal liability on those business debts than they are concerned about their business’ liability on those business debts. 

When a business owner is dealing with business debt and considering bankruptcy for their business, the existence of personal guarantees becomes central to the consideration of whether a bankruptcy is necessary for the business, for the business owner, or for both of them. Moreover, a question about whether or not bankruptcy is the right direction also arises. Sometimes, it makes the most sense to first liquidate the business through a state-law based assignment for the benefit of creditors to seek whether the liquidation will result in a reduction of personally guaranteed debts. Once the business liquidation is underway, business owners may have a better understanding of how much personally guaranteed debt is left over for them to deal with. Unfortunately, given the nature of business debt, these are often large amounts of debt, especially in the context of personal liability on those debts.

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Bankruptcy for Business Owners

As discussed above, business owners who have personally guaranteed their business’ debts often learn that the person in most need of bankruptcy is not their business entity, but themselves. An individual dealing with business debt can generally file for bankruptcy under any Chapter available to individuals, including Chapter 7 liquidation bankruptcy, Chapter 13 reorganization bankruptcy, and Chapter 11 reorganization bankruptcy. 

An initial consideration for individuals when choosing between a liquidation and a reorganization. First, individuals must consider their equity, if any, in their real and personal property. If there is equity in an individual’s bankruptcy estate that is not fully protected by applicable bankruptcy exemptions, that individual’s non-exempt property must be sold to pay down debts. This reality causes many individuals to consider reorganization rather than liquidation through Chapter 7 bankruptcy.  There is also the issue of the means test, which prohibits certain individuals from completing a Chapter 7 bankruptcy and obtaining a discharge if their income level is higher than a certain “median” level of income based upon a number of factors.

A further consideration for individuals considering bankruptcy is whether they want or need to file an individual bankruptcy, or whether they want or need to file a joint bankruptcy with their spouse. This will depend upon whether the individuals and their spouses are co-debtors together on certain debts, as well as upon their asset profiles and considerations regarding exemptions on any exposed equity. There are a number of reasons to carefully consider whether it makes sense to file individually, or to file jointly as a couple, depending on the specific facts in an individual’s case.

A major consideration for individuals with business debt is whether those debts exceed the Chapter 13 debt limits. Individuals with business debts may find that they exceed the Chapter 13 debt limits and have to look for other options. Generally speaking, Chapter 11 is the next best option to a Chapter 13 reorganization. Chapter 11 is an especially good option since the introduction of a Subchapter V election, which permits Chapter 11 debtors with primarily business debt to proceed under a streamlined version of a Chapter 11 reorganization. Subchapter V even permits certain work to be done to reduce secured debt on an individual’s residence where that debt relates to business debt.


Dealing with Business Debt through Middlebrooks Shapiro

Dealing with business debt can be tricky and tiresome. Having an experienced attorney to help you navigate the treacherous waters can help make the process much more efficient and much less stressful. Middlebrooks Shapiro specializes in the intricacies of both business bankruptcy and personal bankruptcy cases. If you are seeking help in dealing with business debt, schedule a consultation with one of our expert attorneys. Our team can help get you back on track.