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Making Sense of Bankruptcy: Should You File a Bankruptcy for Your Closed Business and a Separate One for You Personally?

With a recently closed or about to close failing business, you often can’t and seldom need to file a bankruptcy for the business itself.

Here’s the sentence that we’re explaining today:

If your business is or was a sole proprietorship, it can’t file a bankruptcy separate from you, and even if it can because it’s a corporation or limited liability company it most likely doesn’t needs its own bankruptcy case, unless it has assets that you want a bankruptcy trustee to distribute for you.

If your financial problems arise out of an unsuccessful business venture, you may wonder whether the business can or should file its own bankruptcy case. You hear about big corporations filing bankruptcy, and you wonder whether it would do you any good if your business did so. Could that enable you to avoid filing bankruptcy yourself? Or is there any other benefit to filing a separate bankruptcy for the business?

Sole Proprietorships

In most closed or about-to-close business situations you will either not be able to or not need to file bankruptcy for the business itself. And even in situations in which your business could file its own bankruptcy, almost never would that prevent you from needing to file your own personal one.

Your business would not be able to file a separate bankruptcy if it was not legally formed as a separate legal entity, such as a corporation, partnership, limited liability company (LLC), or such. If so, the business can own assets and owe debts in its own name.

But a large percentage of small businesses are not set up as their own legal entities. Instead they are “sole proprietorships” in which the business’ assets and debts are just part of the owner’s personal assets and debts. The business does not constitute a separate legal entity that can file a bankruptcy case.

The fact that a business has an assumed business name, which may be registered with the state, and may have a local business license and otherwise conducts most of its business under that name usually does not make any difference. Without the formalities of incorporation or a similar creation of a legal business entity, your business is not its own legal entity. Its assets and debts are just part of your own personal assets and debts.

So, it can’t file its own bankruptcy. Nor does it need to because your personal bankruptcy includes all of the business’ assets and debts.

Your Business Usually Doesn’t Need a Separate Bankruptcy

Even if your business IS a separate legal entity and so it COULD file bankruptcy under its own name, practically speaking there usually is no reason for it to do so.

First, you can almost never avoid a personal bankruptcy by having your business file its own bankruptcy. Almost always you will be personally liable for most of the debts of the corporation/LLC, especially the larger debts. That’s because all major creditors—such as the landlord on the lease of your business premises, and the Small Business Administration and banks on business loans—require you to sign guaranties making you personally liable on their debts. And even with debts which you didn’t personally guaranty, you may be liable by operation of law if you didn’t strictly maintain the formalities of the corporation/LLC, such as by mingling corporate and personal income and/or assets. These personal liabilities have to be dealt with through a personal bankruptcy.

Second, by the time a bankruptcy is being considered the corporation/LLC likely no longer has enough assets to be worth the expense of filing a separate business bankruptcy merely to distribute those remaining assets. As far as the corporation/LLC’s debts, they essentially die with the business (assuming that, as usual, the business has no assets from which the debts could be paid).

When Your Might Benefit from Your Business Itself Filing Bankruptcy

If your closed or about-to-close business is a separate legal entity which has the legal capacity to file its own bankruptcy case, doing so may be worthwhile in one particular and relatively rare situation: if the business itself has assets that can and ought to be distributed to its creditors through a Chapter 7 liquidation.

As mentioned above, for a variety of reasons by the time a business corporation/LLC’s owner(s) are looking at bankruptcy alternatives the business usually doesn’t have sufficient assets to justify it going through its own bankruptcy. Often everything of value has been pledged as collateral to its creditors, either at the time of the items’ purchase (for business equipment and inventory, for example) or for business loans (with a local commercial bank, for example). Or the business’ assets have been encumbered through tax, judgment, or some other kind of legally imposed lien. Or the business had already been liquidating its assets in its attempt to stay afloat.

But if indeed the business entity does still own any significant unencumbered assets, liquidating those assets through the business’ own Chapter 7 bankruptcy (while you very likely deal with your personal debts with your own Chapter 7 or Chapter 13 case) may be worthwhile for the following reasons:

  • For an orderly disposition of the business assets: You may be sick and tired of dealing with your former or about-to-be-former business. You’ve likely sunk your heart and soul into it for years, but now need to move on. You either have a new job or need to quickly find one, and need to concentrate on this next chapter of your life. And you need to focus on your personal finances, not that of the business. Handing over to the business’ Chapter 7 trustee all the hassles of gathering and liquidating the business’ assets could be a huge relief.

  • To lessen risks of personal liability for misappropriating corporate assets: There are a variety of financial risks in the closing down of a business, through which you could make a difficult situation worse. For example, as the owner of the business you may be considered a fiduciary to its creditors so that if you favor some creditors over others you may become personally liable for the corporate debts. And this personal liability may not be able to be discharged (legally written off) in bankruptcy. Avoid such risks by passing such responsibilities to the business’ bankruptcy trustee.

  • For the business’ bankruptcy trustee to pay some of your personal debts: You are very likely personally liable on some of the business’ debts. Some of those—such as certain taxes—are ones that the business’ Chapter 7 trustee would pay ahead of other debts. So under the right circumstances you would personally benefit from your business’ bankruptcy.

But careful: whether to use a Chapter 7 case to distribute the assets of a closed business is usually not a straightforward decision. It requires the advice of a seasoned business bankruptcy attorney. And because the timing in these situations is often critical, you should see such an attorney sooner rather than later.

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