Filing business bankruptcy will generally release you from further obligations to pay the debts your business has incurred. However, depending on the form of these debts and of your business, the lenders may actually attempt to recover funds from you personally. This can present unique challenges, and it will affect the strategy you take when filing for bankruptcy. Consider the following factors before proceeding with a business bankruptcy.
The structure of your business affects the way you file your taxes, who is liable in a lawsuit and who is liable for debts associated with the business:
- Sole proprietorship: You will be held personally liable for debts associated with the business. Filing business bankruptcy will not absolve you of the responsibility to repay if you have the personal funds to do so.
- Partnership: All partners will be held personally liable for debts associated with the business according to their ownership stakes. Filing business bankruptcy will not absolve any partner of responsibility to repay debts if he or she has the funds to do so.
- Limited liability company: You will not be held personally responsible for business debts. Filing business bankruptcy may absolve you of some responsibility to pay, but the lenders may still seek recovery in part from a member of the LLC in certain scenarios explained below.
- C Corporation--The business is an entirely separate legal entity from its owners. As a result, you will not be held responsible in any way for outstanding debts of the business if you file business bankruptcy.
- S Corporation--The business is an entirely separate legal entity from its owners. An S corporation functions just like a C corporation in matters of debt; the key difference is how it is taxed, which will not affect bankruptcy proceedings unless the business has outstanding debt to the IRS.
Regardless of the type of business you have set up, you may still be personally liable for debts made in your name rather than the name of the business. Further, if you have placed any personal assets as collateral for business loans, the lender can still seek to recover from you and seize these assets. To avoid personal losses, take these steps before filing business bankruptcy:
- Refinance any loans in your name to place them under the business name. This step is best taken early on in the businesses cycle, before the business has begun to suffer financial damages. If your business's credit has dropped prior to your attempt to refinance, you may find it difficult to move the debt into the business name. In fact, in this scenario, a lender will want to keep the loan in your name in the future. Therefore, wise business owners will move any debts out of their name as soon as the business is financially able to take on the debt. For example, if you have to take a personal loan to provide initial capital to start your business, replace this loan as soon as the business is profitable.
- Replace personal collateral with business collateral at the first available opportunity. For example, it is possible you took a second mortgage on your home to start your business. This is highly risky because your home could go into foreclosure if your business declares bankruptcy. To save this from being a possibility, as soon as you acquire a business asset large enough to replace the current personal collateral, refinance the loan to the new piece of collateral.