What Happens to Business Debt When a Business Partner Dies?

When a business partner dies, the debt does not die with them. The creditors have certain rights to collect their debt and, in many cases, they have those same rights whether your partner dies or lives. Because each business structure is unique, a creditor could pursue claims against the estate, the business partners and/or guarantors, or the business. The extent to which a creditor has these rights could depend on the type of debt (or loan) and how it is documented, as well as your personal involvement in the obligation.

Who to Sue

Usually, the business will be responsible to the creditor for the debt. When the creditor demands payment, and the debt is not paid, the creditor has to decide who to sue, and it could choose to sue the business partners. A lot of determining whether it can do that is in how the business was set up.

The manner in which you structured the business will define your rights and responsibilities to the creditors. Under Delaware’s partnership law, for example, general partners usually are jointly and severally liable for a business debt, meaning they are each liable for the entire amount and individually liable for the debt. That means that the creditor could sue the partnership directly. If the partnership lacks the funds to pay the debt, the creditor could sue the business partners and seek to attach assets to help pay the debt.

Limited liability partnerships and LLCs protect individual partners from personal liability for business debts, so long as that partner or member does not personally guarantee or sign the loan documents. If your partner was personally responsible for the debt or they personally guaranteed the debt, the creditor has a right to pursue payment from them.

If your business partner signed a personal guarantee for the business loan, there is a personal obligation to repay the debt if the business does not. If your partner was personally liable for the debt, the debt, and personal obligation, continues through their estate. If the business partners took out a loan, and both signed a personal guarantee promising to repay the debt, then both partners have personal responsibility for repaying the debt.

For SBA loans, the Small Business Administration (SBA) requires owners of 20 percent or more generally to guarantee the loan, which makes them personally liable for the loan. If your partner dies, however, that promise does not die with them.

When an estate does not have enough to pay all the deceased’s debts, the rest typically goes unpaid. When faced with a shortage of estate funds, the creditor would have to determine whether to take action against any personal guarantors or seek to recover the assets securing the debt. If your partner had any government debts, they jump to the front of the line, and the executor could be held personally liable for other debts they pay before federal claims are paid.

As the surviving business partner you may be on the hook. If you also personally guaranteed the loan, you are responsible for the unpaid balance. The death of a business partner can affect the business’ operations and its ability to fulfill obligations to its creditors.

The Business Won’t Stop Running

When your business partner dies, the business won’t stop running. You still have payroll, client deliverables, and contracts to fulfill. If nobody has authority to act for the business and manage its affairs, operations could easily go into freefall.

A partnership agreement generally dictates how the business will handle a partner’s death. For companies that fail to plan for the contingency of a partner’s death, however, there could be some confusion, or even disputes, about what should happen next.

When you buy out a deceased partner’s interest, Delaware law, for one, requires the partnership to protect the deceased partner’s estate from any old debts or new ones that might crop up. In an LLC, after a member dies, the deceased’s personal representative may use a member’s rights to settle the estate.

Outside the business, the law typically does not require a deceased individual’s family members to pay the person’s debts out of their own assets. When the person dies, however, their estate becomes responsible for paying any outstanding obligations. The biggest exception would be any co-signers or other guarantors on the debt. Also, a surviving spouse in one of the community property states could be responsible for paying debts, depending on when they were incurred. An executor, who is responsible for winding up the estate, can also be in trouble. If they made payments without following the rules in the state they could be on hook for the debts.

Make a List of All the Debts

One of the first things you should do when a business partner dies is to make a list of all the debts you can think of and try to determine whether anyone other than the estate might be responsible for them. One way of finding out if you were personally liable for a business debt is to take a look at the loan agreement. Check who is or was required to repay the debt, whether you signed the loan document, and if any guaranties were given. Also consider whether there is a buy/sell agreement or a partnership agreement that is in place that defines your obligations and what would happen if your partner died or is incapacitated. Before accepting the responsibility for an obligation, make sure you know whether you have any liability under the applicable laws.

It’s wise to plan for your partner’s death before it happens. You can buy life or key-person insurance to fund a debt payoff, and buyout options and life insurance can make sure that a surviving partner has what they need to move forward in the business.

If you don’t take time to plan for this contingency, and your partner dies, you might be in for a nasty surprise. Don’t wait until the impact of the risk creates a crisis for you or your company.