When a small business starts going downhill, the owner gets up in the middle of the night with fears of losing their house or car or wiping out their savings. What’s at risk if the business fails is a thorny issue. A lot of owners worry that business debts are going to spill out into their personal lives. That doesn’t always happen, but it’s possible - especially if you’re a sole proprietor. It depends on how you formed the business, what you signed, and what you pledged. It’s worth knowing exactly where you stand before talking to any lender. So let’s take those three things one at a time.
If your business is a sole proprietorship, there is no legal distinction between the business and the owner. So, if the business is delinquent on its debt, the creditor can look for payment against any asset that legally belongs to the owner. When your business is structured as a sole proprietorship, it is inextricably linked to your personal finances. All the debt you incur as a business owner is your personal debt. If you can’t pay, you may be looking at Chapter 7 bankruptcy.
With a partnership, however, some or all of its individual partners can be responsible for the partnership’s debts. Partners who share ownership can often be personally liable for business debt. How much exposure you have depends on several factors, including the type of partnership you formed.
If your business is an LLC (limited liability company) or a corporation, your personal assets are usually protected, but not always. It’s true that a small-business owner who formally sets up as an LLC or a corporation will often not be held personally responsible for paying debts if the business fails. The trick is that there are lots of exceptions. When a judge does hold owners, members, and shareholders personally liable for business debts, it’s called ‘piercing the corporate veil.’ That’s legal-speak for ignoring the company entirely and going after your personal assets.
The structure is only the starting point, though. Then there is the personal guarantee. By signing this guarantee, the loan applicant has basically said, “OK, if my business doesn’t pay you back, then I will.” The guarantor (or, more often, the guarantors) signs a document that, while perhaps just a single sheet of paper, can have significant ramifications. Owners sign them for lines of credit, leases, loans and merchant cash advances. The guarantee makes you personally liable if your company can’t come up with the money. Even if you have a Corporation, you are on the hook for any guarantee you sign. In short, if your company can’t pay, the bank can come after you for the money and, if necessary, collect it by legal action. Business owners often sign one away without thinking about the implications. Then, when the business goes under, the business owner is left holding the bag. Once it is signed, the only way to get relieved of that responsibility is a court order. So any time you sign a document that sounds like this, you’re putting your personal assets on the line.
What if you backed up a business loan with your personal assets? Then you can potentially lose those assets if you fail to pay back the loan. When your home secures a company loan, you still own the home, and it’s still your property. So does that mean your house could end up in the lender’s hands if the company defaults? You bet it does. Your car, house, business property or any other item that you put up as collateral is yours to lose.
A guarantee’s the obvious way a small-business owner can get roped in, but it’s not the only way. Many owners unintentionally leave themselves exposed by not paying employment withholding taxes or state sales and franchise taxes on time. Does your company owe anything on a 941 form for employee withholding tax? Has it missed a state sales tax filing or a franchise tax report? That can come back to bite you, too. A failed attempt to properly cancel a UCC lien notice, signing a contract with your name instead of the company name, or allowing the corporate veil to be pierced are all risks.
The Debt Is Already in Default or Not
Your options come down to just a few, but before you start digging in, the first step is figuring out if the debt is already in default or not. Is the company behind on payments or are those payments still due? It matters. (That is one good reason to avoid defaulting if at all possible.)
Keeping debts from going into default is vital when the business is struggling to stay afloat. That might seem almost impossible, but it’s worth trying to keep the money flowing. Keep payments on all your debts coming so they don’t go into default. It’s a tough call to make when you are strapped for cash.
No matter what the business agreement says, you as an owner or officer shouldn’t pay any business debt from your own money or personal account. The business has to pay its debts to avoid default. When you use your own funds to pay business debts, you risk losing the corporate shield that keeps you out of the hole when your business fails. If you already made personal payments to suppliers and are near default, don’t wait to get legal advice on the risk of piercing the corporate veil.
If you are already behind on a loan and are worried about being on the hook personally, then please consult an experienced business debt relief attorney or business bankruptcy attorney in your state.
If you were hit with a lawsuit or collector over a business debt, get a state-licensed business debt relief attorney on your side right away. Lenders who prey on desperate businesses will look for opportunities to drain you dry. Don’t let them.
So, can a business creditor take your personal assets? The answer depends largely on how you structured your business, whether you signed any personal guarantees for the business’s debts, whether you’ve given any collateral, and whether you owe any tax bills to the government. You should take action immediately if you’re in trouble, and get advice from an attorney.
