Can my business’s Chapter 11 bankruptcy put my personal assets at risk?

Filing for Chapter 11 bankruptcy may seem like the way out of a business that isn’t working. If you’re considering a Chapter 11 bankruptcy for your business, you might wonder if filing bankruptcy can affect your personal assets, such as your home or a car you own. It’s understandable to be concerned about the safety of your family if you’re facing financial troubles. Taking the time to understand how it works will help you make a smart decision about whether it is a good idea and how your family’s assets may be protected.

Chapter 11 business bankruptcy allows a company in financial trouble to restructure its debt and make a plan to pay its creditors. The business can emerge from bankruptcy as a new entity with a new name. The company continues to operate as a “debtor in possession.” The plan has to be “confirmable” under the Bankruptcy Code, and the company pays its secured debt and taxes. The unsecured creditors must be treated fairly, but the plan can pay them much less than what they are owed. It’s a complicated process.

Whether your personal assets are at risk depends on the circumstances. A lot of small businesses, especially sole proprietors, never go through the process of incorporation. Legally, the owner and the business are one and the same person. That means business problems can have a direct and negative impact on the owner’s credit history. Chapter 11 is available for individuals. A Chapter 11 filed by the owner of a sole proprietorship includes the personal assets and debts of the owner as well as those of the business.

If you’re in a partnership, each general partner is personally liable for the debts of the partnership. The partnership agreement may tie liability to each partner’s ownership interest. This does not stop the creditors of the partnership from suing the partners personally for the debts of the partnership. Partnership bankruptcy functions like that of a sole proprietorship.

A corporation or limited liability company provides a layer of protection for your personal assets. The business is legally separate from its owners. The company has contracts with vendors, lenders, and other creditors rather than with the individuals running the company. So if the company files for bankruptcy, the creditors generally cannot collect from the members or shareholders. The owners’ credit ratings and personal assets are not affected.

Exceptions to Personal Liability with Company Debts

The difference between corporate debts and personal debts doesn’t mean that your personal property and credit are never affected by the debts of your business. There are some exceptions.

• If you are the guarantor for a business loan, as the principal of the company, you can face personal liability for the company’s loan.
• If your company withholds taxes from employees or collects taxes from customers but does not turn them over to the government, you could be personally liable.
• If you collateralize a business loan with personal assets, you can end up losing your collateral. Your liability is limited to the collateral you pledged as security.
• If you don’t treat your business as a separate entity, creditors might pierce the corporate veil and collect the money directly from you.

Just because your company files Chapter 11 doesn’t mean that you are protected from a lawsuit by the company’s creditors. When your business files Chapter 11, there is an automatic stay that halts attempts by creditors to collect from the company. The stay does not prevent collection against the owners based on guarantees or pledges of collateral on secured debts. You may need to file a personal Chapter 7 bankruptcy. Other options may be available depending on the situation.

Many Options

If you have business debt, you have many options. Chapter 11 is one powerful tool, and it can wipe out unsecured debts. You may not need to incorporate to file a Chapter 11, so this option could be good for sole proprietors. It can be a great option if you want to stay in business. It’s not right for every company, and it doesn’t protect all the personal assets of every owner. However, if you want to walk away from the business, a Chapter 7 for the business or dissolving the company could be better. Which option is best depends on what matters most, including whether you’re on the hook for business debt and where you want to take the company.