Many business owners shun bankruptcy because they fear that it will take away their car, house or business. That fear is understandable, but it misses the point. Bankruptcy is about losing your debt. It gives you the peace of mind that comes with being completely debt-free. It stops the collectors’ phone calls and the threats of lawsuits. It gives you the option of a fresh start. When you file for business bankruptcy, you are in essence petitioning the bankruptcy court to give you a fresh start when it comes to your business finances.
So will it drag down your personal credit? The short answer to that question depends on the type of entity and whether you are personally liable for your business’s debts. If you are a sole proprietor or a general partner you will most likely be affected. If you have formed a corporation or you are a limited partner you will probably not be affected, unless you signed a personal guarantee on a debt or you owe trust fund taxes.
Here’s what happens when you file for bankruptcy: An automatic stay instantly halts all collection activity by creditors - they can’t foreclose on your home or otherwise collect. It stops creditors from harassing you over your debts, so you can try to focus on rebuilding your business instead. In bankruptcy, most of your unsecured debt is wiped out (credit cards, for example). If you’ve been operating on a credit line, bankruptcy may be a good option. The type of debt you owe determines what kind of bankruptcy you can file.
Will Appear on Your Personal Credit Report
Note that if you’re a sole proprietor, there’s no legal distinction between you and your business, so any debt that you took on for the business will appear on your personal credit report, and your business bankruptcy will certainly affect your personal score. Depending on whether it’s a Chapter 7 or 13 filing, it could be on your personal report for up to 10 years.
When a business is structured as a partnership, it sometimes makes sense for each general partner to file for personal bankruptcy, even though the bankruptcy will appear on their credit reports. Filing a bankruptcy for the partnership itself can be tricky, however. For a partnership, if liquidating the company’s assets does not pay the debts, the partners remain responsible for what is left.
Being a limited partner, or having a business in the form of a corporation, may insulate you from the responsibility of your business debts. If the corporation files bankruptcy, neither the filing nor the business debts should show up on your personal credit report.
There are some exceptions. If you signed a personal guarantee and your business borrowed from the bank, that is your debt, and it affects your credit report. Trust fund taxes, including taxes withheld from employee pay, are generally not dischargeable. If you collected them and failed to send them to the taxing authority, you are liable for them.
Three Primary Routes
Business bankruptcy doesn’t have to spell the end for your company. However, if you’re a sole proprietor who’s personally liable for the company’s debts and you want to continue operating, filing for Chapter 7 will mean you’ll need to shut down the business. In this case, you should instead opt for a Chapter 11 or Chapter 13 bankruptcy. It works the other way, too: if you file personal bankruptcy while running a business, the filing can also affect your company’s credit rating. The type of bankruptcy you choose does as much to shape your future as it does your credit report. When it comes to business bankruptcy, here are the three primary routes you’ll need to consider.
The easiest bankruptcy case to understand is Chapter 7, the liquidation option. If you are a sole proprietorship, you file your personal bankruptcy. A trustee is appointed to liquidate any non-exempt assets you have. The proceeds from the liquidation are used to satisfy the creditors’ claims. When the debts are gone, you are free to go back into business. If the business is an incorporated one, the trustee liquidates the business assets, and the business itself is closed.
Most people think of bankruptcy as the end of the road, but Chapter 11 is a reorganization that larger companies often use to keep operating while restructuring their finances. It’s not a common route for small businesses, but it can help a corporation, partnership or LLC stay afloat. The bankruptcy court will have to approve a reorganization plan you submit, which typically alters the terms of the payments you make on debt and involves selling off some assets to pay some of the debt.
If you’re a sole proprietor and you’d rather keep your stuff, Chapter 13 is where to look. It lets you pay back all or a chunk of what you owe over a longer stretch, and how long that is depends on what you bring in each month. Plus, the automatic stay kicks in to shut down all the collection calls while you figure things out.
Assess Your Situation
Before you decide what to do, you need to assess your situation. What is your legal status? Are you a sole proprietor, a general partner, a limited partner, or a corporation? Did you personally guarantee a business loan? Have you collected payroll taxes from employees and failed to remit them to the taxing authority? That information will help you determine whether the business bankruptcy will land on your personal credit report, and if it does, a Chapter 7 or Chapter 13 will remain there for as long as 10 years.
There’s a lot of confusion over the different types of bankruptcy. But if you’re considering it, sit down with a bankruptcy lawyer and talk through your options. A competent attorney will be able to explain whether Chapter 7 or Chapter 13 bankruptcy makes sense for your situation, as a way to turn the page and begin your life anew and how each will impact your personal assets and credit.
