Directly Liable for a Company’s Debts
When we talk to owners at Delancey Street who are struggling to repay a merchant cash advance or a bank loan, we’re often asked a question like this: “If my business goes bankrupt, what happens to me?” Forming a corporation or an LLC may protect an owner from personal responsibility for business debts, but the shield isn’t absolute. There are several common situations in which an owner can be directly liable for a company’s debts. Here are six of the most common ones. If you are personally liable for business debts, you’ll need personal bankruptcy, not business bankruptcy, to get rid of them.
First, did you give a personal guarantee? Many suppliers, banks and landlords know that shareholders in a corporation and members of an LLC aren’t personally liable for business debts, so they will often refuse to extend credit or make a loan to a small corporation or an LLC unless the owner signs a personal guarantee. This is a legally binding commitment that says that, if the business fails to pay, the owner will. Many owners sign a personal guarantee despite the fact that they set up the LLC or corporation precisely to limit their personal liability, because they can’t get the financing otherwise. Check any agreements you signed for a loan on a business vehicle or piece of equipment, trade terms with a supplier, a line of credit from a bank or a commercial lease. If you signed one, the creditor can reach your personal assets, whatever your LLC or corporate status.
Second, collateral. Banks often ask business owners for their house or other personal property as collateral when they make a business loan. If you secured a loan that way, you’re personally liable for it. If the business is unable to pay off its debts and it has secured any of those debts against the family home, the bank can foreclose. A Chapter 7 filing will discharge your personal liability on that kind of loan, but the lender’s lien on the property survives the bankruptcy, which means the lender can foreclose on the collateral even after your debts are forgiven. If you want to keep or sell the property, you’ll still have to pay off the secured debt.
Third, look at how you signed things. If you signed a purchase agreement or service contract in your own name, rather than as an owner or officer of the company, you’ve exposed yourself to personal liability. That’s true even if it was an honest mistake. Many small business owners don’t realize that even if they incorporated their business, they can still be held personally liable for certain business debts if they don’t follow proper procedures. Don’t assume your business entity will automatically protect your personal assets. If you aren’t sure how a document was signed, check the signature block for language showing whether you signed it individually or on behalf of the business.
Fourth, how you paid for it. If you funded the business using personal credit cards or home equity loans, you’re personally liable for those debts. Even if a credit card is opened under the business’s name, most agreements contain a provision making the person who signed the application personally responsible for all payments. If you file Chapter 7 in your own name, you can discharge qualifying personal and business debts like these, including credit card balances and home equity loan deficiencies used to finance the business.
Fifth, if you personally commit a tort, meaning a wrongful act that harms another person and causes a monetary loss, you can be personally liable for the damages you cause. When that happens, your personal assets could potentially be used to pay the debt. Your LLC or corporate status doesn’t change that. It doesn’t mean every bad call is on you, though. Owners of corporations and LLCs generally aren’t personally liable for management decisions or ordinary business mistakes. Liability attaches to your own wrongful conduct, not to every error made in running the company.
Sixth, fraud and not keeping yourself separate from the business. Lying to obtain a loan or commingling your funds can lead to full personal liability. Debts taken on by fraud are typically not dischargeable in bankruptcy. Creditors can also attempt to ‘pierce the corporate veil’: a court can determine that the corporation or LLC is a sham and you treated the business as if it didn’t exist, thereby stripping your limited liability protection. And once a creditor pierces the corporate veil, they can turn to your personal assets, including your home, to cover their losses. Typical evidence includes failing to document key decisions in minutes or written resolutions, commingling funds (such as paying business expenses from a personal account or personal bills from the business account), and treating the business as an alter ego. Even a sole owner or a business owned by a married couple must follow the formalities, or risk losing the protection. The key is to treat your business like a separate entity from you and your home.
Personal Bankruptcy
If any of those situations apply to you, personal bankruptcy - not business bankruptcy - is the route to eliminate those debts. And which chapter to file depends on your income, assets, and whether you’re trying to keep the business running. Chapter 7 bankruptcy liquidates nonexempt assets and discharges most qualifying unsecured debts relatively quickly - often within three to six months. It doesn’t let you catch up on secured arrears, though. Chapter 13 bankruptcy restructures personal debts and gives you a three-to-five-year repayment plan. It can be helpful for owners with secured debts on collateral they want to retain.
Go Through All the Contracts and Loan Documents
Before you file, go through all the contracts and loan documents to look for personal guarantees and make sure you know how each one was signed. You should have a bankruptcy attorney look them over, too. They can help you figure out which debts are genuinely your personal obligations, whether any would be nondischargeable (for example, because they were obtained through fraud), and which chapter of bankruptcy is most appropriate for you. Delancey Street is a business debt settlement company, not a law firm. We negotiate with MCA funders, lenders and other creditors to settle for less than the full amount of the debt. We will tell you on the first call if you are better off filing bankruptcy, and we’ll refer you to an independent, vetted bankruptcy attorney.
