Business debt can bleed over into an entrepreneur’s personal assets. Hearing me say that, my client was dumbfounded.
He was aghast that the generous equity in the home he and his wife owned was at risk when his corporate business folded.
That was not because the shareholder is liable for the corporation’s debts. A properly operated corporation confines the business debts to the corporate entity.
No, it’s because he signed the business lease in his individual name. And because he was a corporate officer who didn’t pay all the corporation’s payroll taxes.
As a person liable for a debt, his assets (and the whole of the community property in California) are exposed to creditors.
While exemptions protect some assets, up to a specified dollar value, the non exempt equity in the family home is at risk .
Understand the California homestead
When business vs. personal distinction matters
The only time that it matters whether an individual’s debt is personal rather than business is when figuring the infamous means test. The means test applies only to those whose debts are “primarily consumer”.
So, debts incurred in business, taxes, and debts imposed by law are not “consumer” debts.
If those kinds of debts exceed the total of consumer debts, the means test doesn’t apply. There is no need to “qualify” for bankruptcy relief by reason of income.
Sole proprietors are fully at risk
As a matter of debtor-creditor law, if your business is a proprietorship, there is no legal distinction between you and your business. The debts you incur to run the business have the same legal rights to payment from your assets, personal and business, as the debts incurred for personal living.
When the business is one with the business owner, failure to pay any debt imperils both business and business owner.
Isolating business debt
Corporations and LLC’s are legal “persons” invented to create a distinction between the business and the business owner. The corporation can incur debt in its name alone, and only it is liable.
The practical catch is that vendors and landlords may not want to extend credit where the only “person” liable is a thinly capitalized corporation. They may insist on a guarantor. Execute that guarantee of the corporation’s debt, and the individual has staked his personal assets to pay the debt.
The other way owners of corporate businesses become liable for the business debts is inattention. They never change the vendor accounts to the corporate name when they incorporate.
They are sloppy about how they sign business agreements.
They take a business credit card and don’t realize that they are personally liable.
Who needs bankruptcy
In the case of the entrepreneur I met with, it turns out that the corporation is liable for very little and it can survive as an entity if there is a business future.
The shareholder, however, is a likely candidate for a Chapter 13, to keep the house and pay the debts over time.
More
Is it safe to file a corporate bankruptcy?
