“I want to file bankruptcy for my business, but I don’t need a personal bankruptcy”.
I’ve had 2 such calls to my law office in just the last week. And in each case, bankrupting the business corporation will not solve the debt situation. Here’s why.
The underlying problem is that the individual owner is personally liable for many of the business debts. Whether the corporation just shuts down, or files a Chapter 7 bankruptcy, the exposure of the individual remains. And only individuals get a discharge in Chapter 7.
How does that happen, you ask, when you incorporated to shield yourself from the business? Three ways:
- “Business” credit cards are almost always collectible from the individual owner
- The owner actually agreed to be liable by guaranting the loan or taking the lease in his/her name
- Law makes corporate officers liable for certain taxes
Business credit cards
Even though the plastic has the name of your business embossed on its face, almost certainly you are the one who signed the application and agreed to the terms of the card. If you think about it, it wouldn’t be a great business for card issuers to rely solely on the business, about which they know nothing, to be exclusively liable.
So, figure that the cards you think of as “business” debts are actually your debts.
Guarantees and primary liability
This source of personal liability boils down to “you agreed” to be liable. Guarantees are straight-forward and upfront: your signature as a guarantor makes you equally liable with the borrower for repayment of the debt. Larger EIDL loans are a common example of a guaranteed debt.
The second way this happens is more subtle. Often in the course of starting up a business, the entrepreneur personally arranges for phone service, leases the business premises, or finances business vehicles. Once the corporation is up and running, no one thinks to move those services into the business’s name.
Taxes
Sales taxes and payroll taxes are the most frequent examples of personal liability for corporate debts being imposed by law. In these instances, the law says that these corporate debts are simply not limited to the business, but extend to the individuals who run the business.
So the caller who put the corporation’s payroll tax debt in the corporation’s lap will find that he has liability for at least the trust fund portion of the tax. When the business entity is a pass-through entity for tax purposes, the non-trust fund liability passes through to the shareholder/member as well.
Managing business closure
If you file bankruptcy for your business, you may not have really solved the problem. Explore different paths through a business wind-down here and on our companion site, Bankruptcy In Brief.
Closing up shop outside of bankruptcy
