Corporations and LLCs are separate legal entities from their owners. This means that corporations and LLCs can own property, incur debt, and operate completely independently from their owners. The reason why these business entities are separate from their owners is to shield the owners from the liabilities of the business should the business fail (and shield the business from the owners’ liabilities). Unfortunately, most financial institutions and the Small Business Administration (SBA) will require the owners of small corporations and LLCs to sign personal guarantees for any loans or debts given to the corporation or LLC, which circumvents much of the legal protection inherent in these types of businesses. This personal guarantee means that the guarantor becomes personally liable for the debt.

BANKRUPTCY OPTIONS IF I OWN A CORPORATION OR LLC

If you own a corporation or LLC, as opposed to a sole proprietorship and are considering filing for bankruptcy, you likely have two debt problems: business debt and personal debt (whether debt incurred personally or personal guarantees on business debt).

A corporation or LLC has two options for filing bankruptcy: Chapter 7 liquidation, or Chapter 11 reorganization. In a business Chapter 7 bankruptcy, the business is closed, all assets are liquidated by the bankruptcy trustee, and the proceeds from the business assets are paid out to the business’s creditors. The business cannot exempt any property from being liquidated, and the business does not receive a discharge of its debts at the end; it simply ceases to exist. The business’s unpaid debts remain, but there is no business left to pay them. If there are any personal guarantees to any business lender for remaining business debt, then the business lender can pursue the guarantor for the remaining debt. If there are no personal guarantees, then the debt simply goes away. 

A Chapter 7 business bankruptcy does allow for the orderly liquidation of business assets, and is overseen by the bankruptcy trustee and the bankruptcy court. This can be very beneficial if the business owner wants to make clear that the business has closed and that all closing transactions were done by an independent third party. When a business has aggressive creditors, a Chapter 7 business bankruptcy can protect the owners by making clear that the liquidation will be handled by an independent third party. 

If there is an overriding lien on all business assets by a financial institution, then there may be no reason for the corporation or LLC to file for Chapter 7 bankruptcy. Also, if the business has minimal or no assets remaining to liquidate, there also may be no reason to file. The corporate or LLC owner can simply walk away from the business and allow the creditors to put the business into collection or seek judgments. The corporate or LLC owner is not affected by those actions if there are no personal guarantees or they have themselves already filed for bankruptcy. With no assets available to levy or other parties liable to pay the debt, the corporate or LLC creditors often won’t waste their time pursuing the claim or seeking a judgment. If there is constant harassment by those creditors, the corporate or LLC owner may file a Chapter 7 for the corporation or LLC to relieve that pressure.

Chapter 11 reorganization is a complex restructuring of a business which can give an operating business a longer period of time to pay on its debts. The fees for Chapter 11 bankruptcy are often so high that it only makes sense for large and potentially profitable businesses.  

If you are the owner of a corporation or LLC, you have the right, if you otherwise meet the qualifications, to file either a Chapter 7 or a Chapter 13 bankruptcy. If your debt is more than half business debt, then you can qualify for a Chapter 7 bankruptcy without regard to whether you pass or fail the means test. 

WHAT HAPPENS TO THE CORPORATION OR LLC IF I FILE A PERSONAL BANKRUPTCY?

If you file a Chapter 13, you can continue to operate your business during your Chapter 13 bankruptcy case with two caveats: First, your business must be generating net income for you (and not generating ongoing tax or other liabilities); and second, your Chapter 13 plan must distribute as much to your unsecured creditors as they would receive if you had filed a Chapter 7 bankruptcy case.  

In a Chapter 7, the focus is on the net value of the company, or more precisely, the net value of the shares or membership interest held by the business owner. Recall that corporations and LLCs are separate legal entities. The owner does not own the assets of the business – the owner only owns the shares or membership interest of the corporation or LLC itself. Therefore, we must consider the net value of the LLC or corporation when trying to determine what will happen to a corporation or LLC if the owner files bankruptcy.  

If the corporation or LLC has a net liquidatable value and someone would be willing to purchase it, then the Chapter 7 trustee could do one of two things: sell the business assets, pay the business’s creditors and keep the rest to pay your personal debts; or sell your shares or membership interest in your business to someone else.  

To determine the net liquidatable value of a business, we must identify the total value of the business’s assets (inventory, receivables, money in the bank, supplies, equipment, office equipment, real or personal property owned, etc.) and subtract the total debts owed by the business. This does not take into account any “blue sky” or goodwill value. If the business assets are worth less than the business debts, then the business has no value, and a Chapter 7 Trustee will likely not seek to liquidate the business. To the extent that there is net liquidatable value to a business, the owner can claim his or her shares or membership interest exempt to the extent allowed; this must be done using federal “wildcard” or “spillover” exemptions found in 11 U.S.C. 522(d)(5).

CAN I OPERATE MY CORPORATION OR LLC AFTER I FILE FOR CHAPTER 7 BANKRUPTCY RELIEF?

This depends on several factors. First, if the bankruptcy trustee has liquidated the business, then no, you cannot continue to operate your corporation or LLC. However, it is very rare for this to happen. More often, a business has no or only nominal net value, and the Chapter 7 Trustee does not liquidate the business.  

Second, if the Chapter 7 trustee did not liquidate the business, then you need to keep in mind that if you want to operate your business after bankruptcy, you will most likely have to continue operating your business during the bankruptcy case. Any increase in value of the business that occurs during the pendency of the bankruptcy case belongs to the bankruptcy estate. The bankruptcy case lasts until the bankruptcy trustee closes the estate, so if you intend to keep operating the business, you need to be cautious in creating new contracts and receivables.  

Third, consider the remaining business debt (keep in mind that a personal bankruptcy only eliminates personal guarantees for business debt, not the business debt itself). If the business assets are subject to a bank lien, the bank must continue to get paid by the business in order to prevent the bank from recovering the business assets. If the business has other debt, those creditors have a right to be paid by the business as well. It often does not make sense to continue operating a business after bankruptcy.  

Fourth, consider whether it would be easier, simpler, and less stressful to close the business and form a new and different business.

DETERMINING THE BEST OPTIONS 

If you are a business owner and are considering filing bankruptcy for yourself, your business, or both, your case will be complex. There are many moving parts and interrelationships between your finances and your business’s finances. Prescott, Pearson & Tande, PA has the experience to guide you through this difficult time in your life.