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Personal Bankruptcy and Business Ownership: What You Need to Know

Posted By Allmand Law Firm, PLLC || 19-Sep-2016

If you file personal bankruptcy, it can take a significant toll on any business ownership in your name, depending on how the business was legally organized and the type of bankruptcy petition filed with the court. Under United States bankruptcy code, there are two types of filings for individuals; they are indicated by "Chapter" numbers, and personal bankruptcies are either Chapter 7 or Chapter 13.

Chapter 7 represents the most common type of filing, which is the liquidation bankruptcy. In this process, the court appoints a trustee, which may be an entity or individual, to oversee a liquidation of all the filer's (non-exempt) assets in order to satisfy debt claims. "Non exempt" applies to property that the court permits the debtor to keep in spite of the declaration, and the assets and their value vary state-by-state. In a Chapter 7 filing, the debtors ownership in a business may be considered an asset that can be liquidated; methods for placing a value on the asset can vary widely, and a debate can arise over proportions of ownership in the case of a closely held corporation.

A business can file a Chapter 7 unlike a Chapter 13. However the business does not get a discharge but rather it is a process to liquidate any assets of the business in an organized fashion and equally distribute it to creditors on the basis and priority of their claim. Any balance left owning is wiped out. Usually if a business does not want to close down and liquidate all assets then they can file a Chapter 11 to reorganize and pay back their creditors.

The second type of bankruptcy filing for individuals proposes a reorganization plan and is called a Chapter 13 filing ; that is, taking into account the assets, debts, and potential future sources of income or revenue, the debtor's creditors agree with the court or trustee on settlement or repayment plans. Only individuals can file for Chapter 13. Therefore if you are a sole proprietor or own shares in a corporation you can file an individual Chapter 13 and list your property interest on schedule B to exempt the equity / property interest that you have in it. Also in a Chapter 13 there are debts limits of approximately 1 million in secured debt and approximately 380k in unsecured debt.

Your Business Equity in a Chapter 13 Filing

In a reorganization bankruptcy filing, the court will mandate a strict repayment plan and personal living budget, which the filer must agree to, often for several years. Business ownership assets could be affected, as it is likely that some portion of the monies for debt repayment will flow from the business to the individual.

The Legal Formation of Your Company May Affect the Bankruptcy Outcome

The legal organization of a small business usually takes one of three forms:

  • a sole proprietorship
  • an LLC (limited liability corporation)
  • a corporation

Either S-Corp or C-Corp (S corporations are those where profits or loss flow through to the shareholders, C corporations are taxed separately from their owners. In the case of an LLC, the organization blends elements of both individual and corporate structure. The LLC, like the C corporation, has a legal existence separate and apart from the owners, and US business code provides for owners in LLC to have their liability for corporate debts be limited.

Not all closely-held corporations can benefit from a strict black and white treatment as described above; it's important to have a contact a qualified bankruptcy attorney so you are fully aware of the circumstances for your own situation.

The Sole Proprietorship

If a business is operating as a sole proprietorship, the law does not recognize any distinction between the corporation and the individual, though the specifics of this portion of the code can vary by state.

In general, however, usually in this situation is the fact that due to the close relationship of the individual to the business, a personal bankruptcy is also considered a business bankruptcy, and in Chapter 7, the court will regard the business as just another personal asset that may be liquidated.

The Personal Bankruptcy with Regard to LLC or Corporation Ownership

Since the law recognizes these types of companies as separate legal entities, in the case of an individual with corporate interests of these types declares bankruptcy, only the portion of the business ownership that can be attributed to the bankruptcy filer is affected. The business can continue to operate, with the debtor's equity in the business becoming an asset in the bankruptcy filing.

Homestead Exemptions in a Personal Bankruptcy

A "homestead exemption" is a legal provision that exempts an individual's primary residence from various legal claims, including bankruptcy in many states. This part of the statute is why you will see many entrepreneurs, celebrities and professional athletes have one of these exempt states as their primary legal domicile. In some states, there is no limit on the value of the exempt residence.

Business Ownership Interests in a Chapter 7 Filing

In the case of liquidation bankruptcies, the net value (assets minus liabilities) of ownership interest will be assessed by the court with all other assets of the owner, in order to come up with another source of money available to repay creditors. A theoretical example of this would be an individual declaring Chapter 7 may own a business that has been valued by the the court or trustee at a half million dollars.

If the individual also has another $500,000 in assets that can be liquidated (cash, vehicles, property), potentially there is one million dollars in total to satisfy creditor's claims.

The reason that this is only a theoretical example is due to the fact that quite often, while the court or trustee has placed a value on the business interest, an arm's length, ready, willing, and able buyer cannot be located. Many small businesses have little or no value due to debt on the books from building or operating the business.

One exception should be noted: in some jurisdictions, the bankruptcy code allows for a "fresh start exception." This portion of the law may permit a business to operate going forward without the burden of debt that was attached to the business prior to the bankruptcy filing.

Have any more questions regarding bankruptcy? Don't hesitate to contact us today for a free consultation.

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