Business Chapter 7 With No Discharge: 6 Facts Owners Learn Too Late

Does a business Chapter 7 wipe out all the company’s debts? It doesn’t. A corporation, LLC or partnership can file Chapter 7, but the discharge only goes to individuals, so the company gets none. The business gets liquidated, and some debts follow you personally. Here are six things people find out too late.

Only people get debt relief in bankruptcy. Businesses and business entities like corporations, LLCs and partnerships are not given a fresh start. The people who ran the business might have personal liability for these business debts. They might not.

The bankruptcy trustee will liquidate and sell everything for the benefit of creditors. All creditors are paid by category. No one is allowed to jump ahead in the queue. Business is sold on terms that benefit creditors, not you. You no longer have control. The trustee will keep the doors open briefly, with court approval, only if there’s a reasonable chance the business will bring in enough money to be able to pay some to creditors. You will also be in front of the Bankruptcy Trustee, and you will be sworn in and asked questions. You have to cooperate and appear when you are asked to.

Personal Liability Usually Survives a Business Bankruptcy

Many small business owners and business partners guarantee their business debts. Lenders often require a personal guarantee for business debt. They want some assurance that someone will pay back the loan. So when the business files bankruptcy, you’re already personally liable for the debt. If you have a business loan with a personal guarantee, the creditor can still come after you. If a co-debtor files personal bankruptcy, the creditor can turn to you.

If your business owes payroll taxes, you personally can be on the hook for the so-called “trust” portion of those taxes. Even if you have a corporation, if you failed to pay the IRS withholdings, you can be held personally responsible. When payroll checks are still cashed but the payroll taxes on the earnings have not been remitted to the IRS, you can get personally tagged with a liability called the “Trust Fund Recovery Penalty.” That means if you are the business owner and have control over its finances, you can be personally liable for payroll tax obligations. Business bankruptcy will not stop this.

The trustee can take back money or assets transferred within certain timeframes of filing. There’s a preference payment rule in business bankruptcy. The trustee can require payback on payments made to creditors up to 90 days before filing, or one year for insiders like relatives. That means if you have been in financial trouble, do not play favorites. You are allowed to pay debts in the normal course of business. The trustee can also look back two years for any transaction that the trustee can prove was done to defraud a creditor. This kind of transfer is called a “fraudulent conveyance.”

Attorney Fees

A corporate entity can only have a lawyer represent it, so the costs of filing business Chapter 7 include attorney fees. An exception exists for a sole proprietorship; you as a natural person can file pro se, that is, without an attorney. If you’re in a sole proprietorship, in the eyes of the law, you are your business. So your bankruptcy is a personal bankruptcy, and all your personal debt is dealt with along with any business debts you may have. The Chapter 7 trustee looks at all your assets and liabilities. Business and personal assets can be sold for the benefit of creditors.

Other Options

Chapter 7 may not be in your best interests, and may not be the only way to end your business or solve financial problems. The point of a Chapter 11 is to permit a corporation, LLC, or partnership to reorganize under the protection of the bankruptcy court while they continue to function and run the business. Maybe not all debts need to be wiped out, but instead given a payment schedule through a Chapter 11 or Chapter 13 reorganization. You can try to negotiate with creditors to achieve a payment schedule. They may, or may not, agree to discount what is owed to them. Which option is best depends on what kind of business you have and what liabilities you have.