Chapter 7 for a Corporation vs Chapter 7 for the Owner: 5 Cases That Need Both

What you need to know is that companies, like corporations and LLCs, don’t get discharges in Chapter 7 - the companies are liquidated, and the assets sold for whatever there is, creditors paid as much as possible. A Corporation or LLC’s Chapter 7 liquidates the company but it does not give you a discharge of your personal obligations. The following are five situations where you need to plan ahead for a personal Chapter 7 while the business files for its own Chapter 7, or in a sole proprietorship case.

Personal Liability for Small Business Owners

An automatic stay immediately protects the company as a debtor once it files for bankruptcy, but the owner can still be sued to satisfy any claim on a personal guarantee. That is because the stay only protects the person or entity who files bankruptcy, not other people. You should also not assume that a business which no longer trades is without assets. Inventory, equipment, and even trade receivables can still be valuable. A secured lender may ask the court to lift the stay, and the secured lender does not lose its lien automatically.

If you signed a personal guarantee for the company debt, the creditor can still pursue you even after the company stops paying and files bankruptcy. The amount of the personal guarantee is generally limited to the terms of the guarantee. Personal liability may be confined to certain debts or up to a certain total of debt.

For COVID-19 EIDL loans over $200,000, the SBA required a personal guaranty from the business owner. Then, if the business fails, the owner can be pursued for any debt left after liquidating the business assets. It is important to know that bankruptcy filings by the owners individually may disqualify the business from COVID EIDL payment assistance.

A third kind of personal liability for small business owners is unpaid payroll trust fund taxes. These are the income tax withheld from employees, plus the employees’ share of FICA. Trust Fund Recovery Penalties, equal to the amount of unpaid payroll withholding taxes, are levied personally against a “responsible person” who willfully failed to pay them. Just because you had the title of president, officer, or partner does not make you automatically responsible for unpaid withholding tax--it is about what you did or didn’t do, not a title.

Another kind of claim a trustee may bring involves payments made to the owners (who might also be officers or board members) of the company before it closed. Preferences to owners within a year before filing are scrutinized. Your trustee will look very carefully at business spending and payments to the company owner for potential transfers made at too little value or in furtherance of a fraudulent purpose. The trustee in the business liquidation can even file a suit against the business owner(s) to get repayment for payments made before the bankruptcy filing date.

If your business is a sole proprietorship, your business bankruptcy is a personal Chapter 7 because in that case the individual is the business, there is no difference. It is not a separate legal entity, but the extension of its owner. When a Chapter 7 trustee looks to see what assets will be liquidated, the trustee is looking at the personal assets of a sole proprietorship owner, and their liabilities, to figure out which are exempt and what is left over for the creditors.

Company Case

The company files a Chapter 7 bankruptcy separately from you, and an LLC or corporation cannot just walk into the court. It must have a lawyer. The company will have to file schedules of what it owns and owes. A trustee will be appointed to sell what’s left, and distribute that to the creditors. Your job in a company case is to turn over the company records and cooperate with the trustee. When a corporation or LLC Chapter 7 bankruptcy is filed, the company gets a “creditors’ meeting” also called the “341 hearing”. It generally comes from 21 to 40 days after filing the case. An authorized company representative attends this with company counsel, to answer questions under oath about the assets, debts, and recent transactions of the company. There is no set time by which the case must be finished.

File Your Own Personal Bankruptcy

Don’t assume you can get your personal discharge without filing your own bankruptcy. The bankruptcy court grants debt discharge to individual debtors in Chapter 7 cases in more than 99% of cases, unless the case is dismissed or converted.

If you also file a personal Chapter 7 case, it will have its own rules you must follow. You must get the required credit counseling from an agency approved for your area (within 180 days before filing). And, if you already got a Chapter 7 or 11 discharge in a case filed in the past 8 years, you can’t get another discharge. Personal income taxes are treated differently than most other unsecured debts. That is because the law gives special priority to income taxes of the debtor whose income tax returns were last due, including extensions, within 3 years before the petition is filed. These priority taxes generally survive discharge.

Even though the company’s bankruptcy is not yours, any debts you personally guaranteed or signed on the dotted line for may still appear on your credit report.

Some companies do a bankruptcy that lets the company keep operating, as it “reorganizes” under Chapter 11. Other distressed businesses may be eligible for relief under the “small business Subchapter V” of Chapter 11. Bankruptcy is not always the only option.

When you talk with your attorney about a business bankruptcy, be sure to tell them about any liens, recent transfers made with creditors or other people and any collection actions you have been threatened with or that have already started. If you need to protect your own interests, you may also be advised by your lawyer to file your own personal bankruptcy while the company is working with their attorney on its separate case.