LEGAL GUIDE
Written by attorney Patricia Lyda Williams | Sep 2, 2013

SHOULD MY CORPORATION OR LLC FILE BANKRUPTCY IF I FILE PERSONAL BANKRUPTCY?

By Attorneys Jeff & Patty Williams

If you have a Corporation or an LLC, there is no personal liability for any of the debts unless you signed a personal guarantee. But if do not have a corporation or an LLC, and instead own a Sole Proprietorship or are a partner in a business, you are personally liable for all of the business debts.

Whether your small business entity should be bankrupted or not depends on several factors. Among the factors to be considered are:

· -- Do you have the time, energy, and desire to continue the business?

· --Are there any significant assets (tools, inventory, vehicles, buildings, etc.)?

· --What is the net worth of the entity, when debts are subtracted from assets?

(You need an accurate current Balance Sheet to determine this.)

· --How much profit or loss did your company generate during

(1) the six calendar months prior to your bankruptcy filing and

(2) for the year-to-date when you file?

· --Do you own all the stock or membership interest? If not, who else does?

· --Are any Federal withholding (payroll) taxes due?

· --Are any State sales taxes due?

· --Are there any unpaid salaries due?

Another matter to be decided in making this decision is, are your personal finances and those of your corporation or LLC (hereafter, called “entity") entirely separate, or intermingled? For example, perhaps some months there isn’t enough money in your personal account to make a required house or car payment, so you write a check from your business account to cover it. Or, the business entity has some bills coming up, so you cover them by making payments using your personal charge cards. Intermingling like this can make it very difficult, or impossible, to figure who owes what. It can also invite a detailed tax audit of both yourself and the entity.

If both you and your business entity are way behind on bills with no chance of catching up, and you definitely need to file personal bankruptcy, it may or may not make sense to also file bankruptcy for the entity.

Corporations or LLC s can file either Chapter 7 bankruptcy or Chapter 11 bankruptcy, but not Chapter 13 bankruptcy. Although they cannot discharge their debts in a Chapter 7, they can under certain circumstances in a Chapter 11. But very few small corporations or LLC’s are good candidates for a Chapter 11; most fail (the Courts either dismiss them or force them into a Chapter 7 instead.)

Filing Chapter 7 Bankruptcy for Corporations and LLC’s

Chapter 7 is for the liquidation of a failed entity, not for reorganization or continued operation, as in Chapter 11. Many times, when the owner of a small business corporation or LLC finds it necessary to file bankruptcy, and there are no assets in the entity, they just stop operating it, and do not bother to file a separate bankruptcy for the corporation, to save money. (They allow the corporate status to lapse with the State by not renewing the annual registration. and eventually the State terminates the existence of the entity by Administrative Dissolution. If there are no assets, in many cases this makes sense, as entity debts not personally guaranteed by the owner cannot be charged to him/her, and those personally guaranteed by the owner are wiped out by their personal Chapter 7 filing.

Since there is no discharge of debts when a Chapter 7 corporate or LLC bankruptcy is concluded, any creditors are free to resume suing the entity after the bankruptcy is over. However, there are several situations in which it makes good sense to file a separate Chapter 7 for the entity at the same time as filing personal bankruptcy (whether 7 or 13). Let us now consider these.

ReasonstoFile A Separate Chapter 7 for Your Small Business Entity

  1. If your entity has any assets and owes employment (payroll withholding) taxes or sales taxes, you do not want regular business creditors to get the assets first by filing collection suits. The Federal government will later go after you personally for any unpaid payroll taxes, and the State will go after you personally for any unpaid sales taxes. Also, the Trustee will give priority treatment to any unpaid wages which were earned by any employees of the entity (possibly including you) during the 180 days before filing bankruptcy (or cessation of the business, whichever came first), up to $10,000 per employee.

  2. If there are considerable assets (such as product inventory, vehicles, tools, one or more buildings, etc.), but the business is not going to continue, the owner may wish to hand off the duties of liquidation and distribution of assets to a bankruptcy trustee. This way there is no question that the creditors have been fairly treated under the bankruptcy code, and that they have received all that is available for distribution, even if it is only pennies on the dollar.

  3. Sometimes if the corporation or LLC defaults on its debt and does not declare bankruptcy, one or more of the creditors may file suit in hopes of collecting the debt, often naming the owner/shareholders as well in the suit. Even if only the entity is named, and the owner ignores the suit, when the court enters a default judgment, it may well require routine post-judgment interrogatories to determine whether there are any assets to attach. If the owner or former president/director/manager does not produce these, they could be fined or jailed for contempt of court. Additionally, Georgia no longer allows an officer or owner of an entity to answer for it in court, but requires a licensed attorney to do so. Paying an attorney to do this, and/or paying an attorney to answer for you if they also sue you personally, usually costs more than simply filing a separate Chapter 7 for your entity at the same time. Besides, by filing a separate Chapter 7, you publicly show there are no more assets.

However, filing a separate Chapter 7 for your corporation or LLC can conceivably cause unnecessary problems for you. Here are three of them:

ReasonsNotto File A Separate Chapter 7 for Your Business Entity

  1. The bankruptcy Trustee is obligated by his position to try to find a way to pay creditors. If the entity’s financial affairs were intermingled with yours, the Trustee may choose to seek to reimburse creditors by suing you and piercing the corporate veil.

  2. If the small business entity was undercapitalized, as is the case with most small business entities, there is a risk that the Trustee would seek to hold you liable for all the debts of the corporation.

  3. The Trustee could also sue to collect loans made by the small business entity to you, and he could also sue to recover loan payments made to you in repayment for loans you made to the entity in the year or more prior to bankruptcy.

Before deciding whether to file a separate bankruptcy for your corporation or LLC, you should consider all these factors with a good bankruptcy attorney.

Can I File Bankruptcy Without It Affecting My Corporation or LLC?

People sometimes reason that because a Corporation or LLC insulates the owner from personal liability, there is no problem with continuing to operate the entity as before while filing personal bankruptcy. They are failing to realize that although an owner who is a bankruptcy debtor is not responsible for the debts of the Corporation or LLC, he/she is the sole (or at least partial) owner of all the stock or membership interest! Since they own it, when they file personal bankruptcy, that stock (or membership interest) becomes an asset of the debtor’s bankruptcy estate. Therefore, the debtor must list their ownership interest in their company in their bankruptcy. If that stock or membership interest has any value (i.e., if the entity has any assets), the bankruptcy Trustee has the power to liquidate the assets of the corporation or LLC for the benefit of the debtor’s personal creditors.

However, there are two possible ways out of this mess, if the debtor wishes to keep operating his/her Corporation or LLC.

First, if the net value of the liabilities of your entity equals or exceeds the net value of the assets of the company, your bankruptcy attorney can present to the Trustee a balance sheet proving that, and state that your interest in your company has no net value because the liabilities exceed the assets.

Second, if the net value of the assets of your entity exceeds the net value of the liabilities of the company, you may simply pay the Trustee the fair value of the stock or membership units, generally the liquidation value of the corporate assets (assets less liabilities). Often this liquidation value is not that much, especially if the business assets are subject to bank liens or there is no inventory. So, as the value of the entity is often much greater as an ongoing operation, a bankrupting debtor-owner will sometimes “buy back" the entity’s business assets from the trustee in order to keep the entity solvent.

For either of these solutions to work, you must provide your attorney with accurate valuations. Even your accountant may not have all this information. The bankruptcy trustee will ask you how you valued your company, and you need to have clear, concise explanations as to how you determined the value of each item to avoid harming your case.

In Conclusion

Most of the time, it does not make good sense when filing personal bankruptcy to also file a separate Chapter 7 for your corporation or LLC, unless there are significant assets and also significant unpaid employment or sales taxes. However, every case is different, and you need to gather the information listed above and sit down with a good bankruptcy lawyer with significant small business experience to discuss your particular situation.

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