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Personal Chapter 7 Bankruptcy vs Business Chapter 7 Bankruptcy

As with any economic uncertainty, many businesses small and large are consuming resources to keep the business going. Many of these businesses may decide to look into the advantages of filing chapter 7 bankruptcy. But, which do you file, personal or business? That depends on many factors including

  • How your business is structured; Sole Proprietor, LLC, S-Corp, Inc. or something else
  • How you keep your books and records
  • How you pay yourself
  • How you pay others
  • Transfers of money and assets you may have made

What’s the difference and how do you decide which bankruptcy is best for you? Below, you will find information that applies to both personal and business chapter 7 bankruptcy to help you make a better decision.

Type of Business Structure

Different types of businesses acquire assets and liabilities in different ways. A Sole Proprietor likely incurs assets and debt using the owner’s own money and credit. A Sole Proprietor who owns a landscaping business, for example, likely purchased lawn equipment, tools, and supplies using his or her own personal money. If the owner took out a line of credit to purchase these items, it was likely approved using a personal guarantee. Any time a business owner applies for credit, in most cases, the lender will require the business owner to personally guarantee the loan. The business owner will use his or her own social security number to provide creditworthiness and sign for the loan using a personal signature. Any time that happens, the owner is now liable for the debt just as well as the business. In case of default, the lender can sue or come after both the business and the owner for repayment. If the business goes under, then the owner will bear the entire liability for repayment. If that sounds like something you did, personal bankruptcy may be best for you.

Sometimes businesses that have been around for a long time have acquired some business credit. If that’s the case, you may have liabilities on the books, which you were able to obtain with only business credit. Usually, these types of businesses are structured more formally using an LLC (Limited Liability Company) or Inc. (Incorporated). These businesses may also be partnerships where all parties to the partnership are both jointly and severally liable for all liabilities. If the business goes under, any liabilities that were personally guaranteed are owed by all the partners. The lender can go after just one partner or all of them equally. It is the lender’s choice. If a lender goes after only one party, and that party is found liable for one hundred percent of the debt, that partner could then sue his or her other partners for their percentage of the debt owed.

If the debt is solely owned by the business, then each of the partners would need to decide if a business bankruptcy is best. In that case, the business needs to examine the books and records to determine how and where money was spent and where all assets to the business are located. The business owners need to speak with a bankruptcy attorney for more advice.

Books and Records

In any bankruptcy where a business is involved, how the bookkeeping and records were handled will be especially important. In bankruptcy, the trustee’s job is to review all the books and records to determine if any transaction could be avoidable. For example, an avoidable transaction maybe if one creditor was paid more than it should have been to the detriment of other creditors. Let’s say you own a clothing store. You buy your inventory from many different dealers. While trying to save the business, you pay one particular dealer over the others because the clothing brands you get from this dealer sell faster than other brands and you can only afford to pay one dealer. Once you file bankruptcy, the trustee’s going to be examining these records. If the trustee finds that you paid more to your favorite dealer while other dealers were getting no money, the trustee can go to the dealer you paid to force that dealer to give the money back. What happens when you borrowed money from a friend or family member to keep the business going. Of course, you want to pay them back and you do. But, if your business debts did not get paid, the trustee’s going to be looking for your friend or family member to pay that money back. The law considers your friend or family member as no different than any other creditor. The trustee will then pay all creditors equally with the money returned from the business creditor, friend, or family member.

How you pay yourself

Another detrimental bankruptcy transaction is how you pay yourself. Do you take a monthly or weekly draw? Maybe you have yourself on a W2 and pay yourself just like any other employee of the business? Also, consider how your transactions are run through your bank account. Do you have a separate business account? If not, and you are running your business through your personal bank account, expect your bankruptcy to get very messy. How you pay yourself may become an issue if you paid yourself to the detriment of your creditors. For example, you paid yourself $10,000 last month as your monthly income. Your creditors, however, got nothing because the business was insolvent at the time, and you were out of money to pay them. It may look to a trustee like you paid yourself all the money from the business as a way to hide it from creditors. Do you normally make $10,000 a month? If, in the last twelve months, you made an average of $3,000 a month, you likely now have a problem once you file bankruptcy. The trustee can force you to pay back the wages you paid yourself which were out of the ordinary course of business.

How you pay others

How do you pay your employees? Are they W2 or 1099? For W2 employees, have you kept up with your payroll taxes? Generally, payroll taxes are not dischargeable in bankruptcy. Have you kept current with sales taxes? Most taxes are not dischargeable in bankruptcy, so if you are behind on any type of taxes, whether personal, payroll, business, or sales tax, you can expect to still owe the government after your case is over. For 1099 employees, do you still owe a contracted employee for wages earned? If so, expect that employee(s) to challenge your bankruptcy for the money you owe them. Also, any claim against you for worker’s comp, long or short-term disability, or other types of wage claims may end up in litigation in bankruptcy court. If you lose, you still owe those claims when your case is over.

Transfers of money and assets you may have made

The trustee will be reviewing all transactions you made through your bank account(s) in the months prior to your case filing. The trustee will ask you for a minimum six months of bank statements from both personal and business accounts. If you run your books and records from software or app, you may be required to turn over at least the last year’s worth of records. Additionally, there’s a bankruptcy Rule 2004 exam, which once initiated by the trustee, can require you to turn over many years’ worth of accounting, books, records, bank statements, and any other record the trustee feels might be relevant to you or your business. The trustee will be reviewing each and every transaction you have made during the life of your business. Any transaction that appears to be suspicious to the trustee will be questioned during an intense financial deposition between you and the trustee. A suspicious transaction may be any payment or transfer of assets from you to another party, such as any of the above examples. You definitely need legal representation before attempting to go into one of these bankruptcy Rule 2004 exams on your own. Many trustees like to use this bankruptcy rule to find any money or assets they can, especially when there is a business involved.

Additional items to consider

The bankruptcy code does not provide for discharge in any business bankruptcy. Chapter 7 is not restructuring. In a bankruptcy involving a business, you are liquidating the business, which means you are selling off any and all assets to provide money to your creditors. If you want to keep the business or restructure, consider chapter 13 for personal bankruptcy, chapter 11 for business bankruptcy, and now there is the newest chapter of bankruptcy, chapter V a subchapter of chapter 11. A bankruptcy lawyer should be able to explain the differences between all these chapters for you. In any event, review what you have done with your business, the way you have handled your books and records, and who you paid and when before you file bankruptcy. Also, prepare to know exactly where all the assets of the business are located. If you sell any business assets before filing bankruptcy, keep good records of who you sold the asset to, when you sold, and what you did with the money you received from the sale. The trustee will want to know. Talk to a lawyer and get advice about what you should do. Last, do not attempt to navigate the bankruptcy code on your own. Bankruptcy trustees have their own small business, which is finding money and assets to take away from you.

See the chart below for a breakdown of some of the differences between personal and business bankruptcy.

Chapter 7Personal BankruptcyBusiness Bankruptcy
Do I get a DischargeYesNo
Liquidation of the businessYesYes
Trustee involvedYesYes
Discharges personal guaranteesYesNo
My personal assets involved in the bankruptcyYesMaybe, depending on whether your personal assets were ever comingled into the business
Will I lose my homeDepends on the equity you have and whether an exemption applies to the homesteadNot likely unless you personally guaranteed debt, which has now been attached to your home from a judgment. In that case, you need to file a personal bay to discharge the debt.
Will I lose my car(s)Depends on the equity you have in the car and whether an exemption applies to the car to protect itLikely Yes if the car is owned only by the business.
Will I lose my business nameIt depends on whether the name has any value. If you own a McDonald’s Franchise, then likely yes. If your business is just your own name, likely noLikely yes
Will I lose business assetsDepends on whether an exemption applies to the asset to protect itMost assets will be sold and liquidated
Can I cancel my business location leaseYesYes, but if personally guaranteed, a business bankruptcy will not help you.
What if I own the business locationWill be liquidated if there is equity in the property, otherwise, it will be foreclosed, and your discharge protects you from possible deficiency between the amount received from the sale and what you oweWill be liquidated if there is equity in the property, otherwise, it will be foreclosed. You may be personally liable for any deficiency if you personally tend the loan.
Can I discharge my business debtsYesNo discharge in business chapter 7.
Can I discharge my personal debtYesNo discharge in business chapter 7.
What if I want to keep my businessChapter 13 for personal bankruptcyChapter 11 or Subchapter V for business bankruptcy