Small Business Bankruptcy: Who Is Responsible for the Debt?

Who is responsible for paying the company debt if, alas, my small business simply cannot sustain itself and I am forced to declare bankruptcy?

It’s an oft-asked question – and the answer depends on a couple of moving parts. From bankruptcy lawyers on JD Supra, consider the following:

You are responsible if you’ve personally guaranteed the company’s line of credit

“If the debt is all owed by the corporation or the LLC, then you aren’t going to have a problem. You can just shut the doors and walk away. Unfortunately for most (if not all) small business owners those company credit cards and lines of credit have personal guarantees attached that permit the creditor to go after you personally — putting your wages, bank accounts, and personal assets at risk…” [From Small Business Bankruptcy, by John Skiba]

– You are responsible if you’ve ‘pierced the corporate veil’

Attorney and writer Donna Seyle gives us a bankruptcy case study in which “…under the doctrine ‘piercing the corporate veil’, (in bankruptcy it’s known as ‘substantive consolidation’) the judge determined that Steve and his friends had so blatantly disregarded the separate corporate entity and used the corporation as a tool for personal business that they were not entitled to protection of their personal assets… …In order to preserve protection against personal liability you must show that you have a real business, not just a sham created to dodge personal liability.” [From 9 Ways to Keep Your Corporate Liability Protection Intact by Donna Seyle]

– You’re responsible if your business is a partnership

“Note that if your business is a partnership, the business itself is not a separate legal entity from the general partners and they may be sued individually for the debts…” [From Small Business and Bankruptcy by Jennifer Packard]

In many cases, you can avoid responsibility by letting the business die a natural death and declaring personal bankruptcy

“In most cases where a small business is closing, I will recommend a personal bankruptcy filing and letting the business die a natural death. The reason being is few small businesses have debts that aren’t personally guaranteed. The personal guarantee is the hammer that the creditor can use to get you to personally pay the business debt. A bankruptcy filing will generally totally eliminate any personal guarantee liability on your part…” [From Can I Go Bankrupt On Just My Business Debts? by John Skiba]

Business taxes, bankruptcy, and liability are a complicated mix

For example: “Under California law (as of Sept. 2011), sales taxes are no longer assessable against the individual owner of a corporation or limited liability company (and therefore are potentially dischargeable in bankruptcy) approximately three and a half years after a business closes if the ‘business or its representative’ gave prompt written notice to the State Board of Equalization of the business’ closure. However, if no notice is given to the State Board, the taxes remain assessable against the individual owner (and other ‘responsible persons’) for at least eight (8) years. This is critical because if the taxes are still assessable against an individual when his or her bankruptcy case is filed, such taxes are not dischargeable…” [From Discharging ‘Responsible Person’ Liability For California Sales Taxes by Mark Sharf]

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