If an owner's business is in severe debt, the first step that they should take would be to protect their personal assets. The second step would be to consult with a bankruptcy attorney to assess their business and determine which course of action would be best for their particular situation.
Personal Liability Versus Business Liability
If they have kept their personal assets and their business assets separate and they have not personally guaranteed any of their debts, their creditors should not be able to litigate damages against them personally. However, if they guaranteed secured debts with their personal assets, they are liable for that debt. They would have to proceed by first filing for bankruptcy protection for their business and then separately file for personal bankruptcy.
The only exception to this rule would be if the sale of their business assets satisfied all debts to their creditors. In that case, their creditor may choose to release them from further liability. Of course, their attorney would have to draft a legal document that states that their personal debt has been fulfilled and have the creditor sign the document.
Payroll Taxes: Business Owners are Liable
The IRS holds all business owners personally liable for unpaid payroll taxes, regardless of bankruptcy proceedings. They are liable for all taxes up to the time of filing. These taxes may even be designated to be paid out of their personal assets.
Sole Proprietors and Partnerships
If they're a sole proprietor, they and their business are considered to be a single entity and as such, they are personally held responsible for all debts. If there are not enough assets produced by the liquidation of their business, creditors can and will sue to take possession of their personal assets.
In a general partnership, each partner is personally liable for the entirety of the business' debts. If they are the only partner with personal assets, they could face personal bankruptcy as well. For instance, if their partners have declared bankruptcy and no longer have enough assets to cover their business obligations, the creditors can take their personal assets to pay all of the business's debts, not just their share. Partnerships can lead to financial ruin both personally and professionally. Do not enter into this type of endeavor without legal advice!
Corporations and Limited Liability Companies
If their business is organized as a corporation or a limited liability company (LLC); in general, their personal assets are protected from business creditors. However, in certain situations, they may have allowed themselves to give up their "limited liability" protection.
It is common practice for banks or creditors to require owners to sign a personal guarantee or security before extending them credit or allowing them to lease properties.
Unfortunately, once they sign over their rights for personal protection, they have allowed the creditor access to their assets if the business becomes incapable of paying the debt.
Small business owners could also risk more than the assets in the bank if they decide to secure credit by pledging specific personal property, such as a house, boat, or car. They should be careful and know that their business is sound before risking their personal property.
The Bankruptcy Option
If their business is in debt over $500,000 and there are not enough funds available to cover the debt, small business owner's should consult with a bankruptcy attorney to start filing Chapter 7 Liquidation Protection. Although, there are no guarantees that they'll get to keep their house and/or other property, they should be able to obtain at least a small amount of “breathing room.”
Owner's may also be able to keep smaller objects such as personal clothing and furniture, and if they are lucky they may retain some or all of their equity in their house and car.
For more information, please read the second part of this article, "When Your Business is in the Red-Part Two."
Korie Schmidt - I am a former High School and Middle School English Teacher that decided to stay at home after the birth of my second child. I am a ...
