The Business Structure Question
When a business owner files personal bankruptcy, the first question is: what is the legal structure of the business? The answer determines almost everything about how the bankruptcy affects the business.
The three most common structures for small business owners are sole proprietorships, limited liability companies (LLCs), and corporations (S-corps or C-corps). Each is treated differently in personal bankruptcy, and the distinction between personal and business assets is central to the analysis.
Sole Proprietorships
A sole proprietorship has no legal separation between the owner and the business. The business's assets are your personal assets, and the business's debts are your personal debts. When you file personal bankruptcy as a sole proprietor, the bankruptcy estate includes all of your business assets — equipment, inventory, accounts receivable, and any other business property — as well as your personal assets.
In a Chapter 7 case, the trustee can liquidate non-exempt business assets to pay creditors. Whether you can continue operating the business after Chapter 7 depends on whether the trustee liquidates the assets you need to operate. If the business assets are minimal and mostly exempt, you may be able to continue. If the trustee liquidates the equipment or inventory, the business effectively closes.
In Chapter 13, you can keep all assets — including business assets — by paying their non-exempt value to unsecured creditors through the plan. This makes Chapter 13 a much better option for sole proprietors who want to continue operating their business. Your plan payment will be based on your disposable income, which includes business income minus reasonable business expenses.
LLCs and Corporations
An LLC or corporation is a separate legal entity from its owner. The business's assets belong to the business, not to you personally. When you file personal bankruptcy, the bankruptcy estate includes your ownership interest in the LLC or corporation — your membership interest or shares — but not the business's assets directly.
The trustee's ability to reach business assets depends on the value of your ownership interest. If your LLC or corporation has significant equity — meaning the business is worth more than its debts — the trustee may be able to sell your ownership interest to a buyer who would then control the business. Alternatively, the trustee may force a sale of the business itself.
In practice, the trustee's ability to monetize an ownership interest in a closely held LLC or corporation is often limited. Buyers for a minority interest in a small business are rare, and many operating agreements include restrictions on transferring membership interests. However, if you own 100% of a profitable LLC, the trustee may be able to sell that interest for significant value.
Protecting Your Business in Chapter 13
Chapter 13 is generally the better option for business owners who want to continue operating, regardless of business structure. In Chapter 13:
- You keep all assets, including your ownership interest in an LLC or corporation and all sole proprietorship assets.
- You pay the non-exempt value of those assets to unsecured creditors through the plan — but you do not lose the assets themselves.
- Business income is included in your disposable income calculation, which determines your plan payment.
- You can continue operating the business throughout the plan period.
The challenge in Chapter 13 for business owners is demonstrating that your income is "regular" enough to fund a plan. If your business income fluctuates significantly, the court may require additional documentation or a higher plan payment to account for income variability.
Business Debts vs. Personal Debts
Another important consideration is whether your business debts are personal obligations. If you personally guaranteed business loans or credit cards, those guarantees make you personally liable for the business's debts. A personal bankruptcy discharge can eliminate your personal liability on those guarantees — even if the underlying business debt remains outstanding.
This is one of the most significant benefits of personal bankruptcy for business owners who have personally guaranteed business debts. After discharge, the lender can still pursue the business entity for the debt, but it cannot pursue you personally.
For a more detailed discussion of this topic, see our article on small business failure and personal debt.
When Business Bankruptcy Is the Right Answer
If your business itself — not just you personally — has significant debts that need to be restructured or discharged, the business may need to file its own bankruptcy case. Corporations and LLCs can file Chapter 7 (liquidation) or Chapter 11 (reorganization). Sole proprietors can use personal Chapter 13 to reorganize business debts.
The decision between personal bankruptcy, business bankruptcy, or both is one of the most complex in bankruptcy law. The right answer depends on the business's value, the nature of the debts, the business structure, your personal financial situation, and your goals for the future of the business.
If you are a business owner considering bankruptcy, consult a bankruptcy attorney who has experience with business cases. Use our directory to find a bankruptcy attorney near you who handles both personal and business bankruptcy matters.
Take our free Debt Relief Options Quiz to understand whether personal bankruptcy, business bankruptcy, or another option may be right for your situation.
