When You Might Be Personally Liable for Corporate Debt

LLC and corporation owners can lose personal liability protection in six ways, and when that happens, personal bankruptcy, not business bankruptcy, is the path to discharging those debts. Forming a corporation or LLC normally shields its owners from personal responsibility for business debts—but that protection is not absolute. Several common situations can expose a business owner to direct, personal liability for what are otherwise company obligations. If you are personally liable for any of your business debts, you will need to file personal bankruptcy—not a business bankruptcy—to eliminate them. The six situations below are the most common ways owners of corporations and LLCs end up on the hook for business obligations.

Signing a Personal Guarantee for Business Debt

A personal guarantee makes you directly responsible for a business debt if your company can't pay, and signing one means a creditor can pursue your personal assets for repayment, regardless of your LLC or corporate status.

Because most suppliers, banks, and landlords know that corporate shareholders and LLC members are not personally liable for business debts, they often won't extend credit or lend money to a small corporation or LLC without an owner's personal guarantee: a legally binding agreement that the owner will repay the debt if the business can't. Many small business owners sign personal guarantees—even though they incorporated or formed an LLC precisely to limit their liability—because they can't get the financing otherwise.

Check whether you signed a personal guarantee on any of your business contracts, such as a loan for a business vehicle or equipment, trade terms with a supplier, a bank line of credit, or a commercial lease. If so, the creditor can go after your personal assets to recover the debt.

Pledging Personal Property as Collateral

If you secured a business loan by pledging personal property—your home, boat, or car—you are personally liable for that debt, and the lender's lien on the collateral survives even a personal bankruptcy discharge.

Banks often require owners of small corporations or LLCs to pledge their home or other real estate as collateral for a loan. If your business defaults, the lender can sue to foreclose on the collateral and use the proceeds to repay the debt. Filing for Chapter 7 personal bankruptcy will discharge your personal liability for this type of loan, but the lender's lien on the collateral will survive the bankruptcy. This means you will still have to pay off the secured debt if you want to keep or sell the property. (11 U.S.C. § 506.)

Signing Contracts Personally Instead of for the Business

If you signed a purchase agreement or service contract in your own name—rather than in your capacity as an owner or officer of the corporation or LLC—you're personally liable for the underlying obligation, even if the error was inadvertent. If you're not sure how a document was signed, check the signature block. Look for language showing whether you executed the agreement individually or on behalf of the business entity.

Using Personal Credit Cards or Loans for Business Expenses

Using personal credit cards or home equity loans to fund your business makes you personally liable for those debts, and most credit card agreements, even those opened in a business's name, include a clause holding the individual signer personally responsible for all payments. Filing for Chapter 7 bankruptcy in your own name can discharge qualifying personal and business debts of this type, including credit card balances and home equity loan deficiencies used to finance the business.

Personal Liability for Tortious Conduct

An owner who personally commits a tort—a wrongful act that harms another person and causes monetary loss—can be held personally liable for that harm, regardless of the business's corporate or LLC status. Generally, owners of corporations and LLCs aren't personally liable for management decisions or ordinary business mistakes. Liability attaches to the owner's own wrongful conduct, not to every error made in running the business.

Fraud, Misrepresentation, and Piercing the Corporate Veil

Lying on a loan application or not maintaining separation between yourself and your business can expose you to full personal liability for business debts, and debts incurred through fraud are generally not dischargeable in bankruptcy. Beyond fraud, creditors can seek to hold you personally responsible for business debts under the doctrine known as "piercing the corporate veil." This occurs when a court finds that your corporation or LLC is a sham and that you personally operated the business as if the entity didn't exist, at which point the court can strip you of the limited liability protection your business structure would ordinarily provide. (11 U.S.C. § 523(a)(2).)

The most common evidence creditors use to pierce the veil includes:

• Failing to record important business decisions in meeting minutes or written resolutions
• Commingling business and personal funds or paying business bills from a personal account or personal bills from the business account
• Treating the business as an alter ego rather than a distinct legal entity

Even corporations or LLCs owned by a single individual or a married couple must observe the rules and formalities imposed on these entities. Failure to do so risks losing the limited liability protection that incorporation or LLC formation was designed to provide.

What to Do If You Are Personally Liable for Business Debts

If any of the situations above apply to you, personal bankruptcy—not business bankruptcy—is the mechanism for discharging those debts. The right chapter depends on your income, assets, and whether you want to keep your business operating.

• Chapter 7 liquidates nonexempt assets and discharges most qualifying unsecured debts quickly—typically within three to six months—but the Chapter 7 process doesn't allow you to catch up on secured arrears.
• Chapter 13 lets you restructure personal debts over a three-to-five-year repayment plan, which can be useful if you have secured debts on collateral you want to keep.

Before filing, review all of your contracts and loan documents for personal guarantees and check how each agreement was signed. A bankruptcy attorney can help you assess which debts are truly personal obligations, whether any nondischargeability issues apply (such as fraud-based debts under 11 U.S.C. § 523(a)(2)), and which chapter best fits your situation.