Below are some common ways an owner of a corporation or an LLC might become personally liable for the business's debts. If you are personally liable for some or all of your business debts, you will have to file personal bankruptcy, rather than a business bankruptcy, to rid yourself of these debts.
Because most suppliers, banks, and landlords know that corporate shareholders and LLC members aren't 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. And many small business owners are willing to sign a personal guarantee, even though they incorporated or formed an LLC precisely to limit their liability for obligations relating to the business, because they can't get the money otherwise.
Check to see whether you signed a personal guarantee on any of your business contracts, such as a loan for a business vehicle or business 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 for repayment.
Banks often require the owners of small corporations or LLCs to put up their home or other real estate as security for a loan. If you secured a business loan or debt by pledging personal property, such as your house, boat, or car, you are personally liable for the debt. If your business defaults on the loan, the lender or creditor can sue you to foreclose on the property (collateral) and use the proceeds to repay the debt. Filing for Chapter 7 personal bankruptcy will wipe out your personal liability for this type of loan, but the lender's lien on the collateral will survive. This means you'll eventually have to pay off the debt if you sell the property.
You may also have given up your limited liability if you were careless about signing purchase agreements and service contracts for your business. Sometimes these agreements display the personal name of the business owner without the name of the corporation or LLC. If you signed an agreement in your personal name and not on behalf of the corporation or LLC, you're personally liable for the underlying debt, even if it was a simple mistake. If you're not sure whether you signed an agreement or loan personally, check the language of the agreement and the signature block to see whether you signed it in your name or in your capacity as an owner or officer.
If you used credit cards or home equity loans to obtain funds for your business, you are personally liable for those debts. (Under the terms of most credit card applications, even those used in the name of a corporation or LLC, you agree to be personally liable for making all payments.)
Generally, owners of corporations and LLCs are not personally liable for mistakes in management, but they can be held personally liable for injuring others. An owner who commits a tort (the legal term for an act that harms another person and causes monetary loss) can be held personally liable.
If you misrepresented or lied about any facts when you applied for a loan or credit on behalf of your corporation or LLC, you could be held personally liable for the debt. Likewise, if you failed to maintain a formal legal separation between your business and your personal financial affairs, creditors could try to hold you personally responsible for the business's debts under a theory known as “piercing the corporate veil.” This happens when a court finds that your corporation or LLC is really just a sham and you are personally operating the business as if the corporation or LLC didn't exist. In this situation, a court may decide that you aren't entitled to the limited liability that your business structure would ordinarily provide.
One way creditors try to pierce the corporate veil is by showing that you didn't observe the legal formalities imposed on corporations and LLCs. For instance, you may have made important corporate or LLC decisions without recording them in minutes of a meeting. Or, you may have paid business bills from a personal checking or credit card account or paid personal bills from your business bank account. Even corporations or LLCs owned by a single individual or a married couple have to obey the rules and formalities imposed on these business structures; otherwise, they risk losing their limited liability protection.
Excerpted from Bankruptcy for Small Business Owners: How to File for Chapter 7, by Attorney Stephen Elias and Bethany K. Laurence, J.D.