Will You Have to Close Your Business if You File for Personal Bankruptcy?

You may have to shut your business down if you file for Chapter 7 personal bankruptcy. However, if you own an LLC or corporation with others, you may be able to keep your doors open, even if you are personally liable for a significant portion of its debt. Let's take a closer look.

Sole Proprietorships

If your business is a sole proprietorship, the trustee may insist that you close it, at least until the trustee can assess the value, exempt status, and likely sales price of any business assets in your bankruptcy estate. This assessment usually lasts a couple of months or more. Closing the business also prevents you from incurring any additional liabilities during your bankruptcy case, whether for regular business debts you might take on during the bankruptcy or for potential legal claims against your business (for example, if someone gets hurt on your premises).

Businesses that operate without assets, such as service providers, consultants, or freelancers, might be allowed to remain open during bankruptcy, especially if your chances of running up debt or incurring legal liabilities are small. But even a small service business might be shut down if it has significant accounts receivable that the trustee could collect. For example, if you own a real estate business and have commissions in the pipeline that haven't been paid yet, the commissions will become part of your bankruptcy estate when they are paid. Any proceeds generated by the business while you're in bankruptcy are also part of your bankruptcy estate.

Partnerships and Multimember LLCs

If your business is a partnership or multimember LLC (it has more than one owner), your share of the business will be part of your bankruptcy estate. Unless you are a majority owner, however, most states prohibit the trustee from interfering with the partnership or LLC or taking its assets.

Here's how it works. A creditor or bankruptcy trustee can obtain a "charging order" against the debtor-owner's interest in the business. Essentially, a charging order acts as a lien against the business interest, allowing the creditor or trustee to receive the profits that would otherwise be paid to the owner of the interest. However, a charging order won't do a creditor or trustee much good if a partnership or LLC doesn't regularly distribute profits to its members. The trustee takes over only the economic right to receive income from the partnership or LLC; typically, a person assigned economic rights is not allowed to manage or vote in the partnership or LLC nor to assume other membership rights granted to full owners under the partnership or LLC operating agreement. The trustee can assign or sell the economic rights in your ownership interest to someone else, but generally cannot transfer or sell your share of the partnership or LLC.

You may need to get out of a partnership or LLC before filing for bankruptcy. If you are a partner in a partnership or a member of an LLC, you may have signed a buy-sell agreement that requires you to terminate your ownership interest before filing for bankruptcy. If you violate a provision like this, you could be facing a lawsuit from your co-owners. A small business attorney can help you assess your obligations and options here.

Corporations and Single-Member LLCs

Your bankruptcy estate includes your corporate shares or LLC membership. If you are the sole or majority owner of the corporation or LLC, the bankruptcy trustee can take over your shares or membership interest and vote to sell or liquidate the business, then distribute the proceeds to the business's creditors.

In deciding whether to dissolve a single-owner corporation or LLC, the trustee will take a cost/benefit approach. The trustee will look at the cost of dissolving and liquidating the business, how much the assets can be sold for, and whether any of the assets are exempt. In many cases, the business owes almost as much as (or more than) it owns, so liquidating the business wouldn't make financial sense. But if the business has a moderate amount of debt and valuable, nonexempt assets, the trustee is likely to dissolve the corporation or LLC and sell the assets.

If you own a viable corporation with other members, then your personal bankruptcy may or may not affect your business. For example, if you own a corporation equally with two or three other shareholders, you may be able to file for personal bankruptcy without any consequences to the corporation. Although the trustee has the right to vote shares in a corporation, he or she generally won't be able to call a meeting and force a dissolution of the corporation to get at its assets unless you are the majority shareholder. Your stock is still part of your bankruptcy estate, but it won't have much value to the bankruptcy trustee unless one of the other owners wants to buy it.

Excerpted from Bankruptcy for Small Business Owners: How to File for Chapter 7, by Attorney Stephen Elias and Bethany K. Laurence, J.D.

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