For many business owners, bankruptcy raises more than just business concerns—it can create legitimate questions about personal financial exposure. While certain business structures may offer liability protection, that protection is not absolute. Personal guarantees, improperly signed contracts, and the failure to maintain businesses as a separate legal entity can put an owner’s personal assets at risk.
Whether a business owner is personally liable for business debts in a bankruptcy proceeding depends on a number of factors, including the structure of the business, the existence of personal guarantees, contractual oversight, and whether grounds to “pierce the corporate veil” exist.
Below, KingSpry Bankruptcy Law Attorney, Eric J. Filer, Esq., highlights key considerations for determining whether a business owner may be personally liable for business debts. From business structure to personal guarantees and piercing the corporate veil, Mr. Filer explains how certain business practices can put personal assets at risk.
Bankruptcy Options
Several bankruptcy options may be available to businesses and their owners, depending on the business structure, financial circumstances, and long-term goals.
- In a Chapter 7 (Liquidation) bankruptcy, the business is typically shut down, and a bankruptcy trustee sells business assets to pay off creditors.
- In a Chapter 11 (Reorganization) bankruptcy, the business generally continues its operations while restructuring its debts under a court-approved plan.
- In a Chapter 13 (Repayment) bankruptcy, individuals, including sole proprietors, repay their debts over the course of three to five years in accordance with a court-approved repayment schedule.
Each type of bankruptcy has its own requirements, limitations, and strategic considerations. Before filing, business owners should review their financial situation and goals with experienced legal counsel to determine whether bankruptcy is the right choice and, if so, which chapter is best suited to their needs.
Just as importantly, business owners should evaluate their potential personal liability for business debts before filing. In many situations, a business owner may have inadvertently put their personal assets on the line, leading to costly personal liability. Experienced bankruptcy counsel can help business owners recognize and manage these situations.
Business Structure
The first factor to consider is how your business is structured, as each structure has different implications for personal liability.
- A sole proprietor has no separate legal identity. This means the business and its owner are one and the same, making the individual owner personally liable for business debts.
- A general partnership does not protect its individual owners either. Instead, individual owners are jointly and severally liable for business debts, which means creditors can collect the full amount of debt from any one of the owners—regardless of their ownership interest in the company.
- A limited partnership (LP) protects limited partners from personal liability, but the general partner remains completely responsible for business debts.
- A limited liability partnership (LLP) protects all partners, because each owner is considered to have limited liability protection.
- A corporation or limited liability company (LLC) shields owners from personal liability for business debts, provided the business is properly formed and maintained.
Personal Guarantees on Business Liabilities
Next, business owners should consider whether they have signed a personal guarantee. A personal guarantee is a legal contract that requires an individual to repay a company’s debt when the company cannot do so itself. Banks and lenders frequently require business owners to sign personal guarantees before lending business loans or capital. It is crucial that business owners understand what they are signing before they do it. Once signed, the individual owner becomes personally liable for repaying business debt—regardless of the business structure and protections.
Personal guarantees are commonly signed with regard to business leases, loans, credit cards, and merchant cash advances. Before executing a personal guarantee, business owners should have an attorney review the document and explain the personal liability consequences in the event the business cannot pay its debts.
Signing a Contract in Your Own Name
Similar to personal guarantees, business owners may inadvertently waive their limited liability protection by signing agreements in their individual capacity or personal name. It is critical that business contracts be signed on behalf of the company, in your capacity as an officer of the company. When a business owner signs a contract in their personal capacity, they may become personally responsible for liabilities set forth in the agreement. For example, if a corporation intends to execute a lease agreement for an office space, and the agreement is signed by the owner in their personal capacity, the landlord may be able to reach the owner’s personal assets for back rent.
Piercing the Corporate Veil
Lastly, piercing the corporate veil is a legal doctrine that permits a court to strip away an owner’s limited liability protection and hold them personally liable for business debts. Typically, creditors will rely on this legal theory to file lawsuits against business owners and claim that they failed to treat their business as a separate legal entity. If successful, creditors can collect business debt from the individual’s personal assets.
In determining whether to “pierce the corporate veil,” courts will consider whether the business owner commingled business and personal funds; the business owner failed to maintain corporate records; or the business owner paid for personal expenses from business accounts, among other factors.
Proactively Evaluate Business and Personal Exposure
Ideally, business owners will be intentional about how they structure their business up front so as to avoid personal liability for business debts. If you have found yourself part of a business structure offering no protection and know your business is on the verge of insolvency, it is important to seek professional financial and legal advice to protect your assets to the fullest extent possible.
Moreover, business owners should exercise caution and care when executing legal documents in connection with their businesses. Personal guarantees or contracts signed in your personal capacity could leave you on the hook for your business’s debts.
For business owners concerned about the prospect of bankruptcy, consulting with experienced bankruptcy counsel can make all the difference, helping you recognize, manage, and avoid personal liability.
Together, KingSpry’s experienced Bankruptcy and Business Law Practice Groups are prepared to assist with business planning and bankruptcy proceedings. If you or your business have questions, contact us for personalized guidance.
This article is a publication of KingSpry’s Bankruptcy Law Practice Group. This article is meant to be informational and does not constitute legal advice.
