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When business debt becomes difficult to manage, understanding personal vs. business bankruptcy is an important first step. The right approach may depend on whether the debt belongs to the individual, the business, or both. Business structure, personal guarantees, ownership of assets, and plans for the company can all affect which bankruptcy options may be available.
Quick Answer
Personal bankruptcy is filed by an individual and addresses debts for which that person is legally responsible. Business bankruptcy is filed by a company or other eligible business entity and addresses the obligations of that business. The distinction between personal vs. business bankruptcy often depends on who signed the debt, how the business is structured, and whether the owner agreed to be personally responsible.
How Does Personal Bankruptcy Work?
Personal bankruptcy is filed by an individual or, in some cases, jointly by spouses. Individuals commonly file under Chapter 7 or Chapter 13, depending on their income, debts, property, goals, and eligibility.
A personal bankruptcy may address qualifying debts such as:
- Credit card balances
- Medical bills
- Personal loans
- Certain unpaid balances after repossession
- Business expenses charged to personal accounts
- Personally guaranteed business debts
- Other obligations for which the individual is liable
Chapter 7 is generally a liquidation process. A trustee may collect and sell nonexempt property, when available, and distribute the proceeds according to bankruptcy law. An eligible individual may receive a discharge of certain qualifying debts.
Chapter 13 allows an eligible individual with regular income to propose a repayment plan, generally lasting three to five years. Corporations, LLCs, and partnerships cannot file under Chapter 13 because the chapter is limited to eligible individuals.
When comparing personal vs. business bankruptcy, one of the most important questions is whether the owner is personally responsible for the debt.
When Can Business Debt Become Personal Debt?
A debt used for business purposes does not necessarily belong only to the company.
A business owner may be personally liable when the owner:
- Operates as a sole proprietor
- Signs a personal guarantee
- Uses a personal credit card for business expenses
- Borrows money in their own name
- Co-signs a company loan
- Personally signs a commercial lease
- Pledges personal property as collateral
- Becomes liable under another applicable legal rule
A personal guarantee is especially important. An LLC or corporation may be the primary borrower, but a lender may still pursue the owner if that person separately agreed to repay the obligation.
Determining who owes the debt may require reviewing loan agreements, leases, credit applications, guarantees, and other documents.
How Does Business Bankruptcy Work?
Business bankruptcy is filed by the business entity rather than only by its owner.
Businesses may generally use Chapter 7 to liquidate or Chapter 11 to reorganize. The purpose of a business bankruptcy may be to:
- Close the company in an orderly manner
- Liquidate remaining assets
- Address creditor claims through the bankruptcy process
- Restructure debt while continuing operations
- Address certain contracts or leases, subject to court approval
- Sell part or all of the business
- Resolve financial issues involving vendors, lenders, landlords, or other creditors
The appropriate approach depends on whether the business has a realistic path forward, what assets and debts it has, and whether continued operations are financially practical.
How Business Structure Affects Personal vs. Business Bankruptcy
Business structure can significantly affect the analysis of personal vs. business bankruptcy.
Sole proprietorship
A sole proprietorship is not legally separate from its owner. The individual owns the business assets and is generally responsible for its debts.
A sole proprietor does not file a separate bankruptcy case for the proprietorship. Instead, the owner may file a personal Chapter 7 or Chapter 13 case that includes both personal and business-related obligations.
Partnership
A partnership may be a separate bankruptcy debtor. However, individual partners may also face personal exposure depending on the type of partnership, applicable law, personal guarantees, and the nature of the debt.
A partnership bankruptcy does not necessarily resolve every partner’s individual obligations.
Limited liability company
An LLC is generally treated as a separate legal entity. The company may owe its own debts and may file its own bankruptcy case.
However, forming an LLC does not protect an owner from every obligation. Personal guarantees, co-signed accounts, pledged collateral, or other circumstances may still create personal liability.
Corporation
A corporation is also a separate legal entity. It may file Chapter 7 to liquidate or Chapter 11 to reorganize.
Shareholders are not ordinarily responsible for every corporate debt simply because they own the company. However, they may remain liable for obligations they personally guaranteed or otherwise agreed to pay.
Is business debt putting your personal finances at risk?
The name on the loan, lease, credit account, or guarantee may determine whether the obligation belongs to the company, the owner, or both. A bankruptcy attorney may help you review those documents and understand which options may apply.
Can a Business File Chapter 7?
An individual, partnership, corporation, LLC, or other qualifying business entity may file under Chapter 7.
For an operating business, Chapter 7 generally means liquidation rather than reorganization. A trustee may take control of property belonging to the bankruptcy estate, sell available assets, and distribute funds to creditors according to statutory priorities.
A corporation or partnership does not receive a Chapter 7 discharge in the same manner as an individual. The business may remain legally responsible for unpaid obligations, even if few or no assets remain after liquidation.
An individual Chapter 7 case is often focused on discharging qualifying personal debts. A business Chapter 7 case is generally focused on collecting assets, paying creditors when possible, and winding down the company.
Can a Business File Chapter 13?
A corporation, LLC, or partnership cannot file under Chapter 13.
Chapter 13 is available only to eligible individuals with regular income, including some individuals who operate businesses. A business owner may use an individual Chapter 13 case to address personal debts and qualifying business-related debts for which the owner is personally responsible. However, that filing does not automatically place all assets or debts of a separate company into the owner’s personal bankruptcy case.
How Does Chapter 11 Work for a Business?
Chapter 11 is commonly associated with business reorganization. In many cases, the debtor remains in possession of its assets and continues operating while proposing a plan to address its obligations.
A Chapter 11 case may involve:
- Restructuring secured and unsecured debt
- Modifying payment terms
- Addressing contracts and leases
- Selling assets
- Obtaining court approval for certain transactions
- Continuing operations during the case
- Proposing a plan for paying creditors
Chapter 11 is not limited to large corporations. Small companies and some individuals may also use it, although it is generally more complex than a typical consumer Chapter 7 or Chapter 13 case.
What Is Subchapter V?
Subchapter V is a specialized form of Chapter 11 designed to streamline reorganization for qualifying small-business debtors.
A Subchapter V trustee is appointed, while the debtor generally remains in possession of the business and continues managing its operations. The trustee may monitor the case and help facilitate the development of a plan.
Subchapter V may reduce some of the procedural burdens associated with a traditional Chapter 11 case, but it is not automatically available to every small business. Eligibility depends on the Bankruptcy Code’s current requirements.
What Might Personal and Business Exposure Look Like?
A real-world example can make the difference between personal vs. business bankruptcy easier to understand.
Imagine that the owner of a small construction company formed an LLC and borrowed money to purchase equipment.
The LLC signed the equipment loan, but the owner also signed a personal guarantee. During a slow period, the owner used personal credit cards to pay for payroll and supplies.
If the company closes, the LLC may still owe the equipment debt. The lender may also pursue the owner under the personal guarantee. The personal credit card balances generally remain the owner’s responsibility because those accounts are in the owner’s name.
The company and the owner may therefore have related but legally separate financial problems. A business bankruptcy might address the company’s assets and creditors, while a personal bankruptcy might be considered for debts owed by the owner.
Every situation depends on the business structure, contracts, assets, debts, and applicable law.
How Do Personal vs. Business Bankruptcy Outcomes Differ?
The result of bankruptcy depends heavily on who files and which chapter is used.
Individual Chapter 7
An eligible individual may receive a discharge of qualifying debts while retaining property protected by applicable exemption laws. Nonexempt property may be administered by the trustee.
Business Chapter 7
The business generally stops operating unless the trustee temporarily continues operations to preserve value. Assets may be liquidated, and corporations and partnerships do not ordinarily receive the same Chapter 7 discharge available to individuals.
Individual Chapter 13
An eligible individual proposes a repayment plan based on income, expenses, debts, property, and other requirements. The plan may include both consumer debts and business-related obligations owed personally by the filer.
Business Chapter 11
The business may continue operating while restructuring its obligations through a court-approved plan. The process may affect owners, employees, vendors, landlords, lenders, and other interested parties.
The term “bankruptcy” therefore does not describe one single outcome. Liquidation, individual debt relief, repayment, and business reorganization are different processes with different goals.
Questions to Ask When Comparing Personal vs. Business Bankruptcy
Before deciding whether bankruptcy should be personal, business-related, or both, a business owner may need to determine:
- Is the business a sole proprietorship, partnership, LLC, or corporation?
- Who signed each loan, lease, and credit agreement?
- Did the owner provide a personal guarantee?
- Is personal property pledged as collateral?
- Does the business have valuable assets?
- Is the company still financially viable?
- Does the owner want to continue operating?
- Are payroll taxes or other priority obligations involved?
- Are any debts shared by the owner and the company?
- Could closing the business create additional personal liability?
The answers may reveal that the financial problem is primarily personal, primarily business-related, or a combination of both.
Key Takeaway
The difference between personal and business bankruptcy is not determined only by how a debt was used. The business structure, name on the obligation, personal guarantees, ownership of the assets, and future of the company all matter.
How May a Bankruptcy Attorney Assist?
A bankruptcy attorney may help a business owner:
- Review the legal structure of the business
- Determine who may be liable for particular debts
- Examine personal guarantees and secured obligations
- Separate personal assets and debts from company property and obligations
- Compare liquidation and reorganization options
- Evaluate whether the owner, business, or both may need relief
- Discuss the consequences of closing or continuing the company
Legal representation does not guarantee a particular result. Bankruptcy options and outcomes depend on the facts, contracts, debts, assets, eligibility requirements, and applicable law.
Unsure Whether the Debt Is Personal, Business-Related, or Both?
Understanding personal vs. business bankruptcy can help a business owner identify which debts belong to the company, which obligations may be personal, and whether both issues should be reviewed together.
Brock & Stout may be able to assist you with:
- Reviewing your personal and business obligations
- Identifying debts connected to personal guarantees
- Explaining the bankruptcy chapters that may be available
- Discussing options for continuing or closing the business
Schedule a free consultation to discuss your bankruptcy options.
This article is for general informational purposes and is not legal advice. Bankruptcy laws and procedures can vary by case and jurisdiction. Results depend on the individual facts and circumstances of each case.