How Personal Bankruptcy, and not Business Bankruptcy, Helps Colorado Small Business Owners

July 20, 2011

By: David M. Serafin

Invariably, most clients who intend to file for bankruptcy and who own a small business in Colorado want to file only in the name of the business without including personal debts. But, the reality is that a business bankruptcy is rarely necessary as the personal bankruptcy will discharge most or all of the personal guarantees for business debt (depending on personal and business income/expenses under the Means Test).

Because banks and lenders almost always require personal guarantee of a business debt in order to finance the business operations (because of the enhanced risk involved in loaning money or providing a line of credit solely to an undercapitalized business – even if the lender acquires a security interest in the equipment, inventory or accounts receivable of the business), discharge of the personal guarantees in a personal chapter 7 or chapter 13 bankruptcy is usually sufficient.

Despite the “limited liability” of an LLC or S Corporation, which encourages the false assumption that corporately owned assets are not part of the personal bankruptcy debtor’s Bankruptcy Estate, the small business owner often co-mingles assets and has ready access to personal use or possession of such ‘business’ assets. The business income and expenses personally attributable to the bankruptcy debtor are factored in for purposes of the Means Test to determine eligibility for chapter 7 or chapter 13 (and, if a chapter 13, the duration and amount of the monthly plan payment). Similarly, the value of a business with assets exceeding liabilities (e.g. has equity) is deemed for bankruptcy purposes to be property owned by the debtor.

A debtor who files for personal bankruptcy is required by the Bankruptcy Code to include all personal debts (such as a mortgage, car loan, credit card or medical bill) and business debts for which he/she is personally liable for in the bankruptcy schedules. Particularly if an unsuccessful business liquidates, there’s no need to file a business bankruptcy. To avoid a Section 548 fraudulent transfer issue in the bankruptcy action, the small business owner intending to liquidate the business should first distribute or sell business assets for the benefit of the business creditors. Conversely, the business assets should not be transferred to the business owner(s) personally or to another identical business which is an “alter ego” of the first business.

When the business continues operations, any extra equity can be paid back, interest free, over time in a personal chapter 13 payment plan. Here, a chapter 13 reorganization allows the business owner, who owns a business with equity, to prevent liquidation of the business assets by a chapter 7 trustee and “reconcile the non-exempt equity” to keep a profitable business in operation. For more information, call an Englewood personal debt lawyer at (303) 862-9124.

(The limited situations where a business bankruptcy is appropriate are limited to where the business owners are personally liable for payroll taxes owed to the IRS or State of Colorado, or when multiple lawsuits against the business need to be consolidated into one case and transferred into the more debtor friendly Colorado Bankruptcy Court.)