When to File a Corporate Bankruptcy in Colorado?

Many of my bankruptcy clients in Colorado own a small business (which, for purposes of this analysis, includes LLCs, S-Corps and Partnerships) the business debt of which the client has personally guaranteed. Particularly in today’s quite restrictive lending environment, a bank simply will not loan money to a small business absent a personal guarantee of the business debt by the business owner. What then happens when the business owner needs to file for bankruptcy?

As an experienced Denver business bankruptcy lawyer, I frequently advise my self-employed clients that a personal bankruptcy will discharge most personal unsecured debt and any personal guarantees made on business debt, but that the bankruptcy will not discharge the business debt itself. What this means is that any creditors of the business can still file a lawsuit against the business itself for any business debts (by liquidating any inventory, equipment or accounts receivable, if the business has equity). But, the automatic stay provisions prevent these same creditors from pursuing the debtor personally. (One exception in which a business owner may be held personally liable for a business debt is if the IRS or Colorado State Department of Revenue validly assesses a Trust Fund Recovery Penalty for willful failure of the business owner to remit payroll taxes.)

Let’s examine the chapters of bankruptcy available to a corporation. The Bankruptcy Code only permits individuals, and not any type of corporation or other business entity, to file. So, a corporation only has two chapters to elect: chapter 7 or chapter 11.

Chapter 11 is rarely the best option for a small business owner. Chapter 11 matters are extremely complex (even for most attorneys) and very expensive. Chapter 11 may be feasible for a business owner who intends to continue operation of the company in which a payment plan is proposed to creditors. (The exact intricacies of chapter 11 is beyond the scope of this article because is rarely ever is of utility to small business owners.)

The best option for a small business owner who intends to wind up the corporation’s business affairs and liquidate the company is chapter 7. PLEASE NOTE THAT a corporation cannot discharge its debts in chapter 7.

Almost all of my clients really intend just to file a personal bankruptcy, rather than that in the name of the corporation, particularly if the business will soon be ceasing business operations. At the same time, it may be of benefit to contemplate the occasional filing of a chapter 7 for the corporation.

In a chapter 7 corporate bankruptcy, the court appoints a chapter 7 trustee to liquidate assets owned by the corporation to pay creditors, which normally would otherwise be a responsibility of the business owner(s). Also, the chapter 7 is often filed on behalf of the corporation in order to prevent creditor lawsuits or any harassment, and to provide an opportunity for the trustee to administer the corporation’s assets in a more efficient manner in a forum (e.g. Bankruptcy Court) which is typically the most debtor friendly venue for any type of debtor. Moreover, chapter 7 for the corporation puts all creditors of the business on official notice of the proceeding, making it much more difficult to file a post-petition lawsuit against either the corporation or its owner(s).

Many of my clients in Colorado who own a small business confuse liabilities held solely in the name of the corporation versus any personal liability of the corporation’s owners or officers. To reiterate, a small business owner nowadays almost always is required by a bank or other financing entity to personal guarantee the debts incurred in the name of the corporation. Even so, a personal bankruptcy will discharge any personal liability of the individual debtor. Unless the business owns valuable inventory, equipment or accounts receivable, it is very unlikely that a business creditor will attempt to liquidate the business itself.