2020 was a challenging year for many small businesses. If you are a business owner who has found it necessary to file for personal bankruptcy, you are not alone. You may be wondering how a bankruptcy will affect your business ownership. That will depend on two variables – the way you legally organized your business when you set it up and the type of bankruptcy you file.
According to the United States bankruptcy code, there are two types of filings for individuals. Chapter 7 is a liquidation bankruptcy, and Chapter 13 provides a reorganization and payback plan. While we have previously discussed each of these bankruptcies as they pertain to business, today, we will discuss how your company’s legal formation may affect the outcome of your filing.
Legal Structures of Small Business
The legal organization of a small business typically assumes one of three forms:
- a sole proprietorship
- an LLC (limited liability corporation)
- a corporation
Differences Between the Structures
- A corporation can be either an S-Corp or C-Corp.
- In an S corporation, profits or losses flow to the shareholders.
- In a C corporation, the business is taxed separately from its owners.
- In an LLC, the company combines elements of individual and corporate structures.
- The LLC exists legally apart from its owners, and the liability for corporate debts is limited.
If you are operating your company as a sole proprietorship, there is generally no legal distinction between the corporation and the individual.
Because of the owner’s close relationship to the business, personal bankruptcy is also considered a business bankruptcy. If the owner files a Chapter 7 bankruptcy, the company is regarded as a personal asset by the courts – and it may be liquidated with other assets.
LLC or Corporation Ownership
The court considers these company structures as separate legal entities. Therefore if an individual declares bankruptcy and has ownership of these types, only the portion of the ownership directly attributed to the individual submitting the filing is affected. The business can continue to operate, with the debtor’s equity in the company becoming an asset in the bankruptcy process.
Chapter 7: Business Ownership Interests
During a liquidation bankruptcy, the court will determine the net value (assets minus liabilities) of ownership interest. That value can be used to pay back creditors, along with any personal assets. For instance, if during the case it is determined that the net worth of the business is $250,000, that amount is added to the personal asset liquidation amount (cars, cash, property) for a final total. While this is a general practice, it can be more theoretical than practical. The process assumes that a buyer is ready, willing, and able to purchase the business and related assets. If there is no buyer and thus the company has little to no market value, it may be allowed to continue to operate if it will help pay back creditors.
There is Help Available
If you are a small business owner, we understand that experiencing financial difficulty can be overwhelming. However, there is no reason to try to figure it all out on your own. When bankruptcy seems to be your only option, and you are concerned about the prospects for your business, call the law offices of Richard V. Ellis. We have been helping Sarasota area individuals and small businesses navigate through the bankruptcy process for decades. We are here to help you determine the best next step for your business and your family.