Small Business Separation Issues

Small business owners often say that they think of their business as their “baby.” This metaphor works when you consider the incubation, care and feeding that a business requires of its owner — sometimes 24×7.

But when it’s time to prepare a bankruptcy filing, it’s time to separate the business from its owner to determine who (the business or the owner) needs to file for bankruptcy protection. This is an essential part of bankruptcy counseling.

Separating “owners” and “entities”

Small business owners, and their creditors, must remember that a corporate entity is legally distinct from its owners.

As a general rule, an individual is legally responsible for a corporate entity’s debts only if the individual personally guaranteed the debt. For example, if you own shares of GM, no creditor is going to come to you for payment on the company’s debts since you never guaranteed them.

If the debt of a small business is in the name of the entity and the owners haven’t guaranteed the debt in writing, the entity’s debts don’t impact the owners.

Here’s the rub for small business owners

Because small business owners generally have few financing options, they often mortgage their homes and personally guarantee the credit card debts of the company. Our clients often assume that the “business credit card” is a debt of the company, because the business name is embossed on the card. Not necessarily. The entity is liable only if it signed the credit agreement as the corporate entity. More often than not, the business name is on the card, but the credit agreement was signed and guaranteed by the owner (personally).

When the debt is the responsibility of the owners, we will look at filing personal bankruptcy case for the owners and let the entity continue to operate,  now freed from servicing the credit card debt of the owners. The upshot in this scenario is that these small businesses can survive, while the owners get a fresh start.

Part of our job as attorneys is to help debtors and creditors sort out who may be held liable for any particular debt. Contact us if you need assistance with this or any other area of debtor/creditor relations.

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