In 2009, Bankruptcy filings increased by 32% according to the Associated Press. A significant number of these filings included small business owners who were overwhelmed with debt and needed a fresh start. Although a small business owner's debts are usually related to the business, he or she must utilize consumer Bankruptcy under Chapter 7 or Chapter 13 to eliminate or discharge the debts. There is no such thing as a "small business Bankruptcy." Moreover, any and all debts of the unincorporated business are, in effect, treated as personal debts of the owner.
It is important for small business owners to consider both types of consumer Bankruptcy before filing, as each solution has its advantages and disadvantages.
In a Chapter 7 Bankruptcy, the sole proprietor undergoes a "fresh start" process where his or her assets (other than those exempt from Bankruptcy) are seized, sold and distributed to his or her creditors. If the debts are primarily business in nature, the debtor will not be subject to the "Means Test." The Means Test was added to U.S. Bankruptcy Code in 2005 and has created numerous problems for consumer debtors over the last 5 years. Avoiding the Means Test is a huge advantage for small business owners. If the debtor does not have many assets to liquidate or sell, then Chapter 7 is a great option, especially if the business debts are large. Most debts will be discharged through Chapter 7 with some exceptions (e.g., educational loans, child support, certain taxes, etc.). A Chapter 7 Bankruptcy will stay on the debtor's credit report for 10 years, which is the main disadvantage to filing. The Bankruptcy will make it more difficult during the 10-year period to buy a home, purchase a vehicle, or start a new business.
In a Chapter 13 Bankruptcy, the DBA owner establishes a repayment plan with his creditors, assuming his debts satisfy the debt limitations under the U.S. Bankruptcy Code. The business debts are paid from the debtor's future income over a period of three (3) to five (5) years, depending on income levels. Many small business owners have mortgages and car payments, along with their business debts. If the debtor is behind on these secured obligations, a Chapter 13 Bankruptcy could get them current and help avoid foreclosure and repossession. It could also help eliminate the business debts, although the debtor would be required to pay back a portion of the business debts over time.
Even if the small business was incorporated, the owner may still be liable for certain business debts after the business fails due to guarantees. If an owner signed a personal guarantee or guaranty agreement, or personally guaranteed anything on behalf of the business, he or she will become personally liable for the business debts. Many of our small business clients who were incorporated as a corporation or limited liability company fall into this category. Typically, small businesses cannot get credit, bank loans, or commercial leases without a personal guarantee from the owner. In short, if the business defaults, it will be liable for the breach of contract, along with the small business owner.
One more thing -- although some tax liabilities can be erased through a Chapter 7 Bankruptcy or discharged over time through a Chapter 13 Bankruptcy, a small business owner can never utilize Bankruptcy to escape liability for payroll taxes. The best option in that scenario is to work out a installment agreement or payment plan with the IRS.
If you are a small business owner who is personally liable for the debts of your business, please contact the Law Office of Nicholas R. Westbrook today at (713) 893-6204. Mr. Westbrook is a sole proprietor himself and understands the nuances and laws governing business debts. He is also a dedicated and helpful Houston Bankruptcy attorney who will meet with you in person and explain your legal options. To schedule a free consultation and free yourself of those business debts, please call us today at (713) 893-6204. Stop letting debt ruin your life.