Small business is the lifeblood of the US economy. In California, there are more than 3.4 million businesses so small that they have no employees, and nearly 700,000 more with 1-19 employees. The owners and operators of these businesses are individuals just like you, and sometimes run into their own personal financial problems. But, business owners considering personal bankruptcy often have special concerns about how the bankruptcy filing may impact their business operations. 
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The answer depends on a variety of factors, starting with how the business is structured.
Sole Proprietorships and Bankruptcy in California
Most small businesses are sole proprietorships. Nationwide, sole proprietorships account for 86.6% of businesses with no employees and about 14.3% of those with employees. In one sense, a sole proprietorship is the simplest form of small business. No separate legal entity is created–for both legal and tax purposes, the sole proprietor and the business are one and the same.
In another way, that simple structure is complicated. For instance, if the business gets sued, the sole proprietor is personally responsible. This unity can also create complications if the sole proprietor runs into problems with personal debt. Since there’s no distinction between the person and the business, a creditor or debt collector can reach business assets as well as personal assets.
The same is true if the sole proprietor files bankruptcy. Everything the proprietor may think of as being owned by the business is actually owned by the individual. This has both benefits and drawbacks in a bankruptcy case.
If the business is a sole proprietorship the business and personal debts are resolved in the same bankruptcy case, making the process simpler and less expensive. But, that also means that the sole proprietor can’t discharge personal debts without listing business debts. Discharging debts such as supplier invoices and customer refunds in bankruptcy can obviously have a negative impact on the business’s relationships and reputation. If you’re going out of business, this issue may be less important. But, if you plan to continue operating your business, you’ll want to take this impact into account when deciding how to move forward.
There’s also an upside and a downside to the individual owning all of the business’s assets. The obvious drawback is that any assets the business has, including bank accounts, equipment, and even receivables, are assets to be listed in the bankruptcy and potentially available to the trustee for liquidation. But, sole proprietors also enjoy a bit of extra protection. When a separate business entity files bankruptcy, there are no exemptions. But, the sole proprietor is an individual debtor. That means bankruptcy exemptions may protect “tools of the trade,” and a wildcard exemption may cover some other business assets.
An expert tip from Erik
If your sole proprietorship has significant assets, such as expensive equipment, you may want to consider Chapter 13 bankruptcy. In a Chapter 13 case, the bankruptcy filer makes payments across a three to five-year plan. Obviously, this type of case takes longer to resolve, and the debtor may end up paying more. However, a Chapter 13 filer typically has the option of keeping all property.
As you can see, filing bankruptcy as a sole proprietor raises issues that most individual bankruptcy filers don’t have to think about.
If you own a business and are considering personal bankruptcy, it’s important to make sure that you fully understand the impact the filing will have on your business, and how best to protect yourself and your business. A free consultation with an experienced Los Angeles bankruptcy attorney can be the best place to start.
Partnerships, LLCs, and Corporations in a California Bankruptcy
Other business entities, such as partnerships, LLCs and corporations, are separate legal entities from the owner or owners. That means business debts aren’t listed in or discharged through the bankruptcy case, and assets of the business aren’t listed with the debtor’s property, unless they were personally guaranteed. But, filing bankruptcy as a member in an LLC, a partner, or a shareholder in a corporation may trigger other complications.
One of those possible complications has nothing to do with bankruptcy law: many partnership agreements and other small business operating agreements contain provisions allowing for buyout of a part owner who is insolvent or in bankruptcy. That means the bankruptcy filer’s role in the business may be at risk, even though the business itself is protected. And, of course, the buyout funds may impact the personal bankruptcy.
The risk to the business in the bankruptcy case itself depends on factors such as:
- The value of the business
- Whether the business can continue to operate without you
- Value and transferability of your interest in a business you own with others
For example, if you own a single-member LLC that owns $3,500 in assets and carries $5,000 in debt, the LLC has no value. You’ll still list it as an asset on your bankruptcy petition, but the bankruptcy trustee will have no incentive to step in and liquidate the business, since that won’t yield any money for creditors.
On the other hand, when you list shares in a corporation as an asset, they may have a monetary value. That’s true whether you own 50 shares of McDonald’s or 10,000 shares of a small company you help run. But, the trustee’s options may be different.
That’s because the trustee’s rights to liquidate property are derived from yours. So, for instance, if you have entered into an agreement that limits your ability to transfer your shares, sets a value for those shares, or requires that other shareholders get a right of first refusal, the trustee will typically be bound by those same restrictions.
If you own a business–or a portion of a business–and are experiencing personal financial difficulties, thorough, accurate information is essential.
The experienced bankruptcy attorneys at Borowitz & Clark offer free consultations to make sure you have the knowledge you need to make informed decisions. You can schedule yours right now by calling 877-439-9717, filling out the contact form on this site, or clicking in the lower right-hand corner of this page to chat.