Posted by Kevin on March 4, 2018 under Bankruptcy Blog | 
In the prior blog, we learned that a corporation or LLC (business entity) can file bankruptcy under Chapter 7. Are there any situations where the owner of the business would file bankruptcy when the business fails? The answer is yes under the following circumstances:
– the business is being operated as a sole proprietorship; or
-the owner of the business has provided personal guarantees of the obligations of the business.
If the business entity is a sole proprietorship (for example, John Smith doing business as “The Hot Dog King”), the business and the owner are the same person for legal purposes. All the assets and liabilities of the business are in the name of the owner. If that business fails, the creditors can bring a lawsuit against the owner. Moreover, if the creditor obtains a judgment, that creditor can look to any of the assets of the owner to be made whole. That includes both the business assets and personal assets of the owner. To avoid this outcome and allow for an orderly liquidation of the assets of the sole proprietorship, the owner can file bankruptcy, and obtain a discharge of debt.
If the business is a corporation or LLC, the law considers the business to be an entity separate from its owners. In many cases involving businesses, creditors (especially banks, inventory suppliers, and the like) will require the owner to guarantee business debt. If the business defaults on the obligation, the creditor, which is the beneficiary of the guarantee, may sue the guarantor/owners, obtain a judgment, and attempt to levy on any assets of the owner including assets that have nothing to do with the business. To avoid this outcome, the owner/guarantor can file bankruptcy, and obtain a discharge of debt.
Will the owner of the business, either as a sole proprietor or a guarantor of debt, be able to file a Chapter 7 or will he or she be forced into a Chapter 13 where 3-5 years of payments to creditors are required. While individuals are generally subject to the means test (which we spoke about a few blogs back) , the good news is that you do not have to pass the means test at all unless your “debts are primarily consumer debts.” So if your debts are primarily business debts—more than 50%–you avoid the means test altogether.
Let’s be clear about the difference between these two types of debts. A “consumer debt” is a “debt incurred by an individual primarily for a personal, family, or household purpose.” So, business guarantees are not consumer debts. It can be argued that cash advances on credit cards which are used by the business are not consumer debts. If you had taken out a second mortgage on your home for the clear purpose of financing your business, that second mortgage would likely be considered a business debt. It depends on the purpose for incurring the debt.
Certainly there are times when the line between a business and consumer debt is not clear. Given what may be riding on this—the ability to discharge all or most of your debts in about four month under Chapter 7 vs. paying on them for up to 5 years under Chapter 13—be sure to discuss this thoroughly with your attorney.
Posted by Kevin on September 22, 2013 under Bankruptcy Blog |
If you and someone else jointly owe a debt, bankruptcy can protect you against the debt and against your co-signer. Or if you want, bankruptcy can instead protect your co-signer.
Let’s look at two essentially opposite scenarios involving you and your co-signer getting sued on a debt you both owe:
1) You’ve had a falling out with the co-signer, and all you care about is escaping the debt; or
2) You believe you have a moral duty to protect the co-signer, so that is your highest priority.
We’re going to address the first scenario today, and then the second one in the next blog.
Protecting Yourself…
If you and your co-signer are being pursued by your creditor, and you cannot and will not pay the debt, you have two distinct obligations to worry about—a definite one to the creditor and a likely one to the co-signer.
… from the Creditor Itself
The obligation to the creditor is based on your promise to pay the debt. Most likely that obligation can be discharged (legally written off) by filing bankruptcy.
Like any other creditor, this one could object to the discharge on grounds of your fraud or misrepresentation, but those objections are rare.
You could discharge this debt through either Chapter 7 or Chapter 13, depending on whichever is in your best interest otherwise. Chapter 13 happens to come with the “co-debtor stay,” some extra protection for your co-signer which will be discussed in the next blog, because here we are assuming you don’t care about protecting the co-signer.
… from the Co-Signer
You very likely have a closely related but still distinct obligation to your co-signer, one that is likely less clear than the one you owe directly to the creditor. This obligation to the co-signer is indirect, likely only to arise if your co-signer pays all or part of your debt to the creditor. Even then you may or may not have a legal obligation to the co-signer. There is a good chance that you and the co-signer did not write out the terms of your obligation. So your obligation to the co-signer could be merely inferred, based on an unspoken assumption that you would make the co-signer whole if you ever failed to pay the debt and the co-signer paid the creditor all or part of it. But there could also be a sensible inference—depending on the facts of the case—that the co-signer did not expect you to pay it in that situation. So you could possibly defend against that liability.
But practically speaking, the creditor is going to pursue both you and your co-signer. If you can’t pay the creditor who you clearly owe, there may well not be much point in putting a lot of time and expense into defending against a legal obligation to the co-signer. A bankruptcy would likely discharge both obligations, protecting you from both.
If you do file bankruptcy, be sure to list among your creditors not just the direct creditor but also your co-signer. Otherwise you could remain liable to the co-signer after your bankruptcy case is finished.
As with your direct creditor, your co-signer could object to the discharge of his or her claim against you, based on your fraud, misrepresentation, or similar bad behavior in the incurring of the debt. Although these objections are rare, they ARE more often raised by former friends, ex-spouses, ex-business partners. Why? Because 1) they have a personal axe to grind, 2) misunderstanding tend to arise more in informal arrangements, and 3) these kind of folks may know more damaging information about you than would a conventional creditor.
The best way to protect yourself from such challenges is to explain the situation thoroughly to your attorney when you first meet. That way your bankruptcy documents can be prepared in a proactive way, and you’ll avoid being blindsided.
