Business Bankruptcy: Frequently Asked Questions

Business bankruptcy questionsWhen a business hits the end of the road, bankruptcy beckons.  If bankruptcy is the right choice for the business, it can take two forms:  bankruptcy for the entity itself or bankruptcy for the business owner.

Here are common questions about how a business bankruptcy works.

What happens to my corporation if I file personal bankruptcy?

Since the corporation is a legal entity different and distinct from its shareholders, the filing by a shareholder does not affect the corporation.

The bankrupt stockholder’s shares in the corporation are an asset of his estate.

The value of the shares in the hands of the bankruptcy estate is a function of the share’s marketability, the percentage interest they represent of the corporation, and the net value of the corporation’s assets.

Most small business corporations are of no interest to a bankruptcy trustee looking to liquidate assets of value.  The corporation often has debts of its own than must be paid before money goes to the shareholder.  Further, who would buy the shares if the debtor and former owner of the business could go into competition with the buyer?

What happens to me if my corporation files bankruptcy?

A corporate filing likewise does not directly affect the shareholders. The corporation’s bankruptcy filing doesn’t bring the shareholders into bankruptcy.

The corporation’s bankruptcy trustee has control of the business assets and is charged with investigating the corporation’s finances.

But, the shareholders are not in bankruptcy.

If the officers or shareholders are personally liable for the debts of the business, the automatic stay in the entity’s case does not prevent creditors from seeking to collect from others who may be liable.

My business is a Sub S corporation: does that affect the available bankruptcy remedies?

Designation as a Sub chapter S corporation or a Chapter C corporation is a matter of tax law, rather than anything to do with the kind of legal entity the corporation is.

For the purposes of the bankruptcy code, both are simply corporations.

Watch out however if your sub Chapter S corporation files  for relief. Any taxable income generated after bankruptcy may still be taxable to the shareholders, since the corporation is not a tax paying entity.

Can I file bankruptcy only on my personal debts? only on business debts?

No, a  bankruptcy filing must include all of the debtor entity’s debts, regardless of how or why incurred.

You as an individual,  might be able to separately classify business debts and pay them in full in a Chapter 13 if necessary to continue to utilize vendors.

An individual debtor can also reaffirm debts, if the judge approves.  And nothing keeps a debtor from voluntarily continuing to pay discharged debts.

Can I continue self employment such as consulting if I file bankruptcy?

This question is tricky:  nothing about filing bankruptcy prohibits you from earning a living utilizing your skills.  However, the assets of a sole proprietorship, like business equipment or receivables, are property of the bankruptcy estate which you can only use in your self employment if they are claimed exempt or abandoned by the trustee in a Chapter 7.

Also, a Chapter 7 trustee may want to shut a sole proprietorship down if it has employees or if the operation of the business exposes the bankruptcy estate to the risk of lawsuit by injured customers.

What if I incorporate before I file?

Incorporating a proprietorship creates a legal entity separate from the debtor.  Most trustees will not interfere in the business operations of a corporation that is owned by a debtor.

If the entity has value that is greater than any exemption claimed in the stock, the trustee may insist that the debtor either buy the stock back from the estate or that the corporation be dissolved and any net value distributed to the bankruptcy estate.

In our opinion, incorporation of a sole proprietorship does not constitute a fraudulent transfer but merely a change in form of the asset held by the debtor:  before incorporation, the debtor owned the business while after incorporation, the debtor owns the stock of the corporation that owns the business.

Check the laws and judicial attitudes where you live with an experienced bankruptcy attorney.



About the Author
Northern California bankruptcy lawyer Cathy is a 30+ year veteran of bankruptcy practice in the Silicon Valley. She is known for energetic representation of clients and her command of bankruptcy law.