Small-business bankruptcy can also lead to personal financial problems for the owner, depending on how the business is structured. Banks, credit unions and other lenders often force small-business owners to accept personal responsibility for business loans. That can prompt the business owner to file personal bankruptcy as well as business bankruptcy.
Considerations
Small businesses structured as limited liability companies or corporations are recognized as independent legal entities responsible for their debts. Theoretically, this allows the business to file for bankruptcy without the owner being personally affected. However, that changes if the owner guarantees the loan by offering collateral such as real estate, retirement accounts or stocks and bonds. Trucks, cars, vacation homes and other personal property also are often pledged as collateral. Once the small business files for bankruptcy, the bank will demand that the owner continue making payments on the guaranteed loans or risk seizure of the collateral.
Sole Proprietorships
Businesses operated as sole proprietorships cannot file for business bankruptcy. The owner must personally file for bankruptcy to eliminate or reorganize the debts. Debts incurred by a sole proprietorship are considered personal debts because all revenue and expenses for the business are included on the owner's federal income tax return. Sole proprietorships are popular with a variety of small-business owners, including bookkeepers, landscapers, painters and others.
Partnerships
Some businesses are formed as general partnerships, with each partner fully responsible for the business debt. Banks can file debt lawsuits against each of the partners if the business fails, according to legal website Nolo.com. This eventually could lead to court judgments and personal property liens, even if the property was not pledged as collateral. Legal judgments won in court allow banks and other creditors to file liens against personal property, such as real estate.
Credit Reports
Business debts usually appear on personal credit reports if the owner signed the loan agreement and provided his Social Security number. The bank is clearly holding the owner responsible if the debt is being reported to the credit reporting agencies. Banks will not remove personal guarantees until the debt is paid. The presence of business debt on personal credit reports affects the owner's credit. usually there is not a problem if the business is making timely payments and keeping balances low. However, missed payments leading up to business bankruptcy could cause the owner's personal credit score to drop.
Alternatives
A business owner with personal liability should not take the small business into bankruptcy without frank discussions with the bank. A bank blindsided by a bankruptcy filing may act quickly to protect its interests. That could include demanding that the owner pay the business debt in full. That's usually a bluff, at least initially but could quickly lead to lawsuits if alternatives, such as payment plans, aren't arranged.
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