Business-Related Debt in Bankruptcy

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SBA Loans and Personal Guarantees

The U.S. Small Business Administration guarantees the repayment of business loans to incentivize banks to fund commercial loans for small businesses. Under both the SBA and the bank underwriting standards, borrowers are often asked to sign personal guarantees and grant second mortgages on their personal residence. SBA loans are dischargeable in a bankruptcy as to the personal guarantor. In some cases, a second mortgage securing an SBA loan can be stripped from the title to your home. Personal guarantees on other business loans that are not secured against your personal assets are unenforceable after an individual bankruptcy is filed and completed, including merchant cash advances, or personal loans used for business purchases or expenses.

Non-dischargeable tax liabilities

Most business-related tax liabilities, whether owed to the Internal Revenue Service or to the Kentucky Department of Revenue are enforceable against the individual sole proprietor, independent contractor, or small business owner, even after the business dissolves or liquidates under chapter 7 of the bankruptcy code. Even worse, business-related tax liabilities are non-dischargeable in bankruptcy, which means that even after the individual owner files for bankruptcy, the debt will have to be paid. Taxing agencies can file liens against your personal residence, seize your bank accounts and garnish your wages with little notice and under expedited procedures that do not require the filing of a lawsuit.

The good news is that bankruptcy eliminates the majority of the interest and penalties accruing on tax liability, which often account for a majority of the unpaid tax assessments. Moreover, bankruptcy allows you to dispute the tax liability and any charges that you believe are exaggerated or inaccurate. Filing a business-related personal bankruptcy does not discharge business related taxes, but it can significantly reduce your personal liability.

There is an array of bankruptcy options available to the sole proprietor, self-employed individual and small business owner who is trying to recover financially from business shortfalls or closures.  Depending on your income, the amount and nature of your debt, and your individual goals and objectives, a Chapter 7, Chapter 11 or Chapter 13 bankruptcy can be an effective means of addressing your business-related personal debts. Filing for individual bankruptcy protects your financial and other assets from your business creditors and taxing agencies. You and your family can re-establish a sense of normalcy in the present and start looking toward the future.

Chapter 7 and Business-related Debts

If your debt consists primarily of business debts, you are not required to pass the bankruptcy means test, which is used to determine whether you are eligible for chapter 7 based on your income. This means that you are eligible for chapter 7 even though your income is above median income for a household of similar size. Unlike businesses, individuals filing for a chapter 7, are entitled to various personal exemptions that protect your equity against a liquidation, including exemptions in any equity in:

• • Automobiles

• • Clothing, furnishings, and household goods

• • Jewelry, up to a certain value

• • Pensions and retirement account (no limitations)

• • Your personal residence

• • Tools of the debtor’s profession, up to a certain value

• • And damage awards for personal injuries

Individual Chapter 13 Bankruptcy and Business-Related Debt

Chapter 13 bankruptcy involves a restructuring and repayment of your debts. This option allows an individual to retain their personal assets while paying off business-related debts through a court approved repayment plan, which last from three to five years. Sole proprietors, owners of single-member LLCs, or the self-employed can address both their personal and business-related debts under the protection of the Chapter 13 plan. Chapter 13 bankruptcy only affects your personal debt and will not affect any liabilities of a small business. Corporate entities, including an “S-corp.” or a “C corp.,” an LLC, or a partnership are not eligible for Chapter 13 bankruptcy. Businesses are generally dealt with in a Chapter 7 or Chapter 11.

Under a Chapter 13 plan of reorganization, nondischargeable tax liabilities can be repaid over time, late payments to secured lenders can be cured over time. Unsecured creditors get paid only if there is enough money left over. So, if you make all payments due under the Chapter 13 plan, your tax liabilities are paid in full, late payments on vehicle or home loans are all caught up, and any balance remaining on your unsecured debt is discharged. A Chapter 13 allows you to:

• • Eliminate penalties and stop interest from accruing on business-related tax liabilities.

• • reduce of even eliminate liability under personal guarantees of business-related debts.

• • Protect your co-debtors and partners from collection actions.

• • Pay only what you can afford, while maintaining a decent standard of living.

Individual Chapter 11 Case

The bankruptcy code has special provisions for individuals filing for Chapter 11. If you are ineligible to file under Chapter 13 because your debt exceeds $_________, including your mortgage, student loans, and business-related loans and tax liabilities, chapter 11 should be considered. Chapter 11 also provides you time to pay off tax liabilities over five years, and to modify and extend the terms of business loans secured against your personal or real property. In an individual chapter 11 case, the individual is the “debtor in possession,” which means that you have control over the chapter 11 case and the plan, not a court appointed trustee. With that control you can:

• • Propose a plan that gives you time to liquidate a valuable asset to pay off non dischargeable business debt.

• • Take the opportunity to dispute personal tax liabilities or negotiate workable terms with the taxing authorities.

• • Reduce or reorganize business-related debts.

Chapter 12 for Family Farmers

Chapter 12 bankruptcy offers special protections and flexibility to family farmers experiencing financial hardship. If at least 50% of your debt and 50% of your income is related to farming operations, you, individually or jointly with your spouse, your LLC, or a partnership can file without the expense and complication of a Chapter 11. In some cases, a family farmer can even reduce the balance and the payments under a mortgage against a residence – a benefit that is unavailable under a Chapter 13 personal bankruptcy. Under a Chapter 12, family farmers can among other things:

• • Stop foreclosures and catch up on late mortgage payments.

• • Reduce or eliminate unsecured personal and debt accumulated through farming operations.

• • Catch up on past due trade accounts.

• • Negotiate more affordable terms with secured lenders and taxing agencies.

Dennery Law helps small business owners obtain relief through the restructuring and reorganization of business-related debt. We are available for telephone consultations at no charge to you. In-person or remote appointments are available on weekdays, evenings, and weekends in Lexington, Louisville, and Northern Kentucky.