At the end of the bankruptcy process, the debtor receives a discharge of her unsecured debts. This prohibits creditors from ever trying to enforce their claims against the debtor. Certain debts are not discharged, such as student loans, some taxes, child support, and others, but most debts are wiped out. What about a loan used to start a business? Can that be discharged in bankruptcy?
Many people seek bankruptcy protection because a business they started has gone bad. Statistics show that 90 percent of small businesses fail, so this is a common occurrence. Clients often want to file a bankruptcy for their business, but this is not necessarily the best option.
Owners Guarantee Debts
It is seldom advisable to file a bankruptcy for a small business, especially the typical small business started by one or two people. Filing a bankruptcy for a small business does not bring relief to the person who really needs it – the owner of that business. The owner will have had to guarantee most, if not all, of the debts of a small business and filing a bankruptcy for the business will not relieve the owner of the obligation to pay.
When you start a new business and rent a storefront, warehouse, or other premises, you’ll almost always have to personally guarantee the rent payment. Otherwise, few landlords will lease the premises to new businesses. When you take a small business loan out from a bank, the same is true. Banks will typically only loan to a new business with a personal guarantee from the owners. Small business credit cards are typically issued only to the owners, as well. The card may have the name of the business on it, but it’s actually issued to the owners.
Incorporation May Not Protect You
Widespread advertising that encourages people to incorporate when they start a new business, claiming they will be protected if something goes wrong, fools many people. That’s only the case if the business is the only one liable for the debts. If you’ve personally guaranteed the debt, incorporation won’t protect you. If the loan that that you’re struggling to repay is a loan that you took out to start a business, you’re unquestionably personally liable for it.
Owners Should File for Bankruptcy
If the business is going to stay open, filing for bankruptcy protection for the business may make sense since the business may be able to reorganize its finances and pay the debts. Most small businesses, however, don’t stay open after through bankruptcy. That means there’s no reason to file for bankruptcy for the business. In fact, the courts don’t even issue discharges to closing businesses.
While bankruptcy doesn’t have a lot to offer a business that’s closing, the owners can get a lot out of bankruptcy protection. Unless there was some sort of fraud in contracting the debts, your business debts will be generally be discharged. Because you’re personally liable for those business debts, you’re the one who needs bankruptcy protection.
There are two main types of consumer bankruptcy: Chapter 7 and Chapter 13. The type you file will depend on your income and the amount you owe. Either one can give you a discharge of your small business loan.
SBA Mortgage Loans
A word of warning: if the loan is a second lien on your house, even bankruptcy will not protect you. The Small Business Administration often gives small business loans only where the government can claim a mortgage against your house. Many private banks will request the same setup. In that case, the loan will continue to be a lien on the house, just like a regular mortgage, even after bankruptcy. Bankruptcy will, however, protect you from personal liability for the lien. That means that if the house is foreclosed and sold for less than you owe, you won’t have to pay the deficiency.
What to Do if You’re Struggling with Business Debt
The reality of starting a business is that it is very difficult to make a go of it, but people do it every day. When you start a business, go in with your eyes open. Be aware of the challenges you face and have contingency plans in place for the obstacles that may arise. Make sure you’ve thought through your business plan carefully before you decide to personally guarantee any debts.
Even the best laid plans can go wrong, so remember that bankruptcy may offer you the protection that you need if your business doesn’t make it. Consult an experienced local bankruptcy attorney to learn what type of bankruptcy is best for your unique situation and goals.