Whether or not a business bankruptcy affects your credit score depends on whether you are personally liable for the entity's debt. Business bankruptcy could affect your credit score if you are personally responsible for the business debt. Your liability will depend on if you signed a personal guarantee for the entity's obligation, the type of business entity used for your business, and the entity’s tax liability.
Type Of Your Business Entity And Your Credit Score
If you are responsible for your business’s debts, you should expect the creditor to report the debt on your individual credit report. Again, considering the business structure used when opening the company can help you determine your liability.
A Sole Proprietorship Business
In a sole proprietorship business, the law considers the business owner and the company the same. This means that the business owner is responsible for all the business debts. Therefore, if you wish to discharge your liability for your sole proprietorship business debts, you would have to file a Chapter 7 or Chapter 13 bankruptcy. Filing for either of these bankruptcies could affect your credit score for up to ten years.
A Partnership Business
In a partnership business, a partner is liable for the business’s debts along with the partnership. This means that the creditor can report the business debts to a credit bureau under the partner’s name. You can eliminate partnership business debt by negotiating with the creditors. Each partner can also file personal bankruptcy, even if this filing will still affect their credit score. It can be tricky to file personal bankruptcy on behalf of a partnership. Even if the partnership business owns some assets, the liquidation of the partnership property might not generate enough income to pay off all the debts. If this is the case, the partners will remain liable for the unpaid debts.
Limited Liability Company (LLC), Limited Partnership, And Corporations
You are not legally responsible for business debts if you run a limited liability company, partnership, or corporation. Each of these businesses can file for bankruptcy in their capacity. Therefore, bankruptcy should not affect your credit score. The business debts and the business bankruptcy should not appear on your credit score, except for a few exceptions.
When A Corporation, LLC OR Limited Partnership Bankruptcy Affects Your Credit Score
At times, interest in a corporation, LLC, or limited partnership business could affect your credit score.
When You Sign A Personal Guarantee
Often, many creditors require small business owners or officers to sign a personal guarantee before extending a loan to their business. If you sign a personal guarantee for a business, you agree to be personally liable for the business debts. If the business files for bankruptcy, the person who signed the personal guarantee pays the loan. If you fail to pay the business debt, the creditor could report it as an unpaid obligation, which will most likely have an adverse effect on your credit score.
Specific Categories Of Business Taxes
Certain unpaid business taxes could become the business owner’s liability. Certain taxes are not discharged in bankruptcy. These include taxes withheld from employees’ salaries and taxes collected from other people, including sales taxes. Taxes that are not dischargeable in bankruptcy are usually known as trust fund taxes.
The business has a legal duty to remit these taxes to the government. If you collect these taxes and you fail to forward them to the taxing authority, you will be personally responsible for them. After all, this tax money belongs to your employees or clients. These tax debts will have an adverse effect on your credit score. The effect will be even worse if there is a tax lien against you and the lien is recorded in the public records.
When LLCs And Corporations File For Chapter 7 Bankruptcy
Chapter 7 bankruptcy can help LLCs and corporations intending to close business by enabling an orderly liquidation of the business. Even if filing for Chapter 7 bankruptcy is an ideal option for companies planning to go out of business, this option is not always used. Unlike individuals, these businesses do not receive a bankruptcy discharge under Chapter 7. Therefore, filing for Chapter 7 bankruptcy has a limited value for businesses. Failure to discharge the remaining debts could open lawsuits, leading to a transfer of liability from the company to the business owners.
Chapter 7 bankruptcy does not work the same way for business as for individuals due to the following factors:
- The “separate entity” status for LLCs and corporations
- When businesses close, there is a heightened interest to safeguard the creditor’s interests
- Creditors can take several steps to shift the debt liability from the company to individuals
Forming a limited liability company or a corporation involves paying the registration fees and filing certain documents with the secretary of state. After establishment, the business functions as a separate legal entity. This means that the entity owns assets and is liable for paying its debts.
Since LLCs and entities are separate entities, individuals do not own them directly. Instead of owning the company itself, people own stakes in the company. For example, a person will own shares in a corporation. In an LLC, a person will hold an ownership interest according to the LLC operating agreement.
Closing An LLC Or Corporation
When closing an LLC or a corporation, an LLC managing member or a corporate officer must liquidate the company’s assets and share the proceeds among the creditors. It is mandatory to file a notice of proper closure with the secretary of state. Failing to follow the necessary procedures when closing a company could render the people holding ownership interest liable. These legal requirements ensure that after liquidating a company, the proceeds are not channeled to business partners, stakeholders, and family members. Once the business closes, the creditors lose the ability to collect any remaining loan balance.
Chapter 7 Bankruptcy Does Not Allow A Continued Operation Of A Business
Chapter 7 Bankruptcy, unlike chapter 11 bankruptcy, does not allow a corporation or LLC to continue with operations. Filing for chapter 7 bankruptcy leads to the automatic closure of a company. The bankruptcy trustee will dispose of the LLC or corporation’s assets and distribute the money among the creditors in line with the priority rules outlined by the bankruptcy law.
During a business bankruptcy, no exemptions are available to protect the disposal of a particular property. The goal of bankruptcy is to enhance an orderly liquidation of business assets. In addition to closing the business, Chapter 7 bankruptcy does not allow LLCs and corporations to receive a discharge of the debt that remains after liquidation. Once the company is no longer operational, the creditor can no longer collect money from the company because there will be nothing of value left to take. Leaving some debt in place instead of wiping it means that the creditor can pursue legal action against you when appropriate. The creditor can seek payment from you under a personal guarantee. A creditor can also pursue litigation against you under the fraud theory or the alter ego.
When Chapter 7 Bankruptcy For LLCs and Corporations Does Not Affect Your Credit Score
Filing Chapter 7 bankruptcies for LLCs and corporations might work in your favor, meaning that it will not negatively affect your credit score. Below are some reasons why Chapter 7 bankruptcy for business might be ideal:
- When you wind down a business in bankruptcy, it allows more transparency. This means that you can prove that the closure occurred in accordance with the law. You could prevent dissatisfied creditors from pursuing litigation against you by demonstrating this. This way, you can avoid having the company debt shifted to you. You can also avoid an adverse effect on your score.
- Filing for chapter 7 bankruptcy will also help you alleviate typical creditors' suspicion that you could be diverting some funds into private coffers instead of paying the creditors. Under Chapter 7 bankruptcy, a business sells all the company assets and publicly distributes the money to creditors.
- When you file for Chapter 7 Bankruptcy, you step away from the business closure and leave the work to the bankruptcy trustee. The bankruptcy trustee sells the assets and pays your creditors. Therefore, creditors will not suspect that you kept some liquidation proceeds instead of paying them.
Chapter 7 Bankruptcy Might Not Work In Your Favor
A chapter 7 Bankruptcy for an LLC or corporation might not always work in your favor. When you file for bankruptcy, you will no longer control your business assets. Instead, a business trustee will take control of the company assets and decide whether it is in the best interest of the creditors to dispose of the assets or sell the business as a whole.
You could have a problem if you are liable for any business debts. When a bankruptcy trustee disposes of the company assets, you are likely to remain with higher debt than what would remain if you disposed of the property yourself. This could happen due to the following reasons:
- When you sell the assets, you might get a better price. However, most people who buy bankruptcy assets offer much lower prices.
- The sale proceeds will be less with the amount that the bankruptcy trustee will receive as payment.
- When you file for bankruptcy, you will not have the opportunity to negotiate with creditors. This means there is no chance of settling the debt at a lower amount than what is owed. After the bankruptcy trustee makes a payment to creditors, any remaining amount will be payable by you. As a result, you might remain with a higher liability than if you had negotiated with creditors and disposed of the business assets yourself. This additional liability is likely to affect your credit score negatively.
- Filing for bankruptcy could prove to be more expensive. When you present your case in the bankruptcy court, disgruntled people like business partners, creditors, or even your ex-spouse will have an excellent forum to present their grievances. They will give their complaints regarding how you handled business finances. These disputes have a significant potential of shifting the debt liability from the business to you, consequently affecting your credit score negatively.
- Your creditors might appear at the 341 meeting of creditors. All bankruptcy filers must attend the 341 meeting of creditors. During this meeting, a creditor might present the bankruptcy trustee with information that prompts an investigation. If this happens, you will be subject to investigation and questioning, seeing some of the company debt shifted to you.
- When you file for business bankruptcy, a creditor might file a lawsuit or adversary proceeding. The creditor could allege specific theories to shift liability from the company to you. This action could allow your creditors to collect company debts from your assets. Most people avoid filing Chapter 7 bankruptcy for business because of the possibility of opening doors to the above litigations.
Additional Factors That Could Lead to Personal Liability For Company Debts
Even if LLCs and corporations are responsible for their debts, you could still be liable for the company debts. In addition to personal guarantees and trust fund taxes, below are other factors that could lead to personal liability for company debts:
Alter Ego Claims
If a creditor successfully proves that the company was an alter ego or sham of the shareholder, they can go after an individual's assets. For a creditor to prove this, they must file a claim to pierce the corporate veil. This veil shields a business owner’s private property from creditors. If this lawsuit is successful, the business creditors will have access to more private property from which they can collect.
Other Fraud Crimes
A creditor can access a business owner's private property if they prove an attempt to conceal or hide money from creditors. If there is proof of this, you have to make the affected or harmed party whole by paying back the money. You will also probably face criminal charges, not to mention the adverse effects on your credit score.
Putting your company through a Chapter 7 bankruptcy could help with your debt obligations, but only if the bankruptcy trustee liquidates enough property to cover the debt. If some debts remain after bankruptcy, creditors could still pursue your assets and submit data to credit reference bureaus under your name.
When You File Individual Bankruptcy To Pay Business Debts
Filing for personal bankruptcy to pay business debts could be an ideal option if you are liable for a personal guarantee. The easiest route would be to file for a consumer Chapter 7 bankruptcy. Even if the business remains open, you could get rid of a personal guarantee for debts because you can dispose of most business debts in an individual bankruptcy case.
The best part is that if most of your obligations include business debts instead of consumer debts, you could qualify for individual Chapter 7 bankruptcy even if your income exceeds the Chapter 7 bankruptcy requirements. So by having more business debt than consumer debt, you can avoid both Chapter 7 bankruptcy means test and income requirements.
At times, your debts mix could be such that you cannot meet the income requirements of Chapter 7 bankruptcy or avoid the means test. In this case, you could file for Chapter 13 bankruptcy and pay off the personal guarantee over five years. You should note that filing for personal bankruptcy would affect your credit score even if it will come in handy in helping you deal with business debt. The bankruptcy will remain on your credit record for years.
How Long A Bankruptcy Stays On Your Credit Report
Most people fear that bankruptcy could mean the end of their financial life. After filing for bankruptcy, you might need a loan later when you recover financially. A bankruptcy discharge could remain on your credit record for years after discharge. The good news is that bankruptcy does not affect your credit score forever.
How long a bankruptcy stays on your record depends on the type of bankruptcy. A Chapter 7 bankruptcy remains on your credit report for ten years. A Chapter 13 bankruptcy will stay on your credit score for seven years. The impact of bankruptcy on your credit score lessens with every year that passes. In the first months following a bankruptcy, you might notice a significant drop in your credit score. However, bankruptcy will have less weight on your credit score as the years go by.
How To Rebuild Your Credit Score After Bankruptcy
Filing for bankruptcy gives you relief from business and personal debts. However, most people worry that they might never have decent credit again. Even if bankruptcy could stay on your credit report for up to ten years, its effects fade over time. You can follow specific steps to rebuild your score :
- Practice good credit habits
- Obtain a secured credit card
- Obtain a credit-builder loan or secured loan
- Check your credit reports regularly to ensure the information therein is accurate
Find A Los Angeles Bankruptcy Lawyer Near Me
If your business is struggling to meet its debt obligations, you could be hesitant about filing for bankruptcy due to the impact it will have on your record. However, with the help of an experienced bankruptcy attorney, you can negotiate through the bankruptcy process and limit the adverse effects of bankruptcy on your score. Contact the Los Angeles Bankruptcy Attorney for more guidance. Call us at 424-285-5525 and talk to one of our attorneys.
