The question of personal bankruptcy can be very fraught for small business owners, who may worry that creditors will try to seize the assets of their business or business bank account. That is a possibility, but only if certain scenarios take place.
That question can be very fraught for small business owners, who may worry that personal creditors will try to seize the assets of their business or business bank account. That is a possibility, but only if certain scenarios take place.
Before we look at how that might transpire, it’s important to understand how bankruptcy typically plays out.
How does bankruptcy work?
A bankruptcy is a court-sanctioned plan to handle your debts. It will either allow you to reorganize your finances and pay back your debts over time, or to liquidate them, with serious repercussions for your credit score.
Type of bankruptcy
If you file for personal bankruptcy, it will generally be Chapter 13 or 7.
With a Chapter 13 bankruptcy, an individual debtor may repay debts under a three-to-five-year plan supervised by a bankruptcy court. This type of bankruptcy can be helpful to homeowners who want to keep their home. If you are able to keep up with your mortgage payments on your salary, you’re allowed to repay any payments you missed during this three-to-five-year period.
Debtors who have experienced material financial hardship related to the coronavirus may be able to extend payments for up to seven years after the initial payments on the plan came due, under the Coronavirus Aid, Relief and Economic Security (CARES) Act. A Chapter 13 bankruptcy stays on your credit report for seven years.
A bankruptcy may proceed to Chapter 7 if you reach the point where you are no longer able to pay your bills. Chapter 7 allows for the legal discharge of your debts, but it can have a massive impact on your personal credit. It stays on your credit report for 10 years.
“If you don’t have a plan or are so upside down there’s no way you can pay or there’s fraud, then it could go to Chapter 7,” says Nat Wasserstein, a restructuring adviser who is managing director of Lindenwood Associates in the Greater New York City area.
A bankruptcy reform law passed in 2005 made Chapter 7 bankruptcy difficult to pull off. You must get pre-filing counseling and pass a means test that will block this option if you earn too much money.
See related: Small business bankruptcy: 3 factors to consider
How to file for bankruptcy
To file for bankruptcy, it is advisable to speak with an attorney who specializes in credit and bankruptcy. Bankruptcy is complicated, and the legal fees can be substantial, so it is important to know what is ahead of you before you make any decisions.
An attorney will help you file a petition in the bankruptcy court where you have a domicile or residence. The United States Courts have published a guide to this that is worth checking out if you are planning to file, so you understand what the process looks like.
Generally speaking, as a first step you will need to gather all of your financial records and document your income, assets, debts and expenses.
If your petition is accepted, the court will assign a trustee to you. The trustee will arrange a meeting with your creditors to start working out the reorganization plan.
“That trustee’s whole goal is to recover on the assets – to sell assets or sue people to get money back so they can pay the creditors,” says Wasserstein.
See related: What can I do if bankruptcy is not an option?
Can creditors seize your business assets if you file for personal bankruptcy?
What if you face a personal bankruptcy because of a situation like an unpaid, six-figure medical bill? Can the creditors go after your business?
“They can’t seize your business bank account, but they can go after your stock in the business,” says Wasserstein.
Let’s say you file for personal bankruptcy and own a pizzeria. If the trustee in a bankruptcy finds out you own the pizzeria, he or she could go after the equity in the corporation that runs the pizzeria and become the manager.
“At that point, they could sell it or take the money out to pay these claims,” says Wasserstein.
In reality, the trustee may realize the creditors are better off if you keep running the business.
“You’re the one making the pizza. You’re the one people come for. You’re the one who runs the business,” he says.
The trustee can’t force you to work in the business to pay off your debt, says Wasserstein. That would make you an indentured servant.
Practically speaking, the trustee might allow you to continue to work in the business and allow you to take home some income to pay your bills and require you to send some money to pay creditors, says Wasserstein.
A trustee who’s returned a substantial percentage of the money to creditors may decide to call it a day, relieving you of the burden of paying the entire debts.
At that point, the trustee might say, “I’ll close out the bankruptcy and you can be on your way,” Wasserstein explains.
All of these scenarios are unpleasant, but in today’s world, many people have been forced into financial situations beyond their control. Sometimes, bankruptcy is the best way to move past them and get a fresh start.