Bankruptcy Options for Partnerships and LLCs

2. Reorganization Through Chapter 11

For businesses that want to stay open, Chapter 11 bankruptcy allows restructuring of business debts. This option involves proposing a repayment plan that unsecured creditors and the bankruptcy court must review. The business continues operating while reorganizing finances. However, Chapter 11 can be expensive and more complex. It may be better suited for businesses with ongoing revenue or long-term stability goals.

What is the Role of the Bankruptcy Trustee

During a bankruptcy case, a bankruptcy trustee oversees the financial and legal process. In Chapter 7 bankruptcy, the trustee identifies and sells assets of the business, determines the order of payments, and distributes funds to unsecured creditors based on the bankruptcy code.

The responsibility of the trustee is to make sure all available assets are used to pay creditors. For partnerships and LLCs, this process focuses entirely on the business property—not personal assets, or household, unless personal guarantees are involved.

Protecting Personal Assets & Addressing Personal Liability

One of the primary benefits of forming an LLC or partnership is the separation between the business entity and the personal finances of the owner. Because the business is a separate legal entity, the personal assets of the owners are mostly protected from the company’s debts.

However, this protection is not absolute, and many small business owners sign a personal guarantee when applying for trade credit, loans, or leases. A personal guarantee makes the owner responsible for repaying all the business debt if the business cannot.

This means filing for business bankruptcy may not resolve the personal and business debts of the owner completely. In these situations, an owner may need to consider personal bankruptcy to address remaining unsecured debts.

How Business Assets Are Handled

During Chapter 7 liquidation, business assets such as vehicles, inventory, equipment, or accounts receivable are identified by the bankruptcy trustee and used to satisfy outstanding business debts. The more assets the business has, the more the trustee can distribute to unsecured creditors. If certain assets are pledged to lenders, those items may be sold separately or repossessed.

Partnerships, Personal & Business Debts

In businesses run as partnerships, each partner is generally personally responsible for paying the business’s debts, unless otherwise structured by a legal agreement. Even if the business closes through Chapter 7 bankruptcy, creditors may still pursue the partners individually. In such a situation, partners may need to consider filing their personal bankruptcy if the remaining debt burden becomes too large.

Limited Liability Company Protection

A limited liability company generally protects owners from personal responsibility for the company’s debts. However, that protection only applies when:

• There was no mixing of business and personal funds.
• No personal guarantees were signed.
• The business followed the proper procedures of record-keeping.

If these guidelines were not followed, creditors may attempt to claim personal assets.

How the Bankruptcy Court Views the Business

The bankruptcy court examines the financial records of the business during the process, which includes tax records, debts, assets, and contracts. The goal behind this is to determine the best way to distribute value to unsecured creditors.

The bankruptcy court may also review the conduct of the business owners for any misuse of funds. Accurate documentation is highly important in any bankruptcy filing.

Conclusion

Understanding bankruptcy options for partnerships and LLCs allows you to make the right decisions before debts grow more difficult to manage or pay. These options vary based on the amount of business debt involved and the business’s structure. Partnerships may involve more personal liability if personal guarantees were signed, while limited liability companies may offer more protection as a separate legal entity.

Choosing between bankruptcy and a reorganization depends on whether your business can continue operating or must close. Taking time to review the treatment of business assets, the role of the bankruptcy trustee, and the effects on personal assets can help business owners move forward with clarity.