Last updated: November 29, 2022

One of the biggest fears in business is bankruptcy, whether it is personal or business-related. When you are an individual with personal debt when filing for personal bankruptcy, your credit score greatly suffers.

When a company has business debts when filing for business bankruptcy, its business also suffers.

When an LLC files for personal bankruptcy or business bankruptcy protection, their business and personal debts are combined.

Both the personal and business debts of an LLC will be settled, whether it is through negotiation or if there is no other choice; bankruptcy court.

It all depends on what type of bankruptcy the LLC company files for.

How Does Bankruptcy Affect Credit?

A woman managing files for bankruptcy

You may be wondering what bankruptcy has to do with your personal credit score.

Your personal credit score is a numerical representation of how likely you are to pay back the money you borrow from lenders, such as banks and credit card companies.

If you declare personal bankruptcy, it can severely negatively impact your credit score because people who file for bankruptcy will have their accounts up for collection closed by the credit bureau as part of the process.

This lowers your credit score because you will have a smaller line of available credit remaining, making it harder to get loans or new lines.

If you are declared bankrupt for business debts, on the other hand, there may be less of an impact on your credit score.

It's something people think about, but it's unclear how much of an impact personal bankruptcy will have on your credit score.

It's always better to avoid legal issues such as bankruptcy if you can avoid it because even though your scores may not take a significant hit from the procedure itself, the debts that lead to the situation could show up on your credit report for seven to ten years.

This will harm your credit score, so it is better to be proactive about getting rid of debts before they get out of control.

What Do You Need to File a Bankruptcy Petition?

Files scattered on the floor

According to Bankruptcy Code as amended by Congress in 2005, you need the following documents to file a bankruptcy petition:

  • Proof of Identification. You should provide at least two forms of identification showing your correct name and address. Examples include driver's license, passport, government-issued identification card, and Social Security Number.
  • Bank Statement for the Past 60 Days. This is to show that you have no money in the bank before filing for bankruptcy.
  • Recent Paystubs or Documentation of Unemployment. You should verify that you are not employed, working part-time, or have an income below the poverty thresholds set by the Federal Government for your household size.
  • Copy of Tax Return from the Past 3 Years. This is to show that you're not overpaying and making more than required.
  • Summary of Debts and Assets: You should attach a summary of assets and debts, including filed bankruptcy petition, with this document.

It will also ask whether or not you have a bankruptcy lawyer or plan on using a bankruptcy attorney for your case.

If so, then they will want the name of the bankruptcy attorney that you have chosen to represent yourself. It's essential that you are honest when they ask about your income or any cash advances that you have received; otherwise, they will deny your case.

And if they reject it, then all of your debts remain with you, and it won't be a wise idea to take on more debt.

Liquidation Business Bankruptcy

The liquidation business bankruptcy is when the owner of the business files for bankruptcy.

This type of bankruptcy occurs because the business has accumulated too much debt to pay back or other financial problems that have arisen in the past.

The user will file Chapter 7, which means that the ownership of the business will be dissolved, and it will be sold off to pay back creditors.

One of the best things about filing for liquidation business bankruptcy is that it's fast, and you only have to disclose your name, address, and social security number.

You will include other information on the petition, but there are no legal documents or forms to fill out before submitting it.

The process is also relatively straightforward because you will not have to appear in court.

What Is Chapter 7 Bankruptcy?

Problematic and stressed man holding debt files

Chapter 7 bankruptcy is often called straight bankruptcy, and it works by allowing an individual to eliminate most types of debt through the liquidation (sale) of non-exempt property.

The purpose of Chapter 7 bankruptcy is to give debtors a financial "fresh start" by requiring them to surrender non-exempt assets to a trustee who then sells those assets and uses the proceeds from the sale to pay creditors.

This chapter allows debtors to eliminate many debts because you can not discharge student loans, taxes, most types of debt, and penalties for collection action on non-dischargeable debts owed to a spouse, domestic partner, parent, or child.

It is a court-supervised process that allows you to surrender your non-exempt property to the courts. Chapter 7 bankruptcy also automatically stays – or stops – most collection actions against debtors.

In most Chapter 7 cases, you do not have to appear in court unless the bankruptcy trustee wants you to.

Are You Personally Liable for Your Business Debts?

If you do business in your own name, you are personally liable for the debts of your business. You can lose more than just the money owed; you may also lose your house, car, and any other assets that can be seized.

You can protect yourself by forming a corporation or limited liability company (LLC). If your customers want to sue you, they can only go after the business assets and not your personal property.

When you form a corporation or LLC, state law governs its operation.

This is where the protection lies. Different states have different laws protecting business owners from personal liability for their corporate debts based on whether their businesses are corporations or limited liability companies.

So take the time to find out what your business needs to do to gain protection from your personal assets. It is important to know the difference between a creditor thinking you are personally liable for the debts of your business.

After all, you are doing business in your own name versus actually being personally liable for the debts of your business because you did not form a corporation or LLC.

Personal Liability for Corporate or LLC Debts

Stressed man in suit receiving more paper works

Personal liability for corporate or LLC debts only arises when the corporation or LLC is inadequately capitalized, which means its assets are insufficient to cover its liabilities.

This can come about if:

  1. The corporation/LLC does not receive adequate funding.
  2. The corporation/LLC makes terrible investments.
  3. The corporation/LLC wastes its assets.

If a corporation or LLC is adequately capitalized, then creditors must look solely to the assets of that entity when trying to collect their debts.

Personal liability for corporate or LLC debts only comes into effect when the corporation/LLC is undercapitalized.

In cases of inadequate capitalization, directors and officers may be held personally liable for any debts that cannot be settled from the assets of the corporation or LLC.

Directors and officers cannot contract their way out of personal liability by statute. Personal liability arises solely in the common law.

A person can be held personally liable for corporate or LLC debts on the basis that they are deemed to be acting on behalf of the corporation/LLC (and thus can bind it) and not as a separate entity.

This is known as the doctrine of apparent authority. A person with clear authority will be liable for things done by them, even if such things were done without authority.


Who Is Held Liable for Debts in an LLC?

In general, all members are liable for the LLC's debts. This is why most people do not use an LLC to purchase real estate because if you have a judgment against your LLC, the creditor can also go after your residence.

Thus, if your LLC is sued - or even just threatened with a lawsuit - you should speak with an attorney to discuss the possibility of dissolving your LLC and transferring your assets to a new LLC.

What Happens to My LLC When I File Chapter 7 Bankruptcy?

An LLC can receive distributions before the owner files for bankruptcy.

However, an LLC cannot continue after the owner has filed for bankruptcy because it does not fall into the legal definition of a "person." If you file for bankruptcy, keep in mind that an LLC can be dissolved.

What Happens to Debt When LLC Is Dissolved?

When an LLC dissolves, it must dispose of its assets and distribute the proceeds to creditors.

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