Whether you can be held personally liable for the debts of your business depends on the structure of your business and how it was formed.
If you've owned a business and wonder whether you're personally liable for business debts, it's possible. Whether a creditor can hold you personally responsible for your business's debts will depend on the following:
- whether you agreed to be responsible for paying the debt
- your business structure, and
- if you can eliminate or "discharge" the debt in bankruptcy.
For instance, sole proprietors and most partners will be responsible for business debts. At the same time, an LLC or corporation will shield members and stockholders from personal liability. But the protection isn't absolute. Read on to learn when a business owner is personally liable for the company's debts.
When You're Personally Liable for Business Debt
You're likely assuming that your business type—sole proprietor, partnership, LLC, or corporation—determines whether you must use personal assets to pay a business debt. Although true theoretically, examining business structure is rarely decisive because laws and standard business practices minimize the debt protection business structures offer.
The following question tree demonstrates this point while quickly helping you determine whether you're personally liable for a business debt:
- Did you sign a "personal guarantee"? You're contractually liable for the debt.
- Does the business owe taxes? You're likely liable for the debt—contact your business lawyer.
- Are you a sole proprietor? Sole proprietors are personally liable for business debt.
- If none of the above apply, look to the business structure to determine whether you're sheltered from debt liability.
We explain the concepts in each step in detail below.
You're Personally Liable for Business Debt After Signing a "Personal Guarantee"
Start by checking whether you signed a "personal guarantee"—a contract promising to pay on behalf of the business. This is a regular practice when a new or established business with few assets asks for credit.
So why is this?
A bank, lessor, or supplier knows the company won't pay the debt if the business fails. To protect against a loss, the creditor will require the business owner to agree to be personally liable for the debt if the company fails to pay. You've likely signed a personal guarantee if your business has done any of the following:
- taken out a loan to buy real estate
- signed a lease for an office or retail space
- leased or financed expensive equipment, or
- purchased supplies or materials on terms.
Because a business owner usually must provide proof of assets before entering into a personal guarantee, a failed business can be costly. Fortunately, you can erase a personal guarantee in bankruptcy (more below).
Other Situations Affecting Your Personal Liability for Business Debts
People holding an ownership interest in a company must pay certain tax obligations if the business fails to fulfill its responsibilities, regardless of business structure. Also, creditors can "pierce the corporate veil" and seek debt payment from shareholders when certain corporate formalities aren't observed.
If you or the company owes this type of debt, you should know that tax debts and debts resulting from fraud usually aren't dischargeable in bankruptcy. Learn more about nondischargeable debt in bankruptcy.
When Business Structure Might Help You Avoid Personal Debt Liability
You might have already determined you're personally liable for your business debt. But if the issue remains unclear, it's time to determine whether your business's structure protects you from debt collectors.
Below we explain how the business structures determine who is responsible for paying business debts. Remember, more often than not, companies providing your business with products, services, or real estate will have likely required a personal guarantee negating the following rules.
Am I Responsible for My Sole Proprietorship's Debt?
A sole proprietorship isn't a separate legal entity. You're likely a sole proprietor if you're the only business owner and haven't incorporated or set up a specific form of business entity. You and your business are equally liable for debts incurred by the company.
Since a sole proprietorship does not offer limited liability to its owner, creditors of the business can go after your personal and business assets. If the company doesn't have sufficient assets, creditors can sue you personally and try to collect the debt by taking your house, car, or other property.
Who Is Responsible for Debt in a Partnership?
A partnership is a business entity owned by two or more individuals. In a partnership, liability is more like a sole proprietor than a corporation, with some exceptions for hybrid versions.
- General partnership. A general partnership can be automatically created without paperwork if two or more people agree to conduct a business or activity for profit. Each partner is considered a general partner and is personally liable for the partnership's debts. If your business is a general partnership, you will be responsible for the obligations of the business.
- Limited partnership. In a limited partnership, there is at least one general partner and at least one limited partner. The general partner is personally liable for partnership debts, while the limited partner is not. Creditors can collect from the personal assets of the general partner but not the limited partner.
- Limited liability partnership. An LLP shields all partners from personal liability for business debts. In some states, all partners enjoy limited liability, while others require an LLP to have at least one general partner. Also, in certain states, the liability protection of the LLP applies to negligence claims only. All partners may still be liable for business debts arising from a contract (such as business loans or credit cards).
Am I Personally Responsible for S Corporation or C Corporation Debt?
A corporation is an incorporated entity designed to limit the liability of its owners (called shareholders). Generally, shareholders are not personally liable for the debts of the corporation. Creditors can only collect their debts by going after corporate assets.
Shareholders will usually be on the hook if they cosigned or personally guaranteed the corporation's debts. However, shareholders might also be liable if a creditor can prove corporate formalities weren't followed, shareholders commingled personal, and business funds or the corporation was just a shell designed to shield liability. This is called piercing the corporate veil.
Who Is Responsible for the Debt of a Limited Liability Company (LLC)?
Like a corporation, an LLC offers limited liability to its owners (called members). Generally, members are not liable for the debts of the LLC unless they cosigned or guaranteed the debt personally. However, like a corporation, creditors may also be able to go after the members' personal assets by piercing the corporate veil.
How to Get Rid of Personal Business Liability in Bankruptcy
Except for a sole proprietorship, it would be unusual to put a closing business in bankruptcy when your goal is to eliminate your personal liability for business debts. The reason? It wouldn't work. Chapter 7 bankruptcy—the chapter you'd use when closing a business—won't erase a business's debt obligation.
Instead, most people eliminate personal guarantees by filing for individual bankruptcy. Learn why it's rare for a closing business to file for bankruptcy in Will Bankruptcy Help If I Want to Continue My Business?
What an Owner Should Expect in Chapter 7 After Business Closure
Filing for Chapter 7 after your business closes has benefits, but it can be determinantal. Here are two factors to consider when deciding if filing for bankruptcy will work for you.
Qualifying for Chapter 7 Bankruptcy When Personally Liable for Business Debt
Most people must meet specific income requirements before qualifying for a Chapter 7 bankruptcy discharge wiping out qualifying debt. However, this rule doesn't always apply to business owners.
You'll qualify even if you have significant income if your business-related debt exceeds your personal or "consumer" debt. This approach is possible because a person with a higher percentage of business debt can avoid taking the income-qualifying Chapter 7 means test.
Losing Property When Discharging Business Debt in Chapter 7 Bankruptcy
Although you'd likely welcome the opportunity to eliminate the lease obligation on your closed storefront, the benefit could come at a cost. Here's why.
You're only allowed to keep so much property in Chapter 7 bankruptcy. So if you own more property than you can protect with bankruptcy exemptions, you'll want to be sure that the value of the property you'll lose is less than the total debt you'll wipe out.
Find out more about keeping nonexempt property in bankruptcy.
Talk to a Lawyer About Bankruptcy Alternatives
If filing for bankruptcy isn't financially feasible, another approach is to retain an attorney to negotiate down the business debt or personal guarantee. A local business bankruptcy lawyer can assess your case and help you choose the right approach for you.
Need More Bankruptcy Help?
Did you know Nolo has made the law easy for over fifty years? It's true—and we want to ensure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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