Bad things can happen to small business owners who file personal bankruptcy. Generally, the filing of a Chapter 7 bankruptcy petition usually means that the filing party’s non-exempt assets may be forfeit to the U.S. Trustee for liquidation and/or final disposition amongst creditors.
In the instance of secured debt, i.e., if you have pledged property as collateral for a loan and the creditor has perfected its lien rights, the specific item of property will be returned to the secured creditor. By contrast, the unsecured property, i.e., the property you own that no specific creditor can expressly lay claim to, can be sold by the Trustee to raise cash to pay the expenses of the bankruptcy and for distribution amongst the creditors. If, after the creditors meeting, the Trustee determines that you have nonexempt property, you may be required to either surrender that property or to provide the Trustee with its equivalent value in cash. If the property is not worth very much or would be cumbersome for the Trustee to sell, the Trustee may “abandon” the property — which means that you get to keep it, even though it is nonexempt.
But, what happens if one of your assets is a business entity?
Again, the filing of a Chapter 7 bankruptcy means that all nonexempt assets are subject to surrender to the Trustee. If you own a business entity, such as a corporation or limited liability company, your ownership is vested in the stock or membership units of that entity. That stock or membership unit can be seized and sold by the Trustee, same as any other property. Although the person filing bankruptcy is allowed to bid at the auction of their business, the Trustee is obligated to sell it to the highest, best offeror. This means that the business, together with all of its assets, can be taken from you and transferred to new owners.
So, for small business owners or the self-employed, extra consideration needs to be given before taking the bankruptcy plunge. The new owners will subsequently own and have access to all of the business’ property, which may include an array of confidential and/or competitively advantageous data. Even if you remain in possession and operation of the business while the bankruptcy is pending, it is forbidden to purge assets or to deliberately impair the business’ value during the bankruptcy. The small business owner needs to consider the very real possibility (believe me, we have seen it happen) that persons adverse to the debtor or the debtor’s business will purchase the business unit to eliminate a competitor, pillage the company for its customer and trade information, or gain some strategic leverage or advantage over the debtor that may or may not be related to the business itself.
So, if the business owner desires to start fresh and free from debt, but hold on to his business entity, we encourage them to seek the counsel of a good attorney to explore both a bankruptcy option and a debt workout.
Kevin Fallon McCarthy
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