How Limited Is Your Liability In An LLC Bankruptcy?
Business owners are often advised to set up a limited liability company (LLC) in order to protect themselves should the business fail and require bankruptcy protection. In most cases, a business owners liability is then limited to the value of the shares they have in the company, not the debts themselves. An LLC is a legal entity and as such stands at arms lengths from the owners. A small business that is formed as a sole proprietorship doesn’t have that same protection – the owner(s) and the business are one. In fact, legally, the business is not a legal entity, therefore it cannot be sued, or file for bankruptcy.
While most business owners who set up LLCs feel they are completely safe from creditor action in Bankruptcy, this is not always the fact. Business owners, particularly when a business is in its infancy, are often required to personally guarantee some debts. Credit cards are a good example. While the credit card may be in the business name, and the responsibility of the business, they may still carry those personal guarantees.
A personal guarantee is just that – you are personally guaranteeing that line of credit. If the business is forced into bankruptcy, the lender can, and will, seek any outstanding balances from the guarantee; in other words, you. The only way to avoid this debt is by filing a personal bankruptcy petition at the same time. If you do need to file for bankruptcy as an LLC, be sure to discuss any personal guarantees with your lawyer as they will have a big impact on your petition.
For those who are in business, part of your annual review should, perhaps, be a review of all debts. If you do have personal guarantees on any lines of credit, it may be time to close those lines and to establish new lines that are not guaranteed. This will provide you with protection in the future should your business find hard times.
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March 6th, 2012 at 6:17 pm
This is so important. I really cannot believe people would take on the immense risk of personally guaranteeing a debt or any liability. For example, some of Authorize.net’s underwriting companies for merchant accounts expect you to personally guarantee the account. They act like it’s no big deal, but when you ask to have it waived, they say you can only do that if you have six figures consistently in your bank account.
I gotta wonder, if you’re telling me it’s no big deal and is only to cover $25 dollar charges, then why do I need a hundred thousand to cover that?
Do you have any experience with working around these types of issues?