Starting and operating a business can be an exciting and worthwhile endeavor. Running a business, however, does not come without any risks. According to the U.S. Bureau of Labor Statistics, 20% of new businesses fail within two years, 45% fail within five years, and 65% fail within a decade. In this article, we will discuss the liability of business debt when a business fails.
Can a Business Owner Be Personally Liable For Business Debt?
The heart of the issue for many people is whether a court will hold an individual liable for business debt. The answer is it depends. The first thing creditors will look into is the type of business structure. This will be the biggest factor in whether a court holds the owner personally liable. The two types of corporate structures where the owner(s) will be personally liable are:
- Sole Proprietorship
Despite the popularity of sole proprietorships to operate due to it being inexpensive and simple, it does not create a distinction between the owner and the business. Many courts and creditors will consider the owner of a sole proprietorship and the actual business the same. Given that there is no legal distinction between the person and the entity, the business owner may be held personally liable for the business debt.
Like a sole proprietorship, partnerships do not have a distinction between the owners and the business. In a partnership, the court can hold all general partners personally liable for the debt of the business. The advantage of a partnership is that the debt liability would be spread out amongst all the general partners and as a result, the financial burden on one individual might not be as great as it would be for the owner of a sole proprietorship.
What About Corporations or Limited Liability Companies (LLCs)?
If protecting personal assets are a major consideration for a business owner, then the corporations and limited liability companies (LLCs) offer the best protection. Generally speaking, the owner(s) of a corporation or LLC will not be held personally liable for the debts incurred on behalf of the business. The major exception to this general rule is if the owner(s) personally guarantee debt will be paid. When the owner(s) make such a guarantee, then they are personally liable for the portion of the debt they guaranteed.
Is LLC/Corporation Protection Absolute?
No, there is no absolute protection. Even in situations where the debt was incurred by a corporation or LLC and the owner did not make any guarantees, the courts may still allow creditors to go after the personal assets of the owner(s) to pay off the debt. A creditor may still collect the personal assets of the business owner(s) if they can prove any of the following:
- There was financial fraud.
- There was a comingling of business and personal assets.
- The corporate structure intentionally protects personal assets because they were knowingly engaging in questionable business practices.
- They were negligently undercapitalized.
The attorneys at Dowd Law have years of experience helping business owners avoid personal liability issues due to business debt. Contact us for a consultation on how to structure your business in the best possible way to meet your future goals while also protecting you. If you are an existing business, contact Dowd Law to evaluate your existing business debt or before obtaining any future debt to ensure your personal assets will remain protected.