Updated November 3, 2020:

Overview of Sole Proprietorships and Personal Debt

It is a two-way street when it comes to debt. A sole proprietor is responsible for the debts of the business, and the business is liable for the sole proprietor's personal debts. How you deal with your personal debt can have a direct effect on your enterprise.

If you are in a position where you must file bankruptcy, there are two choices: Chapter 7 and Chapter 13.

Chapter 7

With a Chapter 7 bankruptcy, your business may be in jeopardy and potentially be shut down because all the assets of the business are subject to liquidation. This will be necessary to satisfy your debt under Chapter 7. In most cases, the assets of the business are considered non-exempt and will most likely be sold.

Chapter 13

This type of bankruptcy offers more options, especially if the business is showing a profit. If this is the case, you may be allowed to keep the business up and running and use the revenue generated from sales or service as part of your repayment plant.

Overview of Partnerships

Partnerships are unincorporated business entities that two or more individuals own. There are several types of partnerships:

  • General
  • Limited
  • Limited Liability Partnership (LLP)

General Partnership

Two or more people who are in agreement can create a general partnership without the need for paperwork. Each party is considered a general partner and liable for any debts the partnership incurs. In other words, as a general partnership, each partner is responsible for any obligations attached to the business.

Limited Partnership

With this type of partnership, there is a minimum of one general partner and one limited partner. The general partner takes on the responsibility for the partnership debts while the limited partner is not liable for any of the debts. The general partner is subject to creditors collecting from their personal assets. The limited partner is not held liable.

Limited Liability Partnership (LLP)

When a limited liability partnership is created, all partners are protected from personal liability for debts the business incurs. Some states provide protection to all partners, while other states require there to be at least one general partner associated with the LLP. There are states that have the stipulation that liability protection only applies to negligence claims. This means all partners may be liable for other business debts, such as credit cards and business loans.

Overview of Corporations

Corporations are incorporated entities designed to limit the owners' liability. Shareholders generally are not personally liable for the debts of the corporation. Creditors attempting to collect on their debts do so by going after the corporation's assets. Shareholders are liable if they cosigned or guaranteed the debts of the corporation personally.

In the event that a creditor can prove corporate protocols were not followed, shareholders can be held liable. Examples, where formalities were not followed, would be if the shareholders commingled their personal and business funds or the corporation served as a shell to shield liability. This is referred to as "piercing the corporate veil".

Overview of a Limited Liability Company

A limited liability company (LLC) offers limited liability to its owners, who are also known as members. In most cases, members are not liable for the LLC's debts unless they have cosigned or personally guaranteed the debt.

One purpose of organizing a LLC is to separate the personal and business assets and obligations of the business owner. This business type limits the owner's personal creditors from taking the assets of the business to satisfy the payment of personal bills.

An LLC can be set up as a single-member or multi-member LLC. In the event that a personal creditor obtains a judgment against a member for nonpayment, whether single- or multi-member, the creditor can attempt to attach the member's interest in the LLC.

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