Partnerships and Bankruptcy — How Everyone Is Affected
28 October 2020
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Being in a business partnership offers a unique opportunity to pool your resources with other like-minded entrepreneurs to earn profit for all. But life - both personal and business life - doesn't always work out the way a person wants. Unfortunately, this can sometimes lead to the need to seek bankruptcy protection from creditors.
What happens to your partnership, or to you as a partner, when this happens? Here's what every partner needs to know to protect themselves.
What Happens When a Partner Declares Bankruptcy
Personal bankruptcy affects businesses in different ways depending on which type of legal entity it is. Sole proprietorships, some LLCs, and partnerships are all the sort of business that is irrevocably intertwined with the individuals who own it. Therefore, it's very hard to separate a personal bankruptcy from the business. Generally, this is because partners are personally liable for business obligations.
If a partner must declare bankruptcy, the partnership's path depends on several factors. If a general partner declares Chapter 7 bankruptcy, which is the liquidation of assets, it often causes the partnership to be dissolved as well. A limited partner's bankruptcy may not have the same effect since their liability is defined by their stake in the business.
Reorganization - Chapter 11 or Chapter 13 - may give the partnership more options, though. If the partnership is able to file Chapter 11 after a partner's personal bankruptcy, the business may be able to expel the affected partner by buying out their interest. While this may cause a financial burden for the business or surviving partners, it prevents the partnership from having to dissolve.
What Happens When a Partnership Declares Bankruptcy
Since partnerships are inextricably linked to their owners, how are these owners affected if the business must declare bankruptcy? Chapter 7 bankruptcy - asset liquidation - essentially dissolves the partnership and sells its assets to satisfy debts. Each party would walk away with either some of the remaining assets or nothing.
However, the real difficulty for partners occurs when the business assets don't cover all its debts. Because general partners hold personal responsibility for business debts, creditors may simply come after their personal assets instead.
These personal guarantees of debt cause a ripple effect within a partnership. Once the partnership's business bankruptcy is in play, all general partners may need to consider filing for bankruptcy on a personal level. And if they choose to take different paths regarding this legal protection, some may end up with more debt liability than they want - or expect. This can cause financial and personal impacts.
Chapter 11, or reorganization bankruptcy, is generally open to partnerships just as it is to other businesses. But the personal guarantees by partners makes this route trickier and therefore less popular. Creditors have more leverage because they can opt to pursue personal assets instead of accepting lower or longer payments by the partnership.
Where You Should Start
If you suspect that your partnership or any of its individual owners may need to seek bankruptcy protection, you should seek qualified legal advice as soon as possible. You need to protect your own interests and finances, so an outside attorney without a stake in the business or other partners' interests is ideal.
Together, you and your lawyer can decide whether you will be affected by a partner's or business bankruptcy, whether you need to claim your own bankruptcy, and how the partnership may fare from the effects.
Custer, Custer & Clark LLC Attorneys at Law
can help. We have aided Georgian businesses and individuals in navigating the debt relief waters since 1938. Call today to make an appointment with our experienced team.
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