Which Business Debts are Discharged in Chapter 7 Bankruptcy?

Find out whether Chapter 7 personal bankruptcy will wipe out your business debt.

Many of the debts that drive business owners to file for bankruptcy can be discharged through a Chapter 7 personal bankruptcy. When a debt is "discharged" it means that you are no longer responsible for paying it once your bankruptcy case is complete. After the trustee sells your nonexempt assets (if you have any) and distributes the proceeds among your creditors, then the court discharges any amount that remains unpaid on the debts when your case ends. 

Remember that Chapter 7 personal bankruptcy discharges only your personal liability for debt. (For the basics of using Chapter 7 personal bankruptcy for business debts, see Nolo's article, Can Chapter 7 Bankruptcy Be Used to Solve Your Business Debt Problems.) If your separately structured business (for example, a corporation or LLC) owes the debt, creditors can still come after the business for repayment. (See "Handling Corporate and LLC Debt," below, for information on your options for dealing with these debts.)

Here are some common types of business debts that are discharged in Chapter 7 personal bankruptcy:

• credit card bills
• lawsuit judgments
• medical bills
• unsecured business debts owed by a sole proprietor (such as debts to suppliers, consultants, and professionals like accountants or architects)
• obligations under leases and contracts entered into by a sole proprietor (including commercial and residential property leases and leases to rent equipment), and
• personal loans and promissory notes.

Secured debts debts for which you have pledged property as collateral are handled differently. The lender can take back the collateral securing the loan if you don't make your payments, even if you file for bankruptcy. If you owe more on a secured debt than the collateral is worth, the difference (called a "deficiency") becomes a debt that can be discharged in bankruptcy. But the lender still has the right to take back the collateral if you default on your payments.

Debts That Survive Chapter 7 Bankruptcy

Some types of debt are not dischargeable in Chapter 7 personal bankruptcy, which means you will still owe them when your case is over just as if you hadn't filed for bankruptcy. Some common types of debt that aren't discharged are:

• back child support, alimony, and other domestic support obligations
• court-imposed fines, penalties, and restitution
• certain tax debts including recent back taxes, any back taxes for which you didn't file a tax return, trust fund taxes (the employee's portion of Social Security and Medicare taxes), and debts you took on to pay nondischargeable taxes (for example, if you took a cash advance on your credit card to pay your most recent tax bill)
• debts of more than $550 to any one creditor for luxuries in the 90 days before you file
• cash advances of more than $825 taken within 70 days before you file
• loans you owe to your pension plan such as money you borrowed from your 401(k)
• student loans, unless repaying them would constitute an extreme hardship
• debts arising from your fraudulent activity (for example, lying on a loan application), if the creditor proves the fraud to the bankruptcy court, and
• debts resulting from an incident in which you kill or injure someone while you are driving under the influence.

Handling Corporate and LLC Debt

Chapter 7 personal bankruptcy discharges your personal liability for debts, but does not affect your corporation's or LLC's liability. To take care of its debts, the business will have to use a different strategy, such as:

• Allow the corporation or LLC to lapse. If you aren't personally liable for your corporation's or LLC's debts either because you have filed for Chapter 7 personal bankruptcy or because you were never on the hook for those debts in the first place you can use the business's remaining assets to pay off its debts to the extent possible, and then just dissolve your corporation or LLC. You do this by filing dissolution documents with your state's corporate or LLC office. By dissolving your business entity, you ensure that you are no longer liable for paying annual fees, filing annual reports, and paying business taxes. Be aware, however, that your business has a legal duty to pay off its debts to the extent possible. If your business owes debts when it's dissolved, and it owns cash or assets, you must pay all creditor claims and repay all loans before distributing any remaining property to the owners.
• Make an assignment for the benefit of creditors (ABC). If you don't have the knowledge, time, or inclination to liquidate the assets of your corporation or LLC and pay off its debts, you can hire a specialist to do it for you. An ABC company or law firm that specializes in liquidating insolvent businesses will sell the company's assets and use the proceeds to pay off creditors, while you can move on with your life. The company is motivated to get top dollar for business assets because it receives a percentage of the funds it can raise for creditors. The company can often get more for your business assets that you could on your own and may be able to monetize assets that can be hard to sell, such as intellectual property.
• File for Chapter 7 business bankruptcy. If you use the special Chapter 7 bankruptcy procedures available only to separate business entities (such as LLCs and corporations), the bankruptcy trustee will liquidate your business and settle its debts. When the process is complete and all of the proceeds have been paid out to creditors, the business won't owe any remaining debts. A lawyer is required to file for Chapter 7 business bankruptcy. You can go to Nolo's Lawyer Directory for a list of bankruptcy attorneys in your geographical area (click on the "Types of Cases" and "Work History" tabs to learn about a particular lawyer's experience, if any, with Chapter 7 business bankruptcy).

Next Steps

If you think Chapter 7 bankruptcy might be the right option for handling your business debts, pick up a copy of Bankruptcy for Small Business Owners: How to File for Chapter 7, by attorneys Stephen Elias and Bethany Laurence (Nolo).