Businesses that face significant pressure due to debts may pursue bankruptcy to resolve their financial problems, but a commercial bankruptcy can have significant consequences for business owners or shareholders. The effects will depend on the business’s structure, the type of bankruptcy, and the owners’ involvement in the business’s debts.
Business Structures and Liability in Pennsylvania
First, a business’s legal structure can determine bankruptcy’s consequences for partners and shareholders. In a sole proprietorship or partnership, owners or partners may face personal liability for the business’s debts. A sole proprietor may file for personal bankruptcy to resolve their business’s debts. When a partnership files for bankruptcy, general partners bear liability for the partnership’s debts. In contrast, limited partners only have liability in the form of the capital or assets they’ve invested in the partnership.
In limited liability companies, members also have limited liability for an LLC’s debts, with their exposure limited to the investment they’ve made in the business. However, members who have made personal guarantees of the LLC’s debts may have liability for those debts even in bankruptcy.
Finally, a corporation’s shareholders also have limited liability, protecting them from the corporation’s debts, with shareholders’ risk limited to the money they have invested to purchase their shares.
How Each Type of Bankruptcy Affects Partners and Shareholders
The type of bankruptcy that a partnership or corporation files for will also determine what happens to partners or shareholders. In Chapter 7 bankruptcy, also called liquidation bankruptcy, a trustee will sell the business’s assets to generate money to pay creditors. The company will also wind down and close. In most cases, no business assets will remain after repaying creditors, meaning that shareholders and limited partners will lose their investments. General partners may remain liable for any remaining partnership debts after bankruptcy.
In Chapter 11 bankruptcy, also called reorganization bankruptcy, the business continues operating while it restructures its operations and implements a court-approved plan to repay its debts. As a result, the value of shareholders’ or partners’ interests in the business may decline in the short term as the business rebuilds.
Special Considerations for Partners in Pennsylvania
In Pennsylvania, general partners have unlimited personal liability for the partnership’s debts or liabilities. As a result, general partners may face liability for a partnership’s debts even when it files for bankruptcy. Conversely, limited partners do not have personal liability for the partnership’s debts but may lose some or all the value of their investment when the partnership files for bankruptcy.
Effect on Shareholders of Pennsylvania Corporations
When a corporation files for Chapter 11 bankruptcy, shareholders get to keep their equity interests in the business, although a bankruptcy can temporarily reduce the company’s value. However, when a corporation files for Chapter 7, the business winds down. Shareholders occupy the lowest priority for distribution of the corporation’s assets, after payment to the business’s creditors. As a result, a Chapter 7 bankruptcy usually makes a corporation’s shares worthless.
Protecting Personal Interests
Partners and shareholders can protect their personal financial interests in case their business files for bankruptcy by taking steps such as:
- Avoiding making personal guarantees for the business’s debts
- Observing corporate formalities in corporations and LLCs to preserve limited liability protections
- Seeking legal advice when a business’s bankruptcy seems imminent
Contact a Bankruptcy Attorney
When a business files for bankruptcy, understanding the consequences for shareholders or partners can help managers make informed decisions throughout the case. Contact The Cooney Law Offices today for a confidential consultation with a commercial bankruptcy lawyer to learn more about how a Pennsylvania company’s bankruptcy can affect its shareholders or business owners.
