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Disputes and Litigation Against Your Business Not Stopped by Your Personal Bankruptcy Filing

Careful: if your business is not a sole proprietorship, legal disputes against your business are not “stayed” by your personal bankruptcy’s “automatic stay.”

This series of blogs has been about the benefits of filing a bankruptcy case when closing down your business. A major point of the last blog was that your bankruptcy filing will—through the power of the “automatic stay”— usually stop any ongoing lawsuit from proceeding against you and your business, or prevent a threatened lawsuit from being filed at court. But there are some important exceptions to this, situations in which the automatic stay would not apply. In these situations the creditor’s or claimant’s lawsuit could continue in spite of your bankruptcy filing. Because stopping such a lawsuit could well be one of the main reasons you would be filing bankruptcy, it’s extremely important to understand these exceptions.

The Automatic Stay Protects YOU, Not Any Other “Person”

Bankruptcy and its automatic stay protect the “person” filing bankruptcy and his, her, or its assets. Other “persons” are generally NOT protected. The issue is whether you and your business are considered to be the same or separate “persons” for this purpose.

If your business is a sole proprietorship, the law considers you and your business to be the same “person.” So a lawsuit against the business would be stopped by your personal bankruptcy filing. But what if your business was set up as a corporation, a limited liability company (LLC), or a partnership, and you are dealing with a lawsuit against both you and the business?

Disputes Against Your Corporation, LLC, or Partnership

  • If your business was set up as a corporation or LLC and it is still operating when you file a personal bankruptcy, that filing does not “stay” any litigation against the corporation because it is a separate legal entity, a separate “person.” To the extent the dispute and/or lawsuit is against you personally, that portion would be stayed. But this may not help much if the lawsuit continues to disrupt and threaten your business.
  • Even if your business in the form of a corporation or LLC is no longer operating, but itself still owns some assets, those assets are not protected by your personal bankruptcy filing. This includes assets that the business might own outright—such as receivables that it was waiting to receive, or business assets that are the collateral on business loans—such as vehicles or equipment. Your personal bankruptcy filing will not stop a creditor or adversary from seizing these kinds of business assets.
  • If your business is or was a formal or informal partnership, the partnership’s creditors or adversaries would very likely be able to continue pursuing the partnership and its assets, as well as pursuing your partner and his or her assets, regardless of your personal bankruptcy filing. That’s because partners are generally jointly liable for the obligations of a partnership, and your partner and the partnership itself are both “persons” separate from you. So you have the same problem just outlined above as to partnership assets. As to the lack of protection for your partner or former partner, sometimes you may not care if your partner is left exposed while you are protected by your own bankruptcy filing. Because of a dispute with your partner you may believe that he or she should be held responsible for the partnership debt.  Or the two of you may have an understanding that you will each be filing your own personal bankruptcies.

That leads to the main lesson here. If your business legally qualifies as a separate “person,” and has assets that need to be protected, it may need to file its own separate bankruptcy, presumably a Chapter 7 to make an orderly distribution of those assets to the creditors of the business.

But the practical reality is that most of the time there is no issue about your business being pursued separately because either:

  • Your business is a sole proprietorship so that your personal bankruptcy encompasses and protects your business and its assets.
  • Even if your business was set up as a corporation, LLC, or partnership, by the time you file your personal bankruptcy case very often that business entity no longer has any assets worth fighting about, so there is nothing left to protect and no need for its own bankruptcy. 
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