Bankruptcy and Interest in an S Corporation

Given the cost of living today, you may find yourself seeking out other opportunities to make income beyond just holding a normal 9-to-5 job.  Such opportunities might include forming an S corporation with friends or family members, where you each pool your funds in exchange for an interest in the business and hope that the business turns a profit that will benefit all the investors.

But with so many possible events that could impact your (or one of your partner’s) individual financial position in a negative manner—a dramatic decrease in the value of property you own, the loss of your income earned through a job, bad investments, divorce—you may find yourself in a situation where you cannot make ends meet and you have to consider declaring bankruptcy.  If that is the case in your situation, you may be wondering what will happen to your interest in the business in a bankruptcy proceeding?  Or will your personal bankruptcy result in the shutdown of the business?

Bankruptcy Treatment of Interest in a Business


In a bankruptcy, whether it is a Chapter 7 liquidation or a Chapter 13 reorganization, the bankruptcy trustee will be interested in a list of your assets as well as your debts.  Your interest in a corporation would be considered an asset in a bankruptcy proceeding, so legally you must list it on the appropriate bankruptcy forms.  But what the bankruptcy trustee does with your interest in the business depends on a few details about the interest.

First, is your interest in the business exempt from being included in the bankruptcy?  If your interest in the business is exempt from bankruptcy, you will be allowed to keep the interest even if you declare bankruptcy.  But what assets are exempt in a bankruptcy varies by state.  You should speak with a bankruptcy attorney who is familiar with your state’s bankruptcy laws in order to get the right answer for your situation.

Second, does your interest in the business have any value?  The bankruptcy trustee is looking for assets that can be sold, where the funds from such a sale can then be used to satisfy creditors listed in your bankruptcy.  If your interest in the business does not have value (beyond any sentimental value the interest may have for you) because the business is not doing well for example, the bankruptcy trustee will likely not pursue sale of the asset.  This likewise would mean you could keep your interest in the business.

Remember that because a Chapter 7 bankruptcy that may be used to liquidate your debt entirely is a much more powerful device than is Chapter 13 bankruptcy, there are limits on who can use Chapter 7 bankruptcy.  You will have to pass what is known as the Means Test in order to make use of Chapter 7 bankruptcy.

Affect of Bankruptcy on the Business


As for the impact to the business if one of the investors declares bankruptcy, remember that the above situation is the bankruptcy of an investor, not of the business itself.  Therefore, the business itself will not be dissolved.  However, the interest in the business may change hands if that interest has value.  It could mean that the other investors are given the opportunity to purchase that interest in the business.  Or it could mean that a new investor could buy the interest depending on the circumstances.

While the bankruptcy will not dissolve the business, it could have a significant impact on the business, especially if the interest is purchased by a new investor and that interest happens to be a majority interest in the business.

Finding a Knowledgeable Bankruptcy Attorney


Remember that the information above is general in nature.  It may not directly apply to your situation and should not be used as legal advice for making decisions about your circumstances.  But if you need to speak with a bankruptcy attorney about how declaring bankruptcy will affect your interest in a business or to get answers to any other bankruptcy related questions you may have, please call the phone number located at the top of this web site.  You will be put in touch with an experienced bankruptcy attorney.  He will be able to speak to how the bankruptcy laws of your state will treat your situation and offer guidance on what the best decision may be for you.  So make that call and get the help you need today.

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Beth L. is a content writer for Better Bankruptcy. Good content and information is one of many methods we utilize to bring you the answers you need.