Your Options for Bankruptcy with Partnerships

If the partners in a business have come to the agreement that filing bankruptcy is the best option for the company financially, then there are two Chapters to file under. Chapter 7 and Chapter 11 bankruptcy are options for a partnership. Where Chapter 7 allows for trustees to sell of remaining assets for payable funds through bankruptcy law, Chapter 11 gives partners the ability to keep the business alive while paying a settled amount as a payout.

Filing for bankruptcy in business exists to either reorganize the business in a way that allows for the continuation of its operation, or completely liquidates company assets in order to pay off debts. Deciding which chapter to file under with a business partnership can vary based on the degrees of the partners’ personal liability. Generally speaking, partnership companies are classified as either general partnership, limited partnership, and limited liability partnership.  While this business forms are rare outside the realm of professional enterprises, they certainly exist.  In many states, partnerships may also exist “in fact,” without a written agreement, based upon how the partners present themselves in public.

General Partnership

In a general partnership, all partners are considered to be on the same legal level of involvement with the company. This means that all partners are personally liable for the debts of the business of the partnership. So if the partnership fails to repay its debts, the creditors can recover the amount from the personal assets of the partners.  Essentially, no separate legal entity exists apart from the partners themselves, and no protections from personal liability exist.

Limited Partnership

Limited partnerships are State registered and require at least one general partner as well as other limited partners. The general partner, however, is the one who is completely responsible for the business debts of the business, and often is a corporate entity or a limited liability company. Additionally, there isn’t any personal liability for limited partners in a limited partnership firm.  Often this form is used as a structure for investment companies, wherein the manager of the fund is the general partner and the limited partners are the investors.  Whether it is a hedge fund, or a special purpose acquisition company or similar entity, it is an easy form to limit the control of investors, while utilizing their money for purposes laid out in the partnership agreement.

Limited Liability Partnership

Limited liability firms are another form of partnership where there isn’t any personal liability. This form means that all partners are considered to have limited liability protection.  Do not confuse this form with a limited liability company.  Limited liability companies have different governance options, and are subject to different state laws.  

Chapter 7 and Chapter 11

In the case of Chapter 7 bankruptcy, partnerships cannot receive a discharge the same way that filing for personal bankruptcy would. During the liquidation process of Chapter 7, all of the business assets are dispersed amongst the creditors in which case the bankruptcy is closed once those debts are paid. If after all assets are liquidated from the business, but part of the debts still remain unpaid, then creditors are able to go after partners who are personally liable.

Filing the partnership in a liquidation / chapter 7 bankruptcy, typically makes sense only when there are substantial assets with values exceeding the amount of the secured debt (debt for which there is collateral).  This is because the limited funds can best be allocated to bankruptcies for the partners with personal liability.  Many individuals come to our office looking to file their business in a bankruptcy and close it down.  In the vast majority of those cases, we find personal liability in the form of either direct obligations on business related debt, or personal guaranties.  That personal liability leads to an analysis, which usually results in the individuals filing bankruptcy, and allowing the partnership or other entity to simply fade away.

Once a partnership is liquidated after filing Chapter 7, the business itself will have ended its operation. Only with Chapter 11 bankruptcy can a partnership reorganize its structure and continue operation. Obviously, it is in the partnership’s best interest to have as many assets as possible so the partners themselves can distribute the funds to debtors instead of having a bankruptcy trustee handle the process.  The debtor in possession (debtor which filed bankruptcy) is required to operate as the bankruptcy trustee, and in the interests of all stakeholders such as creditors, those holding contracts with the debtor, and ultimately the owners.  However, the debtor may not look out for the owners’ interests unless or until it is clear that all creditors and other stakeholders are made whole.  So, it must be clear to the owners that filing chapter 11 comes with significant fiduciary duties to others, and that the United States Trustee will be overseeing the process to ensure the debtor complies with these duties.

Filing for bankruptcy as a partnership can be an overwhelming process to handle without proper guidance. Your situation is unique which means your solution will be too. Oppenhuizen Law Firm has not only the necessary experience to help assist you and your organization, but understands the attention and availability you, as a client, deserve throughout that process. If you’re ready to talk about options for your bankruptcy strategy, contact us today.