Many personal bankruptcies are filed by owners of failed small businesses. Sometimes the bankruptcy is filed by the owner to discharge personal liability, and other times the business entity files bankruptcy to reorganize or liquidate the business operation. I received an email from a business owner whose business had filed Chapter 11 bankruptcy and who was confused about the effect of his business’s filing on legal actions pending against him personally as the director, officer, and guarantor of the business. He stated that business creditors had filed state court actions for, among other things, fraud, breach of fiduciary duty, and fraudulent conveyances. The writer wants to know if his corporate bankruptcy prevents or stays the creditors’ state court proceedings.
The general answer is that the business bankruptcy does not stop creditors’ pursuit of claims against the business owner in state court. The business and the owner are distinct legal entities. Each may, or may not, seek bankruptcy protection. Even though the owner may be jointly liable with the business for the business debts the bankruptcy filing of the business will not generally stay separate suits against the owner.
One exception to this general rule may be the fraudulent transfer actions in state court. If the creditors are alleging the business may fraudulent conveyances to the business owner (such as, distributions of money or property to avoid business creditors) the fraudulent conveyance claims probably belong to the bankruptcy trustee and are stayed in state court. The breach of fiduciary duty claim may also belong to the bankruptcy trustee. In many of these failed business situations both the business and the business owner end up filing their own bankruptcy petitions.