In bankruptcy you can usually either “assume” or “reject” leases—retain the asset and remain liable, or return it and discharge any debt.
Our last three blog posts have been about leases of personal property in bankruptcy. We’ve been focusing mostly on consumer leases. Now let’s see how it works in the business context.
“Personal Property” in a Business
Let’s first clear up one thing. Personal property does not mean consumer or non-business property. It simply means property that isn’t real property. (Real property is real estate—“any property attached directly to land as well as the land itself.”)
Personal property for a business would include equipment, office furniture and equipment, computers and other electronic hardware, and vehicles used by the business.
It’s possible to lease just about anything needed in business. Leasing gives you the use of necessary business assets without paying up front for it or tying up your credit. The main downside is that you almost always pay more in the long run. And you commit yourself to keep the business asset for a set period of time.
Bankruptcy Options with Unexpired Leases
In general, regardless which bankruptcy Chapter you or your business files under, you have two basic options with leases. You can retain the use of the property by “assuming” the lease. If so, you are required to “assume” ALL of the obligations under the lease agreement. Or you can “reject” the lease. Then you return the leased asset. And, if you are in a bankruptcy Chapter that provides for this, any remaining liability is “discharged”—legally written off.
There’s a lot to this, depending on your type of business entity, the terms of the lease, and your continued need for the leased property, among many considerations.
Individual vs. Business Liability
Who is the lessee on the lease agreement? Is it in the business’ name or in your name as an individual? Is it in the business’ name but with you as a co-signor or guarantor?
If you have a small business, usually you will be on the hook for all liabilities on the lease. You may well have directly signed the lease, or signed a guaranty. Or if you own the business as a sole proprietorship, you are individually liable for all obligations of the business.
Sole Proprietorship vs. Corporation
A sole proprietorship is not a separate legal entity from you, unlike a corporation or a limited liability company. Corporations and such can own property and owe debts on their own. Sole proprietorships cannot. So if you operate a sole proprietorship, you are liable on the business’ lease agreements. That’s true even if you operate it through a state- or city-registered assumed business name, and only that name is on the lease agreement.
To be practical, most of the time a lessor will require all small business owners to be individually liable. That’s again done either by requiring you to sign the lease agreement or an accompanying personal guaranty. This is usually true regardless whether you have a sole proprietorship or a corporation or whatever. The liability-avoiding purpose of having a corporation or LLC are often defeated this way in practical reality.
So, most of the time you are personally liable on the lease, and often on all of the business’ other obligations.
Filing Individual Bankruptcy
Assuming you are personally liable on your lease, and on all or most of the debts, you will need to file an individual bankruptcy case. If you have a sole proprietorship, it cannot file and does not need its own bankruptcy. (Whether your corporation or other business entity should do file one is beyond this discussion.)
You will likely have the option to “assume” or “reject” your business lease regardless which bankruptcy Chapter you file. Here is a very broad summary of how this works in Chapter 7, 11, and 13. Please meet with your Louisville bankruptcy lawyer for much more specific guidance.
Chapter 7, 11, and 13
Under a Chapter 7 liquidation, if you assume the lease and are behind on the lease payments or are in breach of any other terms, you must get current and/or cure the breach within a month or two. If you reject the lease, you surrender the property and your liability is usually discharged within about 4 months.
Under a Chapter 11 reorganization, you usually have more time to cure any breach. But Chapter 11 is a relatively expensive and time-consuming procedure that is seldom appropriate for a very small business.
Under a Chapter 13 adjustment of debts, you also have more time to cure a breach of the lease. It is a much less expensive procedure—it can easily cost one-tenth as much than Chapter 11. Only individuals can file under Chapter 13; corporations and other business entities cannot. But usually, even on a business lease, there is only personal liability. Or the personal liability is the only one that matters. If you assume the lease, you must still accept all the lease obligations. And if you reject the lease, any obligations arising from it are included with the rest of your “general unsecured” debts. You may have to pay some portion of that. But usually you are only paying a set, limited amount to all those “general unsecured” debts, so adding in the lease obligations does not increase the amount you would pay overall.