If you are an entrepreneur or small business owner, you are undoubtedly passionate about your business and determined to succeed. And like many who are in business for themselves, you may sometimes struggle with bringing work home with you. People in all careers can struggle with work/life balance, but it can be even more difficult when you are your own boss.

And while it may be okay to answer an email from home every now and then, there is one thing that all business owners should never do – mix your business and personal finances.

There are many good reasons for keeping your finances separate, especially if your company should ever struggle financially. When a business falls on tough financial times, unfortunately, owners can make irreversible mistakes and overlook potential resources.

As a Chapter 7 panel trustee and a bankruptcy attorney, I often witness these instances and wish that if I had been involved earlier, I could hopefully offer some insight to help the business and its owners address their financial issues, and protect personal assets that may be exempt from business creditors.

While often thought of as a last resort, bankruptcy can be a very useful tool for business owners, allowing a corporation to potentially slough off substantial amounts of debt, and emerge from bankruptcy a far leaner, more efficient business entity. Unfortunately, it is often the case that business owners take this step long after it could have been utilized to maximum effect.

Chapter What?

Generally speaking, there are two types of bankruptcies – liquidation and reorganization.  “Straight bankruptcy” or liquidation usually takes place in the context of a Chapter 7 proceeding. Reorganizations take place in a Chapter 13 or Chapter 11 proceeding.  Chapter 11 is usually reserved for corporate reorganizations or reorganizations by high net-worth individuals.

In a Chapter 7 case, a panel trustee, like myself, collects a debtor’s non-exempt assets, sells those assets, and distributes the proceeds to creditors in accordance with a priority scheme established by the Bankruptcy Code. In a reorganization case, the debtor remains in business, continues to operate, and usually makes some repayment to creditors over some period of time.

 Personal Assets That May Be Exempt from Business Liability

When a closely held business is overloaded with debt, there is a strong likelihood that the owners of the business are also liable for such debt(s) in the form of personal guarantees. One of the most pervasive stories that any bankruptcy practitioner hears is that of the Mom and Pop business owners who spend all of their life savings, mortgage their homes to the hilt, cash in all of their 401(k) and IRA accounts expecting and hoping to salvage a struggling business.

Of course, by the time the attorney hears these stories, the proverbial sunny day never comes and, inevitably, the business fails. To add insult to injury, it is not uncommon for the owners of a failing business to deplete their life savings in an effort to right the sinking business ship, oftentimes compelling the business owner to file personal bankruptcy.

Unfortunately, what many business owners often learn in hindsight is that certain assets are fully exempt and can never be touched by creditors. With limited exceptions, funds in an IRA and/or Roth IRA are fully exempt and cannot be executed upon by creditors.  401(k)s and similar retirement accounts are also fully exempt. In North Carolina, if real property is owned jointly by a husband and wife, then creditors of just the husband or just the wife cannot look to such real property in collection of their debts.  (Conversely, if both the husband and wife are liable for the subject debt, then the real property is subject to execution by the creditor).

For many individuals, retirement accounts and equity in real property are the most valuable assets that a person owns. As stated, these assets can be, and most often are, fully exempt from collection by creditors, and therefore, are not only nest eggs, but titanium nest eggs. Yet, instead of retaining such assets in their titanium shell, desperate business owners may be inclined to tap into (and often wholly deplete) such otherwise impervious assets in hopes of turning a failing business around.

Certainly, there may be many good reasons for trying to save what would otherwise appear to be a failing business:  the business is your life – you know nothing else; there are employees who rely on you and the business for their livelihood; the business owes money to vendors and your moral fiber implores you to fight tooth and nail to ensure that the legitimate obligations of the business get paid.

Although rationale such as these are certainly laudable, the million-dollar question – sometimes literally – is whether such rationale justify throwing good money after bad. Clearly, these are personal judgment calls that nobody can make except for the small business owner.

What Business Owners Should Do When Facing Extreme Financial Challenges

Certainly, there is no magic elixir that will help all businesses in every scenario. Just as there are a myriad of economic and financial difficulties that a business may face, there are just as many potential solutions. What is right for one business and its owner(s) may not be right for the next. Having said that, knowledge is power; informed judgments and decisions are almost always better than the ill-informed decisions based on desperation.

Before tapping into otherwise exempt assets to pay creditors or to add liquidity to a flailing business, it would certainly behoove all business owners to consult a professional about their rights, their assets, and applicable collection and exemptions laws. Even if a business enterprise cannot be economically salvaged, an experienced attorney should be able to help stop the bleeding, and, hopefully, assist the business owners in protecting their own personal assets so that those assets are not lost along with, and in addition to, the failing business enterprise.

About the Author: Daniel C. Bruton

 Dan Bruton is an attorney at the law firm of Bell, Davis & Pitt who focuses on bankruptcy, creditors’ rights, and litigation (commercial, banking and financial services, and general). Dan also serves as a Chapter 7 bankruptcy trustee for the U.S. Bankruptcy Court for the Middle District of North Carolina.