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How to Mitigate Your Business Partner’s Debt or Bankruptcy

Starting a new business sometimes feels like a honeymoon. Sure, it’s a legal commitment same as marriage, but it’s also a time of exciting possibilities. You imagine your business growing to become anything - maybe even a great, thriving success. Surely.

At the time of such optimism, it’s still important to implement safeguards to protect your business and your personal assets. A business partnership is like a marriage, legally connecting you to another individual (or individuals) indefinitely. Retaining an Ohio business planning lawyer will help you plan and stabilize your business from day one.

It’s sometimes difficult in the joy of a new venture to imagine unfortunate events like your business partner’s personal bankruptcy, or potentially being held liable (personally or via your business) for their debts. But just as a prenuptial agreement can help protect those entering marriage, a strong business plan/partnership plan can help ensure that unfortunate future events will not impact you or your business.

Business Planning to Protect Your Assets

The first portion of this blog post will assume you are in the process of starting a business. Perhaps you have conceived of a project, or you and your partner have begun to discuss or negotiate terms. This is a practical and important time to consider all potential eventualities.

Partnership agreements/incorporation documents may include language stating that a partnership is ended should any general partner file for bankruptcy. And although it is important to distinguish between business and personal bankruptcy, we are talking here about personal bankruptcy infringing upon a joint business venture. That is because even a personal bankruptcy may have negative repercussions for a business and its partners. Care must be taken at the time a partnership agreement is drafted to plan for such future events.

Even if a partnership is not severed by a personal bankruptcy—and indeed, some portions of the bankruptcy code may bar such dissolution—you may wish to buy out your partner at that time. This and other steps to preserve your assets and save the business will be further addressed below.

The partnership agreement should also provide concrete language about how personal or business debts will be treated in the event of a partner’s bankruptcy. For instance, many partnership agreements will state that debt will be the equal responsibility of each partner, yet many loans consider all partners “jointly and severally responsible,” meaning you are both one hundred percent responsible.

For example, if your partner files for bankruptcy and you do not, your partnership agreement will not protect you if your business loan says you were both responsible for the debt. You would still be considered one hundred percent responsible for the remaining debt in that situation, even if your partner was able to void their responsibility via bankruptcy.

Partnership agreements should address matters of collateral (what money each party or the business puts up), solvency (how to ensure there is sufficient cash flow), and indemnification (agreeing another party is not responsible for liability) to ensure the business itself (and all partners) are treated fairly should one of the partners fall on hard times. Otherwise, the insolvency or bankruptcy of a partner may spread like a contagion to other partners, and eventually the business itself.

What to do if My Business Partner Has a History of Financial Problems?

You should be particularly wary if your business partner has a history of financial troubles, prior bankruptcies, or other insolvencies. As they say, past behavior is the best predictor of future behavior. That said, even if you’re going into business with a veritable “saint,” you should insist on these same types of protections. Things can change, and many events in life are outside our control. A divorce, a serious health issue, or an unexpected personal lawsuit can derail even the best intentioned of partners. But should you negotiate your partnership agreement without counsel?

Although there’s plenty of inexpensive ways to incorporate including online forms or even through state websites, it’s imperative that you consult with business planning attorneys before signing any business documents. An ounce of prevention now will be worth a pound of cure in business litigation or partnership disputes. Remember that you often get what you pay for. Although business lawyers may seem an expensive and perhaps unnecessary expense at the start of a business venture, such cost is minimal compared to your potential exposure. And being able to sleep well at night is often priceless.

And by now you may be thinking, sure, that’s all well and good…but what if I’m already running a business? What if my partner is considering bankruptcy and we already have a partnership agreement?

Living With a Business Partner’s Debt

It’s a scary thing to be tethered to the success of someone else. Planning ahead is the best course of action, but the time machine has yet to be invented. Let’s now discuss some of your options if your business partner has filed for bankruptcy or is approaching insolvency.

The best thing you can do is try to maintain business profitability. Money is a great problem solver. Even if your business partner is going through a personal lawsuit, divorce, health issues, or the other common causes of bankruptcy, keeping the business afloat and profitable may allow everyone an opportunity to dig out.

As stated above, this is also a good opportunity to attempt to buy your partner out, perhaps at bargain prices. However, as the business may be considered an asset for your partner, you should work with business planning lawyers to determine a purchase agreement might be reached. You may need to buy your partner’s interest from a bankruptcy trustee, or you may be able to purchase the business interest from your partner outright. Either way, it’s a complicated situation with many moving parts, so you’ll want to make sure you have proper legal counsel.

In the meantime, your business should continue paying all business debts. This may all fall on you, as your business partner’s debts will likely be frozen by what is known as the “automatic stay,” the process in bankruptcy by which all pending debts are frozen until the bankruptcy is resolved.

Whether you are entering a new partnership or trying to find your way out of an old one, we’re here to help.

Ohio Business Planning Attorneys

The law firm of Bridges, Jillisky, Weller & Gullifer, LLC emphasizes Ohio business planning. If you are entering into a new business venture, or are confronting issues of partner debt or bankruptcy, then you should call us today at (937) 403-9033 to schedule an initial consultation, or feel free to utilize our firm contact form.

Our firm relishes the opportunity to serve as one of the trusted advisors of your business. We look forward to working with you to build and stabilize your business interests, present and future.