When two or more people agree to go into business together and do not establish themselves as a corporation, limited liability partnership (LLP), the result is a general partnership. Each partner is personally responsible for all debt arising from the partnership, meaning that if the new enterprise defaults on any of its obligations, creditors can pursue the partners’ personal property to satisfy their claims.

This fact creates a unique and problematic situation if the partnership ever files for Chapter 7 bankruptcy. As with personal bankruptcy, a trustee is appointed to liquidate partnership assets and distribute the proceeds to creditors. In most instances, all business activity ceases so that there is no chance of the company incurring new liabilities.

However, a general partnership bankruptcy does not change the responsibility of the partners for business debts. There is no automatic stay of proceedings for co-debtors, so partners who guaranteed those business debts can be sued directly by creditors once the business itself goes bankrupt.

The bankruptcy trustee can even sue the partners for the difference if the sale of assets does not completely cover the amount owed (a state known as a deficiency). He or she can opt to file suit against the partners that have the most assets, which is tantamount to one or two partners paying a debt technically owed by everyone. These affected individuals can sue the other partners for their share of the amount, but this adds another legal process to an already challenging time.

Liquidating the partnership’s assets can take a while, so in some instances, the bankruptcy court will restrict each partner’s right to transfer their personal assets during this evaluation and liquidation period. Alternatively, the court may request them to post a bond to ensure that any asset transfers will not leave them unable to pay a deficiency.

What if an individual partner files?

When an individual partner files a Chapter 7 bankruptcy, neither their creditors nor the trustee can seize assets that specifically belong to the partnership. The bankruptcy estate does, however, receive any income or profits realized by the partnership, although the trustee cannot assume the debtor’s place and participate in management decisions.

The law gets a little blurry when it comes to the effect of a partner’s personal bankruptcy on the partnership itself. While the law indicates that a Chapter 7 filing requires the partnership to be dissolved, it is allowed to carry on business until all its affairs conclude. This unusual situation has resulted in some confused and conflicting case law in New York.

If your general partnership is preparing to file for bankruptcy or you intend to do so personally, then it is important to review your options with an experienced New York bankruptcy attorney first. A Chapter 7 filing can have some unwanted consequences to each partner, so such a move should be made only after consulting with competent counsel. Jayson Lutzky has over 34 years of legal experience and has handled thousands of cases for highly satisfied clients over the years. If you are considering bankruptcy, then set up a free in-person initial consultation with Mr. Lutzky. Call 718-514-6619 or visit www.mynewyorkcitylawyer.com.