Podcast: The LLC Myth in Chapter 7 Business Bankruptcy
Today’s podcast and accompanying transcript explain the confusion surrounding Limited Liability Companies (LLCs) and Chapter 7 business bankruptcy. After practicing bankruptcy law for more than two decades, I often see business owners make a critical mistake: assuming their LLC offers 100% protection from personal liability on business loans.
By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).
Updated on November 6, 2025.
Listen: The Professor’s Audio Briefing.
Separating Fact from Fiction on Limited Liability Companies (LLCs) and Business Debt
That assumption is, unfortunately, often far from true. This post summarizes the key points from the discussion, focusing on where the liability shield fails and what you can do about it.
The Professor’s Take: The primary benefit of an LLC is to shield your personal assets from the business’s operational debts (like vendor invoices or lawsuits). It rarely protects you from liabilities you personally guarantee, which is common in small business lending.
Business Bankruptcy: The Two Paths
When a business faces financial distress, the choice of which bankruptcy chapter to file depends on the intended outcome:
| Chapter | Purpose | Entity Eligibility | Individual Debt Option? |
| Chapter 7 | Liquidation (Closing the business) | Businesses & Individuals | No (only the business closes) |
| Chapter 11 | Reorganization (Staying open) | Businesses & Individuals | Yes, but typically complex for small businesses and used for high wealth individuals |
- Chapter 13 is not a business option. While a business owner can file Chapter 13, it is strictly for personal debt reorganization (a repayment plan over three to five years). The business itself cannot use it.
The Myth of the LLC Shield: Personal Guarantees
The biggest misunderstanding involves the personal guarantee on business debt.
The Reality: In almost all cases for small businesses, banks and lenders require the owner to personally guarantee the loan or line of credit.
- When you signed those loan documents, even if you scrolled quickly and clicked “I agree,” you likely consented to a clause making you personally liable.
- If the business closes and files Chapter 7, the business debt is liquidated for the company, but the creditor can still pursue you, the individual, based on your personal guarantee.
- Always review loan documents for phrases like “personal guarantee” or “unconditional guarantee” before signing.
Piercing the Corporate Veil: The Separation Rule
Even without a personal guarantee, personal liability can arise if you fail to maintain the legal separation between yourself and the LLC. This is known as piercing the corporate veil.
The Principle: The LLC is a legal entity separate from you. If you treat its finances as an extension of your own, the court may disregard the liability shield.
| Action that Pierces the Veil (Don’t Do This!) | Result |
| Commingling Funds | Paying business bills from your personal checking account, or vice-versa. |
| Lack of Records | Failing to hold required meetings or keep clear financial statements. |
| Undercapitalization | Not putting enough money into the LLC to cover expected basic liabilities. |
- Actionable Step: Maintain strict separation! Use a dedicated business checking account for all business income and expenses. Never pay for personal items from the business account or business items from your personal account.
Professor Hernandez is an attorney specializing in consumer finance and debt relief. He is the published author of Consumer Bankruptcy Law (Routledge Publishing) and teaches law and finance courses in both English and Spanish for an international university.
Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. Paralegals and students who are buying single copies can do so via Amazon Books. To access my YouTube channel, click this link. You can also listen to my podcast on Spotify.
You can learn more about filing for bankruptcy and the bankruptcy petition via this link. Information on the bankruptcy court system, contact information for trustees, and your state’s exemptions can be found here. The federal bankruptcy exemptions are listed here. The latest version of the 341 Meeting of the Creditors can be found here.
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Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.
Updates:
- February 22, 2025.
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