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How is bankruptcy harmful to business?

When an owner is considering filing for bankruptcy, there are many factors that affect how it can hurt the credit rating—both for the owner and the business. In Canada, where businesses are subject to specific national and provincial regulations, it is essential to understand how an insolvency situation affects a company’s financial position.

Understanding the concept of solvency for business

Solvency is the ability of a company to repay its debts and meet its obligations. Lenders, as well as lessors, suppliers and lenders, seek to assess creditworthiness to determine the risk associated with extending credit or financing a business.

A key factor in this rating is the company’s credit rating, which reflects the company’s history of borrowing and repaying debt.

What is the company’s credit rating?

A business credit score – just like an individual – is a numerical representation of creditworthiness that helps lenders assess the risk involved in extending credit to a business.

Canada has three major credit bureaus: Equifax, Experian and Dun & Bradstreet, the latter of which specializes in business credit reports. Each produces multiple scores that give potential lenders an idea of ​​your business’s financial health and the likelihood that its payments will be on time.

Bankruptcy and business structure

The impact of bankruptcy on the creditworthiness and solvency of the business depends to a large extent on the structure of the business. However, in most cases, once a business files for bankruptcy with the Office of the Insolvency Inspector, it can no longer operate.

Sole proprietorships and partnerships

If you haven’t registered your business, according to the Canada Revenue Agency, “you and your business are the same legal entity.” The business therefore belongs to you, or it belongs to you and your partners. If you decide to file for bankruptcy, you are filing for personal bankruptcy (instead of a business bankruptcy) and your personal credit score may be affected.

For example, some contractors and landlords may require small business owners to post personal property as collateral. You may also have taken out a personal loan to support your business finances. In either case, a licensed insolvency practitioner (LIT) will liquidate the remaining assets of the business to repay your creditors.

Because sole proprietorships and partnerships are closely tied to their owners, these bankruptcies appear on the owner’s personal credit report and have the same effect as a personal bankruptcy on the owners’ credit score.

Note: Due to the more complex structure of the partnership, bankruptcy may or may not end the existence of the business. If the company has more than two partners, the personal bankruptcy of one of them does not necessarily end the existence of the company.

Corporations and Bankruptcy

If your business is listed and goes bankrupt, it is not a personal bankruptcy. Corporate bankruptcy affects any business, regardless of its size. According to the CRA, “in most cases, if a bankrupt company fails to pay all debts owed at the time of bankruptcy, the company is dissolved”.

It should be noted that there are other solutions for small businesses than bankruptcy. A trustee can help explore these solutions to save the business from bankruptcy and prevent impacts to the business owner’s credit rating.

This article is intended to provide general information only and is not intended to provide legal, financial or other professional advice. Please consult with a professional advisor regarding your specific situation. The information presented is believed to be factual and current, but we do not guarantee its accuracy and cannot be considered an exhaustive analysis of the topics discussed. Opinions expressed reflect the judgment of the authors as of the date of publication and are subject to change. Royal Bank of Canada and its entities do not promote, either explicitly or implicitly, the advice, opinions, information, products or services of third parties.

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