Am I Liable for Business Debt My Partner Hid?

By Elaine PofeldtLifestyle and

Dear Your Business Credit,

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I became a business partner with my friend, who has been running this firm for a few years. And only now I found out that he has debts from our local Internet company, registered under the company's name. They sent me a letter stating that I have inherited the debts as well. Is there any way for me to get out of it or what is the best solution to this situation? Thank you. 

- Hansley

Dear Hansley,

I'd suggest making a quick call to a lawyer familiar with the laws on credit and debt in your state to find out what your responsibility is, instead of taking the bill collector's word for anything. Typically, a business owner is not personally liable for the debts of a corporation or LLC unless he has personally guaranteed them or co-signed for a loan. As you probably know, one common reason business owners form a separate entity to house a business is to shield them from business debts.

However, even if you are not personally responsible, that does not mean the business itself is not obligated to pay debts taken out in its name. Without knowing more about how your business is structured, the contract your friend signed, or the status of the debts, it is hard for me to find an attorney that can say who, if anyone, must pay them.

There's a larger matter at stake: trust. Your story is not the first I've heard of someone joining a business partnership, only to discover that the other partner had not been forthcoming about debt in the business.

Sometimes, a business owner won't mention debts like this to a potential partner because he or she is too disorganized to keep track of them. In other cases, the owner doesn't want to scare the partner away by mentioning flaws in the business.

The only way to prevent that from happening is to do thorough due diligence, even if the owner is a good friend. It can be awkward, which is why some would-be owners hire an attorney or accountant to do the digging into a firm's books for them and act as a buffer. That way they can mention to the existing owner that the attorney or accountant came across something they'd like to ask about, instead of playing the "bad cop" role themselves.

Even this scenario can feel awkward, so many people avoid it. As a result, some find themselves in situations like yours.

I'm assuming you didn't do much due diligence because you trusted your friend. Now you're understandably upset that you're being held responsible for a debt you didn't even know existed.

If we're talking about an amount of money your friend is capable of paying and you want to give your partner another chance, the simplest solution is to ask him to pay the debts ASAP. On a basic human level, it does not seem fair for you to get sucked into obligations that your partner did not mention before you joined the business. If you paid money to buy a stake in the company, the amount was based on what you knew about the status of the firm.

If you've concluded you don't want to keep working with your friend or the debt is shockingly large, it may be worthwhile to ask an attorney if you have some legal recourse. I would ask if it is possible you were victimized under common law fraud, meaning there was a knowing concealment of information relevant to the value of the business.

If you made a handshake deal, it may be hard to prove anything. However, you may have some recourse if you made a formal agreement to buy into the business and completed the legal paperwork to make you an owner. Have an attorney review the fine print and you'll know for sure.

See related: Will I inherit my partner's debt when I go into business with him?, Risks of getting a credit card with a business partner, Financing equipment when partners' credit profiles differ