Why a Sole Proprietor Filing Chapter 7 Bankruptcy Had Better Retain a Good Bankruptcy Lawyer

Sole Proprietorship Business in Personal Chapter 7 BankruptcyMy simple advice to self-employed business owners needing to file bankruptcy, is to consider filing Chapter 13 bankruptcy. But let’s say that there is some reason why the debtor cannot file a Chapter 13–for example, she has debts greater than the limits set for Chapter 13.

If you own and operate a small business as a sole proprietor and are thinking about filing a personal Chapter 7 bankruptcy, I cannot stress enough how important it is that you first seek the advice of an experienced bankruptcy attorney. First, you and your lawyer will need to work through the tedious and often thorny issues involved in placing a value on the small business. Your sole proprietorship is not a separate legal entity from you, so its assets are your assets, and that means you will need to diligently list and provide values for the business’s tools, equipment, fixtures, inventory, accounts receivable, intellectual property and so forth on your personal bankruptcy petition.

Unlike Chapter 13, Chapter 7 is a liquidation bankruptcy, so if the value of your business assets is greater than the exemptions available to protect those assets, then the trustee in your Chapter 7 case can seize and liquidate some or all of those assets. So it may be that you will not be able to keep your business in a Chapter 7 in any event. This is just one reason why getting thorough bankruptcy advice prior to filing is all the more critical for the self-employed sole proprietor. Suppose, however, that the current replacement value of the debtor’s business assets are minimal, and can be fully protected by the available bankruptcy exemptions. In that case there may be little or no risk that the Chapter 7 trustee will seize any of the debtor’s sole proprietorship business assets. Can you go ahead and file Chapter 7 bankruptcy with nothing else to worry about? If only it were that simple.

When a debtor who owns a sole proprietorship files a personal Chapter 7 bankruptcy, some bankruptcy trustees will force the debtor to cease all operations immediately after he files his case. If your small business is your only source of income then being forced to close up shop will obviously impose an enormous hardship as you may lose all of your day to day income for the duration of your Chapter 7 bankruptcy case. When a trustee forces a sole proprietor to stop working during her bankruptcy case, it is truly adding insult to injury. After all she is suffering from insufficient income to meet her expenses in the first place. That’s why she has filed Chapter 7 bankruptcy.

How can a Chapter 7 trustee demand that a bankruptcy debtor stop operating her sole proprietorship business? Not all Chapter 7 trustees will demand that a sole proprietor stop doing business while the case is pending. Those who do claim to have authority to demand that the debtor’s business cease operations under Bankruptcy Code section 721, which allows a trustee to seek authorization from the court to operate a debtor’s business. But where the business assets would be entirely exempt, this reasoning is specious. Certainly, the trustee does have discretion to allow continued operations of the debtor’s business, and where all business assets are exempt and the debtor has adequate insurance coverage, a Chapter 7 trustee ought to allow the debtor to continue working.

However, some trustees will argue that while the business is property of the bankruptcy estate (i.e., while the case remains open), then operating the business could hypothetically lead to some liability to the estate, if for example, the debtor’s business operation causes damage to a third party. This is why trustees generally do not demand that a debtor’s business cease operations if it is a corporation or limited liability company, because such separate entities would theoretically provide liability protection to the bankruptcy estate.

If a Chapter 7 debtor’s business assets are entirely exempt, and the bankruptcy trustee demands that the debtor stop operating his business until the bankruptcy case closes, the debtor has only one option available. He must file a motion with the bankruptcy court to compel the trustee to abandon the business assets so that the debtor may again open shop and earn a living. I’ll leave discussion of the mechanics of such a motion for a later post.

If you own a small business and are considering personal bankruptcy in the Bay Area, contact us for a free bankruptcy consultation. We have helped hundreds of people like you obtain a fresh start through bankruptcy.


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