How Chapter 7 Affects Sole Proprietors

February 21, 2011

Most businesses are legal entities separate from the individual owners. Microsoft, for instance,
is not the same as Bill Gates. Corporations, LLCs and the like are recognized as operating
independent from the business’s owners. When an incorporated business files bankruptcy, the
owners are not in bankruptcy, and vice-versa.

On the other hand, when the business is a sole proprietor, the owner is the same as the business.
The business is not a legal entity that is separate from the individual. In fact, the business is not
recognized as existing apart from its owner. The business income, expenses, property, and debts
all belong to the owner. Therefore, when a sole proprietor files bankruptcy, the business is also
bankrupt.

The Chapter 7 trustee who administers your bankruptcy case is under a mandate to seize control
and cease operations of your business. The main reason for this is that the business assets are
considered personal assets and part of the bankruptcy estate. Fortunately, in most cases personal
exemptions are able to protect tools and equipment used in the sole proprietor’s business.

Accounts receivable are also part of the bankruptcy estate, so it is important to provide accurate
business records to assist your attorney before your bankruptcy is filed. The trustee will want to
see all gross income received by the business, and all business expenses. Since this gross income is included in your personal gross income, business income can sometimes push the total family income over the qualifying ceiling for Chapter 7 bankruptcy. Additionally, business debt is considered personal debt, so it is generally included in the bankruptcy discharge.

Every sole proprietor bankruptcy case is different. For instance, in a case where the debtor runs
a day care from her home, there may be little or no business inventory or assets. In bankruptcy
terms, there are no business assets for the debtor’s estate. However, where the sole proprietor
runs a restaurant, there may be significant assets for the bankruptcy estate. It is important for you
to speak candidly with your attorney and discuss your sole proprietor business thoroughly. Your
attorney can effectively advise you on the best future action including whether it is permissible
to continue business operations, whether you should form a corporation or LLC, or taking some
other action to best protect your interests. If you are dealing with a personal financial difficulty,
speak with an experienced bankruptcy attorney before making any decisions regarding your sole
proprietor business.

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