Bankruptcy Alphabet – S is Sole Proprietorship

by Jeff Curl

What happens to my sole proprietorship in bankruptcy?

Operating a sole proprietorship is a huge topic in bankruptcy that covers a lot of ground.  So let’s take a couple of smaller bites and break down what operating a sole proprietorship means in bankruptcy.  We have the pleasure of working with a lot of business owners, and sole props have their own special issues.


You Cannot “Just File for the Business”

A lot of sole prop owners in financial distress ask if they can file the business only, and not involve themselves personally.  The short answer is no.  Having a license from the city to operate as a DBA (doing business as) does not create a separate legal entity.  Corporations and LLCs are formed as separate entities under the laws of the state where they are formed.  Sole proprietorships do not obtain this legal designation.  So if you are John Smith DBA John’s Auto Shop, you will be filing yourself and business as one.


Filing a Sole Prop in Chapter 7

It is really important to understand what happens when filing Chapter 7 and you are operating a business as a sole prop.  Here are couple of major considerations:

  • When you file Chapter 7, all of your assets go into the bankruptcy estate, including the inventory and receivables of the business.  Your Chapter 7 trustee is the trustee of the estate, meaning she or he controls the assets.  Understanding the values of your assets is paramount because you are allowed to exempt and keep a certain amount, but it is not unlimited.  If you cannot protect everything, the trustee may liquidate your unprotected assets.
  • The trustee is also responsible for any liabilities that arises from the business. Therefore, there’s a risk that the trustee may demand that you cease operating your business while the trustee administers your assets. This varies by trustee to trustee and varies by the business.  For example, operating a restaurant as a sole prop has many inherent liability potentials, such as payroll taxes, suits by employees against the business owner, and injuries claimed by patrons.  Contrast this with the person working as a consultant with his or her laptop out of their home that raises less concerns from a liability perspective.  This is a factually sensitive discussion you should have with your bankruptcy attorney.


Filing a Sole Prop in Chapter 13

There are several distinction between Chapter 7 and Chapter 13 when it comes to operating a proprietorship.  Here’s a couple of important ones:

  • The sole proprietor can continue to operate the business in Chapter 13 without the threat of shutdown by the trustee as can happen in Chapter 7.  A sole proprietor can also opt to shut down the business before or during a Chapter 13 as well.
  • A Chapter 13 trustee does not liquidate assets like a Chapter 7 trustee.

In other words, Chapter 13 generally offers flexibilities and forgiveness that are not available in Chapter 7.  But sometimes one chapter is better than the other, or sometimes you only qualify for one.  Operating a business leads to a lot of complicated issues quickly in the bankruptcy world, so please consult with a bankruptcy attorney familiar with these complications.

Photo by elycefeliz