Self-employed persons face special challenges in filing bankruptcy. When I hear that a potential debtor has a business, a slew of questions come up: is the business incorporated, a partnership, or a sole proprietorship? Does the debtor want to reorganize and continue, or just let the business fold? Is the business a service business catering to walk-in customers? What kind of insurance does the business have? What kind of debts is the debtor discharging?

One Solution – Incorporation

One debtor had a computer repair shop that wasn’t doing well, but he wanted to keep it running. He had so little income he could qualify for a chapter 7 bankruptcy; however, a chapter 7 trustee might have required that he shut the business. So, the debtor incorporated the business prior to his personal bankruptcy, and put all the business assets into the corporation. He then reported this transfer of assets on his bankruptcy schedules, and reported the corporation’s stock (rather than the individual assets, such as motherboard diagnostic stations) as his asset. Here, the Trustee was convinced that the business had no value if sold as an ongoing business, and that the business assets and liabilities transferred into the corporation canceled each other out such that there was no value. Read more about why I almost always recommend a personal chapter 7 rather than a business chapter 7 for small business owners here.

Another Solution – Shutting Down the Business

If the business does something dangerous, or caters to walk-in clientele, the trustee will probably shut it. One debtor had a business filling propane tanks for people living in the hills above Santa Barbara and Goleta. After I filed the case, the trustee called me and said: “John, this business scares the s*** out of me.” He was much relieved to hear that the debtor had stopped his activities, and would give him the keys to his warehouse at the creditors’ meeting.

A Secret Solution – Ignoring Trustee Order to Close

Another client had a consulting firm he ran from an office, advising people how to market their business. He spent most of his time meeting clients at their offices and working on their matters at his own office; no walk-in traffic. The business was a sole proprietorship (no corporation, no partners), and he used a fictitious name (for instance, “Aardvark Advertising”). The trustee told him in public that he needed to shut it down right away. I called the trustee back and asked what that would look like: does he have to stop visiting his office? His home office? May he mail out the billing statements he has ready? Does he have to swear not to turn on his computer, or make a phone call? The trustee replied that, under local guidelines, he has to tell people to shut down their businesses, but no one would be able to enforce this, so he should continue to work. And so I advised the client.
Had any of these clients filed bankruptcy on their own, they might not have been able to reach the discharge they eventually got.

Always consult a bankruptcy attorney (or even two or three) to determine how best to file bankruptcy if self-employed.

June 28, 2012

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