What Happens to a Personal Business in Chapter 7 Bankruptcy?

When an individual files for Chapter 7 bankruptcy protection, all of the debtor’s assets become part of a bankruptcy estate that is overseen by a bankruptcy trustee. The trustee is tasked, among other things, with liquidating any non-exempt asset for the benefit of creditors. But what happens when an individual has a privately owned business?

If the business is incorporated, the individual’s bankruptcy will have no immediate effect on the company. An incorporated business is considered a legal entity that is separate from the individual. The company may continue to operate despite the bankruptcy filing.

On the other hand, if the business is unincorporated, the trustee is effectively the new owner of the business. The trustee will want the business shut down immediately to safeguard assets and avoid any potential legal or financial complications. The trustee will examine the business inventory, its receipts, and determine whether the business has any value to creditors. That may mean selling equipment, fixtures, tools, contracts, or even the entire business.

In most Chapter 7 sole proprietor businesses, the individual is the asset. In a case where there are no non-exempt assets, the trustee will eventually abandon his interest in the business. At that time the debtor may resume operations. The debtor may also seek an order from the bankruptcy court to compel the trustee to abandon the business. However, this process is expensive and can be lengthy.

In rare situations the trustee may continue to operate the debtor’s business for a limited period, if in the best interest of the estate. This usually happens only when there is a sale pending and continued operations will enhance the value of the business.

A sole proprietor in bankruptcy is not required to cease business activity when the case is filed under Chapter 13. In fact, the Bankruptcy Code specifically authorizes the debtor to continue operating his business during bankruptcy.

After reading the above, I hope that the following is crystal clear to a sole proprietor contemplating Chapter 7 bankruptcy: incorporate a business before filing a Chapter 7 bankruptcy. Simply, if the business is unincorporated, the trustee will shut it down. If it is incorporated, the company can continue doing business.

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