Small Business Can Be Big Trouble

The newbies in my neighborhood have had a vigorous online  debate about the risks in filing Chapter 7 bankruptcy  for a debtor with a proprietorship business.  One faction simply refused to believe that a bankruptcy trustee could or would shut down an operating business upon filing.   Believe it.

I got to ask a couple of panel trustees that question when I moderated a presentation on What Chapter 7 Trustees Wished You Knew.  To a woman, they said they were inclined to shut down an operating business where the form of the business was a proprietorship or partnership.  Their overriding concern was the possibility  for further liabilities incurred after filing while the trustee is supposed to be in charge and in control of the debtor’s assets.

As in most things, further discussion showed that the operative answer “it depends”.  A business with employees, rented space, inventory, or real assets was almost certain to be shuttered by the trustee, even if only long enough to bring a motion to abandon the business.  A one man consulting business was much less likely to present the risks that drove trustees to lock the doors.

The trustees advised that,  if you filed a case with an operating business that might trigger the trustee’s desire to close the business, counsel should contact the trustee immediately with the facts and be prepared to bring a motion to compel abandonment of the business on shortened time.  It was clear that the sooner the court could hear the motion, the more comfortable the trustee would be.

This issue is not present when the business is owned and operated by a corporation or LLC, since that entity is a distinct legal personage from the debtor.  The value of the shares in the entity is an asset of the debtor’s bankruptcy estate but the business itself belongs to the entity.  It can, in my experience, continue operating while the shareholder files Chapter 7.

Personally, my directive to clients is: incorporate the business or file Chapter 13. In 13, it is expected that the debtor remain in possession of the business.

The expense and stress of the motion to compel abandonment by a Chapter 7 trustee can be expected to be the same order of magnitude as the cost of incorporating.  The uncertainty of whether the trustee sees the valuation issues the same as the client is simply not worth the risk of business interruption.

Image courtesy of mviramontes.

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  • http://ca-bankruptcylaw.com Malcolm Ruthven

    I’ve so far had 100% success with trustees not wanting to take over clients small-business sole proprietorships. None had employees except in one case the spouse. None had a retail storefront or significant assets including inventory. So thanks for a reminder of the danger, especially when any of the “danger elements” are present.

  • Joseph Bazan

    Hi, Cathy:  I’m reading through your blog and find it very useful.  Keep up the great work!  For this entry, do you have any written materials from the “What Chapter 7 Trustees Wished You Knew” presentation?  I’d love to read them.  Thanks!

    • CathyMoran

      I would need to look.