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Chapter 7 and the Sole Proprietorship

bankruptcyWhen North Carolina businesses fail, they typically file for bankruptcy protection. And while some of these struggling firms are corporations or LLCs–business entities that exist separately from their individual owners–many others are sole proprietorships. This means that the individual debtor and the business are one-in-the-same, at least as far as the State of North Carolina and the IRS are concerned.

A sole proprietor may be eligible to file for bankruptcy under Chapter 7, Chapter 11, or Chapter 13. In this article we will briefly examine the Chapter 7 option. This refers to a “liquidation” bankruptcy, where a debtor’s non-exempt assets are liquidated by a bankruptcy trustee and used to pay off any outstanding debts. At the end of the Chapter 7 process, any remaining unsecured debt is typically discharged by the bankruptcy court, meaning the creditor has no legal recourse to seek further payment.

The Chapter 7 Means Test and Business Debt

Before a debtor can file for Chapter 7 protection, he or she must first pass a means test. This is basically a formula for calculating the debtor’s disposable income–i.e., their average monthly earnings less specific monthly expenses. If the debtor has too much disposable income, they do not qualify for Chapter 7 bankruptcy and must instead file for Chapter 13 (or Chapter 11 if they are reorganizing a business).

But the critical thing to understand about the Chapter 7 means test is that its focus is consumer debt–that is, debt acquired for purposes of paying for the debtor’s personal or household goods. In contrast, if the Chapter 7 filer’s debts are primarily related to their business–i.e., debts incurred in the course of attempting to make a profit–then the means test does not apply. So for example, if an individual running a sole proprietorship files for Chapter 7 and reports $100,000 in business debts, but only $5,000 in personal consumer debt, the debtor would not have to pass the means test.

North Carolina Bankruptcy Exemptions and Business Assets

In Chapter 7 cases, the debtor is allowed to keep a certain amount of “exempt” property from the trustee and their creditors. North Carolina law specifies what property is exempt. For example, a debtor can exempt up to $2,000 worth of “tools, professional books, and implements involved in a trade.”

However, the bankruptcy exemptions may not be enough to protect the assets of a sole proprietor who relies on a significant amount of physical goods or equipment. For instance, if the sole proprietor runs a restaurant, most of those business assets will not be covered by the exemptions. This means the trustee may be required to liquidate part or all of the sole proprietor’s business in order to pay back creditors as part of the Chapter 7 process.

Get Help from a North Carolina Bankruptcy Attorney Representing Creditor Interests

If you are a creditor looking to protect your own interests when a business debtor files for Chapter 7 bankruptcy, the attorneys at Howard, Stallings, From, Atkins, Angell & Davis, P.A., can help. Our qualified North Carolina business bankruptcy lawyers represent creditors in bankruptcy proceedings throughout the state. Call us today to schedule a consultation.

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