Where Is The Dividing Line Between Chapter 7 And Chapter 11 For An Independent Contractor?

A sole proprietor or independent contractor's business is structured quite differently from other businesses. The differences between personal and business expenses and debt are often blurred. So if a sole proprietorship or independent contracting business -- not an LLC or one-person corporation -- takes on too much debt and does not have enough income to pay even on a payment plan, and the owner needs to file bankruptcy, does that mean the best option is Chapter 7 or Chapter 11? It turns out that the owner can file either one, but important distinctions may drive the owner to one option instead of another.

Personal vs. Business Debt

First, the owner needs to divide up the personal and business debt. Independent contractors (for the sake of simplicity, let's use that term to refer to both the contractors and the sole proprietors) may have debt that is solely related to the business, or they could also have a lot of personal debt, like credit card debt used to sustain daily living expenses because not enough income came in. If the debt is personal, Chapter 7 is appropriate because that debt is not business debt in the traditional sense. If the debt is business-related, like a small-business loan from your bank, then Chapter 11 may be an option.

Ending vs. Restructuring

Next, the owner needs to decide if the business should end, or if it should restructure. For those filing for Chapter 7, that doesn't matter; a freelancer, for example, can continue to freelance after Chapter 7. But for someone filing for Chapter 11, the goal can make all the difference. Chapter 11 is about restructuring business debt, and if that's what the owner wants, Chapter 11 is the way to go. It's a fine distinction, but some business owners don't want the stigma of Chapter 7 bankruptcy -- they want to keep the bankruptcy as a business-only issue. While Chapter 11 can still show up on a credit report, the distinction could make some creditors, prospective landlords, and others less anxious.

Easier Process vs. Creditor Committee

Finally, Chapter 7 is an easier and often less expensive option. If someone is a freelancer who needs to dump debt to get out of a big financial hole, the clear-cutting of a Chapter 7 bankruptcy can be a relief that is over with relatively quickly. While creditors are notified, if they don't respond, the court can approve the filing if there are no other objections. Chapter 11, however, takes longer and is more expensive -- and it involves a creditors' committee that acts in the interest of the creditors and that can push back on your plans. Chapter 11 bankruptcy takes your business dealings out of your hands and places the financial side with the U.S. Trustee's Office.

One thing is for sure: No matter which bankruptcy path you take, you must speak with a bankruptcy attorney. Even a simple Chapter 7 case can flounder if you attempt it yourself and don't fill out paperwork correctly. A bankruptcy attorney can show you how to handle all of the different aspects so that your case has a much better chance of being approved. Contact a firm, like Price James S & Associates, to get started.

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