Chapter 7 and Chapter 13 bankruptcy are just as available to self-employed people as they are to those who are traditionally employed.
However, the mere fact that a person is self-employed will cause any bankruptcy attorney to mentally kick open a box of “further questions” to ask and possible red-flag issues to explore before filing the bankruptcy case.
What are these issues—and what can a self-employed person do to prepare for a bankruptcy filing?
Self-Employment: A Definition
First, what does mean to be “self-employed?”
At least for the purposes of this article, the term is intended to sweep in individuals with sources of income other than paychecks from employers.
It is not intended to implicate someone like, say, Jeff Bezos or the CEO of any mid-sized or large corporation who is a paid employee of an employee of an organization of which he or she happens to be in charge.
Instead, what we mean by “self-employed” is someone running a one-person enterprise or freelancing or operating entirely within the gig economy.
Although these folks do not necessarily bear the weight of an Amazon.com or other large corporation, they shoulder certain challenges and responsibilities that paycheck-drawing employees do not. And they are certainly not as well paid as the Bezos’s of the world.
That all said, what are those red-flag issues resulting from the arrival of a self-employed person at an initial consultation meeting with a bankruptcy lawyer?
3 Common Self-Employment Bankruptcy Issues
A bankruptcy attorney representing a debtor considering filing for Chapter 7 or Chapter 13 bankruptcy must review the facts of that debtor’s situation as would a Chapter 7 Trustee, Chapter 13 Trustee, or a staff attorney with the US Trustee’s Office.
That is, a bankruptcy attorney must scrutinize the affairs of the prospective client with an eye toward issues that would inspire:
- A Chapter 7 Trustee to seize the person’s assets,
- A Chapter 13 Trustee to object to the confirmation of a person’s bankruptcy case;
- A US Trustee staff attorney to move to dismiss a bankruptcy case or to prosecute a person for bankruptcy fraud;
- A creditor to move for denial of discharge of any debt.
That last bullet-point regarding creditors will not be addressed in this article with any detail, but, yes, it deserves to be on that list.
The point is that a bankruptcy attorney cannot take information presented by a potential client at face-value any more than a Trustee is going to.
One of the first questions anyone walks into a bankruptcy consultation asking is, “Am I eligible for Chapter 7 bankruptcy?”
Thus, the first issue that arises with a self-employed person is with regard to the source or sources of that person’s income.
For self-employed people, the form of income earned and the means by which it is paid to the person can take many forms. From direct cash payments to check deposits to direct bank account deposits or PayPal and Venmo and other electronic deposits to even trade or services bartering, these forms can vary wildly.
All of these types of payment are income for bankruptcy services. Regardless of the form that the income payment takes, it must be documented on paper for turnover to the Chapter 7 or Chapter 13 Trustee assigned to the case.
That is not always easy to do or to ascertain for the person filing the bankruptcy. It is, however, non-negotiable.
To pass the Chapter 7 bankruptcy eligibility Means Test and support the average monthly income disclosed in the bankruptcy petition schedules, documentation evidencing that income must be provided to the Chapter 7 or Chapter 13 Trustee.
Personal vs. Business Bookkeeping Problems
Another common issue for freelance or self-employed individuals conducting business is poor or commingled bookkeeping.
When operating on one’s own, it is tempting to simply treat a business bank account as a second personal accounting, using the business debit card to buy household groceries, pet supplies, or other personal expenses.
However, this creates confusion for the Chapter 7 or Chapter 13 Trustee who will be reviewing at least 90 days’ worth of your personal bank statements and often a year or more of business bank statements.
Worse than confusion, it can create an opportunity for a Chapter 7 Trustee to avoid or unwind transfers of funds from one account to another as a fraudulent transfer.
Too much loosey-goosey accounting is one reason a bankruptcy attorney may recommend a Chapter 13 bankruptcy. In Chapter 13, assets are not liquidated, and fraudulent transfers are generally not avoided.
In any form of bankruptcy, personal expenses paid directly from business bank accounts must be calculated as income for purposes of the Means Test.
This will, at the very least, mean going through at least 6 months’ worth of your business bank statements to highlight every single line-item debit of this sort. It is a hassle for you and for your attorney.
Actual, flagrant bookkeeping monkey business will be a reason not to file bankruptcy at all.
Business Entity Valuation
The valuation of a business entity owned wholly or partially by a debtor is a complicated business.
There are different methods for calculating an entity’s value. For example, there is market-based valuation, asset-based valuation, ROI-based valuation, something known as “going concern” valuation, and many others. The case-law in bankruptcy courts around the country as to which is the “right” method to use is all over the place and is jurisdiction-specific.
The quickie, asset-based way a bankruptcy lawyer will often do it at an initial consult is sort of a dumbed-down asset-based method in which the current fair-market value of the business’ assets, bank balances, and receivables is compared to the debt owed by the business itself—which may include “debts” to the debtor that can be collected upon.
A Chapter 7 Trustee has the ability to stand in the shoes of the operating debtor, once a bankruptcy case is filed, and write corporate resolutions on behalf of the entity, collect on the business’ debts, liquidate assets, and otherwise spin the business out of existence. Or operate it for a temporary period of time until it can be sold for the benefit of the debtor’s personal creditors.
A business owned by a debtor is, in Chapter 7 or Chapter 13, just another asset that either can or can’t be exempted.
There is no exemption available for business ownership, other than the limited value afforded by the so-called wildcard exemption.
A bankruptcy attorney will need to get a good bead on this value prior to recommending any bankruptcy and, in particular, a Chapter 7 bankruptcy.
Bankruptcy for Self-Employed Individuals: The Bottom Line
The bottom line is that these are just a few of the most common issues that can arise for a self-employed person in bankruptcy.
A self-employed person or business owner or shareholder should never attempt to file, in particular, a Chapter 7 bankruptcy without consulting a highly experienced bankruptcy attorney.
Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has been assisting individuals with Chapter 7 and Chapter 13 bankruptcy matters in Michigan for over 28 years.
We will help you determine the best course of action for you in obtaining the debt relief that you too deserve.
Contact us to schedule your initial consultation.