Chapter 11 Bankruptcy: Why Incorporation is Safer than Sole Proprietorship

When dealing with a business formation and the possibility of bankruptcy, the question of what type of business entity you have formed will inevitably come up.  Broadly speaking, it is safer to file for Chapter 11 bankruptcy as an incorporated business than as a sole proprietorship, and there are a number of reasons that this is the case.  So, what are the reasons why incorporation is safer than sole proprietorship bankruptcy in a Chapter 11 bankruptcy, and how can knowing these reasons help you make the right choices for your business when you are incorporating or starting up, as well as when you are faced with the prospect of bankruptcy?

Understanding Chapter 11 as a Corporation vs. Sole Proprietor

• One main reason why incorporation is safer than sole proprietorship when faced with a Chapter 11 bankruptcy is that an incorporated company is a separate legal entity than the individuals involved in the corporation.  

What this means, in short, is that the assets of a corporation are considered separately from the assets of the individuals who own the corporation, so the assets of the owners are safe from being seized to repay business debts or other outstanding liens in the case of a bankruptcy proceeding.  Assets of a sole proprietorship are intertwined with the business and so personal assets can be ordered sold to repay bankruptcy debts in these cases.

• Another reason why a corporation is safer during a bankruptcy proceeding than a sole proprietorship is because of the ability to issue stock that is granted to a corporation.  

Because stock may be issued and sold, a corporation can be owned by many different individuals, in various amounts, while a sole proprietorship is, by definition, owned by one person.  The ability to issue stock can also be of assistance during a bankruptcy because stockholders can be called upon to give additional money in exchange for more shares of the company in order to help satisfy debts, while the sole proprietor has no such lifeline available to inject funds into the operation in times of need.

Getting Legal Help

Whether you are already incorporated or operating as a sole proprietor, or whether you are considering starting a business and are weighing the options available to you before deciding, you should always consider the increased liability and asset protection offered by incorporation versus sole proprietorship, because you do not want to lose everything in the case that something happens with your business which will cause you to have to file for Chapter 11 bankruptcy. You should also speak with a lawyer to find out what is best for you and your business to protect you from bankruptcy or to help you through a bankruptcy you are undergoing.