Liability for Sole Proprietorship Business Debts

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 What Is A Sole Proprietorship?

A sole proprietorship is a specific type of business organization that is owned by one single individual. Under this type of business structure, this person is considered to be the sole owner. As such, they can be held personally responsible for any of the debts and/or liabilities that are incurred by the business.

Another way of putting it would be that the business and the owner are treated as one single entity in a sole proprietorship. It is considered to be the most simple type of business ownership.

Some common examples of sole proprietorships may include:

  • Freelance writers;
  • Consultants;
  • Direct sellers;
  • Landscapers;
  • Fitness instructors;
  • Graphic designers;
  • Bookkeepers; and
  • Local restaurant or store owners.

Additionally, a business owner does not need to comply with any specific requirements in order to form a sole proprietorship. Because of this, if sole proprietors have complete control over their work and/or participate in a business activity that fulfills this exact definition, they may already be the owner of a sole proprietorship.

There are a handful of characteristics that separate sole proprietorships from other business structures. The defining feature that separates sole proprietorships from other types of business structures would be that, as previously mentioned, they are generally operated by a single business owner. This would be the “sole” in the name of this business structure.

Additionally, the owner of a sole proprietorship generally:

  • Has total power over their entire business;
  • Owns all of its assets; and
  • Has the ability to hire and fire staff as they wish.

However, what this also means is that the owner can be held legally responsible for the wrongdoings of their employees, as well as for any debts incurred by the business. Because of this, creditors are permitted to place liens against both the owner’s business and personal assets in order to satisfy debts.

This is in contrast to business organizations, such as corporations and limited liability companies that are controlled by multiple persons, such as board members and general or limited partners. Corporations and limited liability companies generally shield their owners from being held liable for company debts.

Another distinguishing feature of sole proprietorships would be that the business may continue to operate for as long as its owner desires. However, if the owner of a sole proprietorship dies, the business will be lumped in with the owner’s estate and as such will cease to exist unless it is granted to beneficiaries who take over the business. Additionally, the owner of a sole proprietorship is free to transfer all or some of their business by selling company assets.

This differs from corporations, partnerships, and limited liability companies. With these structures, all of the business owners must participate in a vote or agree to the sale or transfer of company assets. Additionally, there are also differing rules for when a member or partner dies.

One feature that sets sole proprietorships apart from other types of business models would be how they are taxed. Any profits or debts that are associated with the business are also tied directly to its owner. As such, sole proprietors are required to pay personal income taxes on profits, and must report any losses resulting from a business.

Are There Any Laws Associated With Liability For Sole Proprietorship Business Debts?

Liability for sole proprietorship business debts is another way that this business model is different from other business forms, such as a corporation or limited liability company (“LLC”). An example of this would be how in an LLC, a person cannot sue the owner and have them pay off business debts with their own personal bank account money. This is because the business assets and personal assets are kept separate.

With a sole proprietorship, because there is no legal distinction between the owner and their business, the owner can become personally liable for the debts of their sole proprietorship. If a creditor sues the business because the business owes them money, they can access the owner’s own personal property in a lawsuit.

What this means is that a sole proprietor runs the risk of losing their own personal property because of their business debt. Alternatively, there are many legal mechanisms and insurance policies in terms of debt collection protection for sole proprietorship owners.

Debt collection protections refer to laws that prohibit deceptive, unfair, and abusive acts when engaging in debt collection activities. For consumers, the primary source of debt collection protection comes from a federal law known as the Fair Debt Collection Practices Act (“FDCPA”).

However, despite the fact that a sole proprietorship and its owner are treated as a single entity, they are not covered by this Act. This is because its provisions explicitly state that the law does not apply to business debts; rather, debt collection protections for sole proprietorships will largely be governed by contract law. They will also be covered by the fair practice guidelines that are set out by the Commercial Collection Agency Association (“CCAA”).

An alternative option to access debt collection protection for sole proprietorships would be to forgo the idea of creating a sole proprietorship entirely in exchange for registering as a corporation or limited liability company. When doing so, the business and the individual will be treated as separate entities, as opposed to a single entity that could be held responsible for all total debts.

What Are Some Examples Of Liability Involving A Sole Proprietorship?

An example of liability in a sole proprietorship would be if a person runs a small manufacturing business out of their home, as a small proprietorship operation. The owner then orders $30,000 worth of supplies from a packaging company and signs a contract to pay off the supplies over a period of 5 years. However, in the middle of production, there is a drop in demand and the small business owner must cease the business operation.

The packaging company could sue the small business owner for the remaining payments on the supplies. If the business owner is unable to fulfill the debt by using business assets, the packaging company can go after the owner’s personal property in order to fulfill the debt. This could include their personal bank monies, their automobile, or even their home.

Another common example involves personal injuries that are caused by the sole proprietorship business. A person operates a small pizza delivery restaurant as a sole proprietor, and one of their employees injures a pedestrian while delivering pizza. Their business may be held liable for the injuries; as such, the injured person can then sue and will be able to reach the business owner’s private assets, such as their car or home, in order to pay for their losses.

Do I Need An Attorney For Help With Liability For Sole Proprietorship Business Debts?

If you are considering opening a business under a sole proprietorship structure, or are experiencing issues associated with liability for sole proprietorship business debts, you should consult with an experienced and local commercial lawyer.

An attorney can help you understand your legal rights and options according to your specific state’s business laws, and will represent you in court as needed. Additionally, your commercial attorney can assist you in business planning from the beginning in order to avoid as many future issues as possible.

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