Posted by Kevin on August 6, 2019 under Bankruptcy Blog | 
Lawsuits against You that Bankruptcy Ends
Many legal claims against you or your closed or closing business are resolved by the filing of your bankruptcy case. They are resolved either legally or practically, or both.
Claims that are legally resolved by your filing of bankruptcy are those intended to make you pay money. The discharge (the legal write-off) in bankruptcy of whatever debt you owe will usually result in you not needing to pay anything on the claim under Chapter 7 “straight bankruptcy.” There’s not much point to a lawsuit to determine whether you owe money or about how much you owe if any such debt will just get discharged in bankruptcy.
Lawsuits that Bankruptcy Does NOT End
However, there are certain types of debts that would still need to be resolved by a court. In these situations the creditor would likely get permission from the bankruptcy judge to start a lawsuit or to continue one already started. Here are three types that need court resolution.
1) Determining the Amount of a Debt
If a debt is being discharged in a no-asset Chapter 7 case—one in which all assets of the debtor are “exempt” and protected—then, as indicated above, the amount of that debt makes no practical difference. Whatever the amount of the debt, it is getting discharged without payment of anything towards that debt.
But in an asset Chapter 7 case, in which the bankruptcy trustee is anticipating a pro rata distribution of the proceeds of the sale of assets, the amounts legally owed on all the debts need to be known for that distribution to be fair to all the creditors. That’s because the established amount of any single debt affects the amounts received by all the creditors. So litigation to determine the validity or amount of a debt needs to be completed, even if by a relatively quick settlement.
2) Possible Insurance Coverage of the Debt
If a claim against a debtor may be covered by insurance, then the affected parties likely want the dispute to be resolved legally.
That’s because a court needs to determine 1) whether the debtor is liable for damages, 2) whether those damages are covered by the insurance, and 3) whether the policy dollar limits are enough to cover all the damages or instead leave the debtor personally liable for a portion. The following types of business litigation tend to involve insurance coverage issues:
- vehicle accidents involving the business’ employees or owners, especially those with the complication of multiple drivers (and thus, multiple possible insurance coverages)
- claims on business equipment damaged by fire or flood, or stolen
In these situations the bankruptcy court will likely give permission for the litigation to continue outside of bankruptcy court, while not allowing the creditor to pursue the debtor as to any amount not covered by the insurance policy limits.
3) Nondischargeable Debts
Some of the biggest fights about business-related debts occur when a creditor argues that its debt should not be discharged in the bankruptcy case. The grounds for objecting to discharge are quite narrow—in general the debtor must have defrauded the creditor, embezzled or stolen from the creditor, or intentionally and maliciously hurt the creditor or its property.
Also, and much more prevalent in the last few years, are student loan debts. Since the average student loan debt for an undergraduate is zeroing in on $40,000, litigation over whether the student loan debt is dischargeable, is become much more commonplace.
Posted by Kevin on February 17, 2019 under Bankruptcy Blog |
“Adjustment of Debts of an Individual with Regular Income”
That is the formal name given to Chapter 13 of Title 11—the U. S. Bankruptcy Code.
As the word “Individual” indicates, you must be a person to file a Chapter 13 case—a corporation cannot file one. This also applies to a limited liability company (LLC) and other similar types of legal business entities.
But if you have a business which you operate as a sole proprietorship, you and your business can file a Chapter 13 case together.
The assets of your sole proprietor business are simply considered your personal assets. The debts of your business are simply your debts.
This is true even if your business is operated under an assumed business name or d/b/a.
Chapter 13 Helps Your Sole Proprietorship Business in 6 Major Ways
1) Chapter 13 addresses both your business and personal financial problems in one legal and practical package. You are personally liable on all debts of your sole proprietorship business, as well as, of course, your individual debts. So as long as you qualify for Chapter 13 otherwise, you can simultaneously resolve both your business and personal debts.
2) Chapter 13 stops both business and personal creditors from suing you, placing liens on your assets, and shutting down your business. The “automatic stay” imposed by the filing of your Chapter 13 case stops ALL your creditors from pursuing you, including both business and personal ones. Your personal creditors are prevented from hurting your business, and your business creditors are prevented from taking your personal assets.
3) Chapter 13 enables you to keep whatever business assets you need to keep operating. If you do not file a bankruptcy, and one of either your business or personal creditors gets a judgment against you, it could try to seize your business assets. Also, if you filed a Chapter 7 “straight bankruptcy,” under most circumstances you could not continue operating your business. However, Chapter 13 is specifically designed to allow you to keep what you need and continue operating your business.
4) Chapter 13 gives you the power to retain business and personal collateral which secure a business debt even if you are behind on payments. Chapter 13 will allow you to pay those arrearages over the term of the Chapter 13 plan which could be between 36-60 months usually with no interest.
5) If you have second or third mortgages of your personal residence which are completely underwater (e.g. residence worth $200,000 subject to a $225,000 first mortgage and a $60,000 home equity loan), Chapter 13 allows you to strip off the second mortgage and treat it like an unsecured date. That means that the $60,000 second gets paid for pennies on the dollar from your monthly payments to the Chapter 13 trustee. And if you successfully complete the Plan, the second mortgage must be cancelled of record.
6. Business owners in financial trouble are generally also in tax trouble. Chapter 13 gives business owners time to pay tax debts that cannot be discharged (permanently written off), all the while keeping the IRS and other tax agencies at bay. Chapter 13 usually stops the accruing of additional penalties and interest, enabling the tax to be paid off much more quickly. Tax liens can be handled especially well. At the end of a successful Chapter 13 case you will have either discharged or paid off all your tax debts, and will be tax-free.
Posted by Kevin on September 7, 2018 under Bankruptcy Blog |
A creditor can challenge the discharge of its debt in bankruptcy.
Why Creditor Challenges Are More Common in Closed-Business Bankruptcies
For the following reasons, creditors tend to object more to the discharge of their debts in bankruptcy cases that are filed after the debtor has operated and closed a business:
- The amount of debt owed in business bankruptcies tends to be larger than in a consumer case, making objection more tempting to the creditor.
- In the business context some debtor-creditor relationships can be very personal. Consider debts between former business-partners who are blaming each other for the failure of the business, or between a business owner and the business’ primary investor who believes the owner drove the business into the ground, or between the contract buyer of a business and its seller in which the buyer feels that the seller misrepresented the profitability of the business. In these situations the aggrieved creditor is more personally motivated to fight the discharge of its debt.
- The owners of businesses in trouble find themselves desperate to keep their businesses afloat. So they may make questionable decisions which then expose them to objections to discharge.
- In the kinds of close creditor-debtor relationships mentioned above, the creditor often has hints about the business owner’s questionable behavior, and so is more likely to believe it has the legally necessary grounds to object.
But Objections to Discharge Are Still Not Very Common
When former business owners hear that any creditor can raise objections to the discharge of its debt, they figure an objection would very likely be raised in their case. But in reality these objections occur much less frequently than might be expected, for the following reasons:
- The legal grounds under which challenges to discharge must be raised are quite narrow. To be successful a creditor has to prove that the debtor engaged in rather egregious behavior, such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property. These are not easy to prove.
- In his or her bankruptcy case the debtor files, under oath, papers containing quite extensive information about his or her finances. The debtor is also subject to questioning by the creditors about that information and about anything else relevant to the discharge of his or her debts. If the information on the sworn documents or gleaned from any questioning reveals that the debtor truly has no assets worth pursuing, a rational creditor will often decide not to throw “good money after bad” by raising an objection.
Conclusion
In a closed-business bankruptcy case there are these two opposing tendencies. Challenges to discharge are more likely, especially by certain kinds of closely related creditors. But these challenges are still relatively rare because of the narrow legal grounds for them and the financial practicalities involved. A good bankruptcy attorney will advise you about this, will prepare your bankruptcy paperwork to discourage such challenges, and will help derail any such challenges if any are raised.
Posted by Kevin on June 7, 2018 under Bankruptcy Blog |
Eligibility depends on 1) the kind of debtor, 2) the kinds and amounts of debts, 3) the amount of income and 4) of expenses.
1) The Kind of Debtor
If you are a human person, you may be eligible for either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” case. You and your spouse may also be eligible to file one or the other of these together in a joint case.
However, if you are the owner or part-owner of a business partnership, corporation, limited liability company or other similar business entity, that business entity could not file its own Chapter 13 case. But it could file under Chapter 7.
2) The Kinds and Amounts of Debts
If your debts are “primarily consumer debts” (more than 50% by dollar amount), then to be able to file a successful Chapter 7 case you have to pass the “means test.” That’s a test related to your income and expenses (discussed more below.) If 50% or more of your debts are not consumer debts, than you can skip the “means test.”
Chapter 7 does not limit the amount of debt you can have to be eligible to file a case. However, you cannot file a Chapter 13 case if your debts exceed the maximums of $394,725 in unsecured debts and $1,184,200 in secured debts (or if you do file a case it will very likely be “dismissed” (thrown out)).
3) Amount of Income
You can quickly and easily satisfy the “means test” and be eligible for a Chapter 7 case if your income is no more than the regularly adjusted and published “median income” for your family size and state.
To be eligible for Chapter 13 you must have “regular income.” That is defined not very helpfully as income “sufficiently stable and regular” to enable you to “make payments under a [Chapter 13] plan.”
Also for Chapter 13, if your income is less than the “median income” for your family size and state of residence, then the plan generally must last a minimum of three years (but in many situations it can last longer, especially if you need it to, but for no longer than five years). If your income is at or above the applicable “median income” amount, the plan must almost always last five years.
4) The Amount of Expenses
In Chapter 7, if your income is NOT less than “median income” for your family size and state of residence, then you may still pass the “means test” and be eligible for filing a Chapter 7 case IF, after accounting for all your allowed expenses, you don’t have enough money left over to pay a meaningful amount to your creditors.
In Chapter 13, a similar accounting of your allowed expenses determines the amount of your “disposable income,” the amount you must pay into your plan each month.
Summary
Once you recognize that you need relief from your creditors, choosing between Chapter 7 and 13 is often not difficult. But because there are many, many differences between them, the choice can sometimes turn into a delicate balancing act between the advantages and disadvantages of those two options. That’s why when you have your initial meeting with your bankruptcy attorney, it’s smart to be aware of and communicate your goals, but also be open-minded about how best to accomplish them.
Posted by Kevin on May 1, 2018 under Bankruptcy Blog |
The Regular “Automatic Stay”
The automatic stay—your protection against just about all collection efforts by your creditors—kicks in just as soon as your bankruptcy case is filed. It applies to all bankruptcy cases, including those filed under Chapter 7 and Chapter 13. It is one of the most powerful and important benefits of filing a bankruptcy case.
But it protects only you—the person filing bankruptcy—and your assets. It does not protect anybody else who may also be legally liable on one of your debts.
The Very Special “Co-Debtor Stay”
Chapter 13 adds another layer of automatic stay protection—applicable to your “co-debtors, or co-signers.
Section 1301 states that once a Chapter 13 case is filed, “a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any other individual that is liable on such debt with the debtor.”
A creditor on a consumer debt is already prevented by the regular automatic stay from doing anything to collect a debt directly from the debtor. Now, under Chapter 13 only, and only on consumer debts, that creditor is also prevented from collecting on the same debt from anybody else who has co-signed or is otherwise also obligated to pay that debt. The co-signer may not even know that you are protecting them from the creditor.
Conditions and Limits of the Co-Debtor Stay
Besides being limited to consumer (not business) debts, the “co-debtor” protection:
1. Does not protect spouses from joint liability on income taxes. That’s because income tax debts are not considered “consumer debts” for this purpose.
2. This protection does not extend to those who “became liable on… such debt in the ordinary course of such individual’s business.”
3. Creditors can ask for and get permission to pursue your co-debtor to the extent that:
(a) the co-debtor had received the benefit of the loan or whatever “consideration” was provided by the creditor (instead of the person filing the bankruptcy); or
(b) the Chapter 13 plan “proposes not to pay such claim.”
4. Even if a creditor does not seek or get the above permission, this co-debtor stay expires as soon as the Chapter 13 case is completed, or if it’s dismissed (for failure to make the plan payments, for example), or converted into a Chapter 7 case.
Conclusion
Choosing between Chapter 7 and 13 often involves weighing a series of considerations. If you want to protect a co-signer or someone liable on a debt with you from being pursued for that debt, seriously consider Chapter 13 because of the co-debtor stay.
Posted by Kevin on April 17, 2017 under Bankruptcy Blog |
If your business needs bankruptcy relief, you have to start with basic questions about how your business was set up and its debt amount.
Sole Proprietorship
The most straightforward business bankruptcies tend to be those in which the business is a sole proprietorship. Your business is operated through you under your name or under an assumed business name (“doing business as” or “DBA”). So, for purposes of bankruptcy, if you operate a sole proprietorship, you file bankruptcy in your name and it will include your personal assets and liabilities and the assets and liabilities of the business.
Other Forms of Business
Basically, this includes corporations, partnerships and LLC’s (limited liability companies). In these cases, the business entity is the debtor. If the owner of the business is liable under guaranties, the owner might also need to file an individual bankruptcy.
Purpose of Bankruptcy
Once you have established what type of business entity is involved, the basic question is whether you want to utilize bankruptcy as a tool to continue in business or as a tool to liquidate and shut down the business.
The General Guidance
Beyond these initial points, here are some basic rules. They will help you be a bit more prepared when you come to meet with an attorney.
1. A corporation, or LLC, or partnership cannot file a Chapter 13 “adjustment of debts.” Only an “individual” can. So, if you operate a sole proprietorship, you and the business may be eligible for a Chapter 13 filing.
2. Chapter 13s are sometimes mislabeled “wage-earner plans,” but any source of “regular income” is allowed.” The requirement is simply “income sufficiently stable and regular to… make payments under a plan under Chapter 13.” So if your business income—combined with any other income—is even somewhat stable, you would likely qualify under this “regular income” requirement.
3. But you and your sole proprietorship CAN’T file a Chapter 13 case if your total unsecured debt is $394,725 or more, or if your total secured debt is $1,184,200 or more. (Note: these limits are adjusted for inflation every three years.) While these may seem like relatively high maximums, be aware that they include BOTH personal and business debts (since you are personally liable for all the debts of a sole proprietorship). Also, the amount of unsecured debt can include that portion of your mortgages and other secured debts in excess of the value of the collateral. So a $750,000 debt secured by real estate now worth $550,000 adds $200,000 to the unsecured debt total. In addition, if you want to file a Chapter 13 as an individual and you are the owner of a corporation, you may have to consider as your unsecured debts those debts of the corporation which you personally guaranteed.
4. If your debt totals are above one of the above debt limits, you can still file a Chapter 7 “straight bankruptcy” case for the business, but that means, for all intents and purposes, the business will shut down. Chapter 7 tends to be a better option for cleaning up after a closed business, whatever its legal form.
5. A corporation or LLC does not receive a discharge in a Chapter 7.
6. If your debt totals are above one of the Chapter 13 debt limits and you are trying to save the business, one option is a Chapter 11 “business reorganization.” for the corporation, LLC, or partnership. The disadvantages of Chapter 11 are that it is a hugely more complicated than Chapter 13 which translates into substantially higher legal, filing and Trustee fees, and the financial reporting requirements are more onerous. Bankruptcy courts have tried to address these shortcomings with streamlined “small business” Chapter 11s, but they are still often prohibitively expensive.
7. If you do end up filing a personal Chapter 7 case when owing substantial business debt, you may have the advantage of being exempt from qualifying under the “means test” (a test based on your income and allowed expenses) if your business debts are more than half of your total debts.
If you are trying to save your financially struggling business, it is crucial to get competent business bankruptcy advice, and to do so just as soon as possible. You have no doubt been working extremely hard trying to keep your business alive. You will need a solid game plan for using the bankruptcy and other laws to your advantage.
Posted by Kevin on April 15, 2017 under Bankruptcy Blog |
Most small businesses do not have any reason to file bankruptcy after they fail. Instead it’s the individual owner or owners of the business who may well have to think about bankruptcy.
Business Corporation Is No Shield for Owners of Small Businesses
Why does a small business owner sets up his or her business as a corporation? One reason is a concept called limited liability. The corporation is legal entity that is separate from its owners. A corporate debt is just that- it is a debt of the entity and not its owners. In other words, the investor-owners of the business are not liable for those business debts. That’s the theory.
But in practice it doesn’t work that way, not with small businesses. Why? Because:
- Many new businesses cannot get any credit at all, and so have to be financed completely through the owner’s personal savings and credit. This credit tends to include credit cards, second mortgages on homes, vehicle loans, and personal loans from family members.
- For those businesses fortunate enough to receive financing in the name of the corporation, the creditors will very likely still require the major shareholder(s) to sign personal guarantees. This makes the shareholders personally obligated if the corporation fails to pay. Common examples of this are commercial leases of business premises, major equipment and vehicle leases or purchases, franchise agreements, and SBA loans.
As a result, when the business cannot pay its debts, the individual shareholder(s) are usually on the hook for all or most of the debts of the business. The business corporation’s limited liability is trumped by the shareholders’ contractual obligations on the debts.
Ever Worth Filing Bankruptcy for the Business Corporation?
By the time most small businesses close their doors, they have run themselves into the ground and do not have much remaining assets. And often, what little is left is mortgaged, with the assets tied up as collateral, leaving nothing for the corporation’s general creditors. This applies not just to purchases and leases of assets, but also to bank loans which require a blanket lien on all business assets, and commercial premises leases with broad landlord liens.
Without any assets with which to operate, the business dies. Without any assets for creditors to pursue in the business, the debts die with the business, except to the extent the shareholders are personally liable.
But sometimes the business does still have substantial assets when it closes its doors. Assuming the business is in the form of a corporation or partnership and so is eligible to file its own Chapter 7 bankruptcy, doing so may be worthwhile for three reasons:
- A bankruptcy would enable the owners to avoid the hassles of distributing the corporate assets by passing on that task to the bankruptcy trustee.
- There are risks for the owner of a failing business in distributing the final assets of the business, which can result in personal liability for the owner. Filing bankruptcy avoids that risk because the bankruptcy trustee takes care of that responsibility.
- In some situations, a debt owed by the business corporation is also owed by the business’ shareholder. So when that debt is paid through the trustee’s distribution of assets, that reduces or eliminates the shareholder’s obligation on it.
Most of the Time You’re Left Holding the Business’ Debts
Regardless whether your business can or can’t file bankruptcy, and whether or not it ends up doing so, you will likely have to bear the financial fallout personally. By their very nature bankruptcies arising out of closed businesses tend to be more complex than straight consumer bankruptcies. So be sure to find an attorney who is experienced in these kinds of cases.
Posted by Kevin on April 7, 2017 under Bankruptcy Blog |
Your Business as a Sole Proprietorship
Practically speaking, your business is operated as a sole proprietorship if you did not create a corporation, limited liability (LLC), partnership, or any other kind of formal legal entity when you set up that business. You own and operate your business by yourself for yourself, although the business may have a formal or informal “assumed business name” or “DBA” (“doing business as”).
There are various advantages and disadvantages of operating your business this way. For our immediate purposes what’s important is that you and your business are legally treated as a single economic entity. That’s different than if your business operated as a corporation which would legally own its own assets and owe its own debts, distinct from you and any other shareholder(s). This blog post, and the next few on this broad topic of business bankruptcies, assumes that you operate your business as a sole proprietorship.
Chapter 7
Chapter 7, “straight bankruptcy,” or “liquidating bankruptcy,” allows you to “discharge” (legally write off) your debts in return for liquidation—surrendering your assets to the bankruptcy trustee in order to be sold and the proceeds distributed to your creditors. In most Chapter 7 cases you receive a discharge of your debts even though none of your assets are surrendered and liquidated, because everything you own is protected–“exempt.”
But if you own an ongoing business—again, a sole proprietorship—which you intend to keep operating, Chapter 7 may be a risky option. You and your attorney would need to determine if all your business’ assets would be exempt under the laws applicable to your state. Certain crucial assets of your business—perhaps its accounts receivable, customer list, business name, or favorable premises lease—may not be exempt, and thus subject to being taken by the trustee. Proceed very carefully to avoid having your business effectively shut down in this way.
Chapter 13
The Chapter 13 “adjustment of debts” bankruptcy option is generally better designed than Chapter 7 for ongoing sole proprietorship businesses. It provides much better mechanisms for retaining your personal and business assets. Even business (and personal) assets that are not “exempt” can usually be protected through a Chapter 13 plan.
You and your business get immediate relief from your creditors, usually along with a significant reduction in the amount of debt to be repaid. So Chapter 13 helps both your immediate cash flow and the long-term prospects for the business. It is also an excellent way to deal with tax debts, often a major issue for struggling businesses. Overall, it allows you to continue operating your business while taking care of a streamlined set of debts.
Next…
In the next few blogs we will focus on some of the most important benefits of filing a business Chapter 13 case.
Posted by Kevin on November 29, 2014 under Bankruptcy Blog |
Ongoing litigation, or the threat of it, against you and/or your business, usually dies with your bankruptcy filing.
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A Chapter 7 case can help by:
- immediately stopping most litigation against you and/or your business, at least temporarily;
- permanently stopping most litigation by legally discharging the disputed claim; and
- providing strong disincentives for your adversary to keep pursuing you after your bankruptcy filing.
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This series of blogs is about the benefits of filing a bankruptcy case when closing down your business. The reality is that businesses are often closed as a consequence of litigation, or the threat of litigation, against the business or business owner. These disputes can take every possible form—by way of example, simple collection actions by creditors, contractual disputes with customers, enforcement action by governmental regulators, and fights with other business owners or investors. A bankruptcy often becomes necessary when either the opposing party wins a judgment against the business and/or the owner, or the business runs out of money to pay the attorney fees and other costs of litigation. The business is often already on the ropes, and the judgment, or just the financial and emotional costs of the lawsuit, or sometimes even just the threat of one is enough to persuade the business owner to throw in the towel and close down the business.
The question is: what will happen to the dispute and/or litigation against you and/or the business?
Litigation Immediately Stopped by the “Automatic Stay”
The automatic stay legally stops creditors from taking any new collection action against you, and from continuing any action, including litigation. It is imposed simultaneously with the filing of your bankruptcy, without a judge needing to sign an order. The automatic stay requires your adversary to at least take a pause in his efforts against you, and often persuades him to do nothing further against you.
Why Most Disputes Will End at Your Bankruptcy Filing
This immediate stopping of collection and litigation usually ends up being permanent, for a number of reasons.
Your adversary is usually trying to get you or the business to pay something, and that alleged obligation is discharged—legally written off permanently—in your Chapter 7 case.
Bankruptcy law does allow any of your creditors (including those with alleged claims of any kind) to try to object to the discharge of their debts or claims. But these objections are relatively rare, for two reasons:
1. They are difficult for a creditor to win. The legal grounds for objections are relatively narrow. Debts are assumed discharged unless the creditor can prove to the bankruptcy court that those narrow grounds are met. Instead of just proving the existence of a valid debt or claim, as in a conventional lawsuit, the creditor has to provide convincing evidence that you engaged in certain specific bad behavior, such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to a person or property.
2. The creditor is faced with practical indications that it is wasting its time and money to pursue you further. In filing bankruptcy, you present to the court a rather detailed set of specific information about your finances. You are able to be questioned by the creditors about those documents and about anything else relevant to the discharge of the debts. When these reveal that you genuinely have nothing worth chasing—which is almost always the case—most creditors accept that pursuing you further will do them no good.
The Exceptions: Disputes Not Be Stopped by Your Bankruptcy Filing
There are two sets of exceptions: 1) when you are not protected by the automatic stay; and 2) when a creditor challenges the discharge of its debt or claim. These will be addressed in the next two blogs.
Posted by Kevin on October 12, 2014 under Bankruptcy Blog |
Chapter 7 can legally write off some business-related taxes, and put you in a good position to take care of the rest.
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Although Chapter 13 can be the best way to handle taxes owed from running a business, not necessarily. Sometimes Chapter 7 is the better solution. Through it, you may be able to discharge some or all of your income tax debts, or maybe at least clean up your debts enough so that you can realistically take care of the remaining taxes.
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If you own, or recently owned, a business that is failing or failed, you likely have a more complicated financial situation than people with just regular consumer debts. You may have heard that the Chapter 13 “adjustment of debts” type of bankruptcy often deals better with messy situations. But you’ve also heard that this option takes three to five years, and that doesn’t appeal to you. However you might also think that the comparatively quick and straightforward Chapter 7 is not up to the task. But it just might be.
In deciding whether a Chapter 7 is right for you in this kind of situation, the main considerations are the kind of debts and the kind of assets you have. We first get into the debt issues, starting today with taxes.
Business Debts…
Chapter 7 tends to be the better solution if most or all of your debts are of the kind that will be discharged—legally written off—leaving you with little or no debt. Chapter 13 is often better if you have debts that are NOT going to be discharged—especially taxes—because it can give you major leverage over those debts. It protects you from them while giving you a sensible way to pay them. So let’s look at this in the context of tax debts.
… Personal Income and “Trust Fund” Taxes
It seems inevitable—people who been running a struggling business almost always owe back taxes. As a small business hangs in there month after month, year after year, often there just isn’t enough money for the self-employed owner to pay the quarterly estimated income taxes, and then not enough money to pay the tax when it’s time to file the annual tax return. Tax returns themselves may not be filed for a year or two or more.
And if the owner was being paid as an employee of the business, or if the business had any other employees, it may have withheld employee income tax and Social Security/Medicare from the paychecks but then did not pay those funds to the IRS and the state/local tax authority. These are the so-called “trust fund” taxes, for which the business owner is usually held liable, and which can never be discharged in bankruptcy.
If you have a significant amount of tax debt, and especially if it includes “trust fund” taxes, and/or the taxes you owe span a number of years, Chapter 13 may be better for a number of reasons. Mostly, it can protect you and your assets while you pay the IRS or other tax authority based on your actual ability to pay instead of according to whatever their rules dictate. And you often have the power to pay other higher-priority debts at the same time or even ahead of the taxes, allowing you to hang onto a vehicle or catch up on child support, and such.
But you don’t always need that kind of Chapter 13 help, so don’t take the Chapter 7 option off the table without considering it closely. Keep these two points in mind:
First, personal income taxes which are old enough and meet a number of other conditions can be discharged in Chapter 7. That could either eliminate your tax debt—if you closed your business a while ago and your taxes are all from a few years ago—or at least reduce it to a more manageable amount.
Second, regardless whether you can discharge any taxes, if you know that you will continue owing income taxes after your Chapter 7 case is completed you may be pleasantly surprised how reasonable the tax authorities can be with their repayment terms. You will need to continue paying interest, and usually also a penalty—both of which would likely be avoided through Chapter 13. But the interest rate right now—with the IRS at least—is quite low, and some penalties reach a cap and stop accruing after that. You do need to keep in mind that the taxing authorities may or may not be flexible about lowering the payments if your finances take a turn for the worse. So you should avoid entering into a tax installment payment agreement unless you have reliable income source.
Posted by on December 16, 2013 under Bankruptcy Blog |
A Chapter 13 case is often the preferred way to keep a sole proprietorship business alive. But can a regular Chapter 7 one ever do the same?
In my last blog I said that “if you own an ongoing business as a DBA… which you intend to keep operating, Chapter 7 may be a risky option.” Why? Because Chapter 7 is a “liquidating bankruptcy,” so the bankruptcy trustee could make you surrender any valuable components of your business, thereby jeopardizing the viability of the business. But this deserves further exploration.
Your Assets in a Chapter 7 Bankruptcy
When a Chapter 7 bankruptcy is filed, everything the debtor owns is considered to be part of the bankruptcy “estate.” A bankruptcy trustee oversees this estate. One of his or her primary tasks is to determine whether this estate has any assets worth collecting and distributing to creditors. Often there are no estate assets to collect and distribute because the debtor can protect, or “exempt,” certain categories and amounts of assets. The exempt assets continue to belong to the debtor and can’t be taken by the trustee for distribution to the creditors. The purpose of these “exemptions” is to let people filing bankruptcy keep a minimum amount of assets to get a “fresh start”.
Business Assets in a Chapter 7 Case
If you own a sole proprietorship, are all the assets of that business exempt and protected? In other words, is the entire value of the business covered by exemptions, whether approaching the business as a “going concern” or broken up into its distinct assets.
Many very small businesses cannot be sold as an ongoing business because they are operated by and completely reliant for their survival on the services of its one or two owners. In most such situations the business only has value when broken into its distinct assets. So the Chapter 7 trustee must consider whether the debtor has exempted all of these business assets to put them out of the trustee’s reach.
The assets of a very small business may include tools and equipment, receivables (money owed by customers for goods or services previously provided), supplies, inventory, and cash on hand or in an account. Sometimes the business may also have some value in a brand name or trademark, a below-market lease, or perhaps in some other unusual asset.
Whether a business’ assets are exempt depends on the nature and value of those assets, and on the particular exemptions that the law provides for them. For example, a very small business may truly own nothing more than a modest amount of office equipment and supplies, and/or receivables. In these situations the applicable state or federal “tool of trade” or “wildcard” exemptions may protect all the business assets. You need to work conscientiously with your attorney to make certain that all the assets are covered.
So it is possible for a business-owning debtor to have a no-asset Chapter 7 case, potentially allowing the business to pass through the case unscathed.
The Potential Liability Risks of the Business
However, there is an additional issue: will the trustee allow the business to continue to operate during the (usually) three-four months that a no-asset case is open or instead try to force the business to be shut down because of its potential liability risks for the trustee?
How could the Chapter 7 trustee be able to shut down the business? Recall that everything that a debtor owns, including his or her business, becomes part of the bankruptcy estate. As the technical owner—even if only temporarily—of the business, the trustee becomes potentially liable for damages caused by the business while the Chapter 7 case is open. For example, if a debtor who is a roofing subcontractor drops a load of shingles on someone during the Chapter 7 case, the estate, and thus the trustee, may be liable for the injuries.
The main factors that come into play are whether the business has sufficient liability insurance, and the extent to which the business is of the type prone to generating liabilities. There’s a lot of room for the trustees’ discretion in such matters, so knowing the particular trustee’s inclinations can be very important. That’s one of many reasons why a debtor needs to be represented by an experienced and conscientious attorney who knows all of the trustees on the local Chapter 7 trustee panel and how they deal with this issue.
Conclusion
In many situations it IS risky to file a Chapter 7 case when you want to continue operating a business. You need to be confident that the business assets are exempt from the bankruptcy estate, and that in your situation the trustee will not require the closing of the business to avoid any potential business liability.
