Posted by Kevin on March 4, 2018 under Bankruptcy Blog | 
In the prior blog, we learned that a corporation or LLC (business entity) can file bankruptcy under Chapter 7. Are there any situations where the owner of the business would file bankruptcy when the business fails? The answer is yes under the following circumstances:
– the business is being operated as a sole proprietorship; or
-the owner of the business has provided personal guarantees of the obligations of the business.
If the business entity is a sole proprietorship (for example, John Smith doing business as “The Hot Dog King”), the business and the owner are the same person for legal purposes. All the assets and liabilities of the business are in the name of the owner. If that business fails, the creditors can bring a lawsuit against the owner. Moreover, if the creditor obtains a judgment, that creditor can look to any of the assets of the owner to be made whole. That includes both the business assets and personal assets of the owner. To avoid this outcome and allow for an orderly liquidation of the assets of the sole proprietorship, the owner can file bankruptcy, and obtain a discharge of debt.
If the business is a corporation or LLC, the law considers the business to be an entity separate from its owners. In many cases involving businesses, creditors (especially banks, inventory suppliers, and the like) will require the owner to guarantee business debt. If the business defaults on the obligation, the creditor, which is the beneficiary of the guarantee, may sue the guarantor/owners, obtain a judgment, and attempt to levy on any assets of the owner including assets that have nothing to do with the business. To avoid this outcome, the owner/guarantor can file bankruptcy, and obtain a discharge of debt.
Will the owner of the business, either as a sole proprietor or a guarantor of debt, be able to file a Chapter 7 or will he or she be forced into a Chapter 13 where 3-5 years of payments to creditors are required. While individuals are generally subject to the means test (which we spoke about a few blogs back) , the good news is that you do not have to pass the means test at all unless your “debts are primarily consumer debts.” So if your debts are primarily business debts—more than 50%–you avoid the means test altogether.
Let’s be clear about the difference between these two types of debts. A “consumer debt” is a “debt incurred by an individual primarily for a personal, family, or household purpose.” So, business guarantees are not consumer debts. It can be argued that cash advances on credit cards which are used by the business are not consumer debts. If you had taken out a second mortgage on your home for the clear purpose of financing your business, that second mortgage would likely be considered a business debt. It depends on the purpose for incurring the debt.
Certainly there are times when the line between a business and consumer debt is not clear. Given what may be riding on this—the ability to discharge all or most of your debts in about four month under Chapter 7 vs. paying on them for up to 5 years under Chapter 13—be sure to discuss this thoroughly with your attorney.
Posted by Kevin on March 3, 2018 under Bankruptcy Blog |
Under State law, a business entity, such as a corporation or an LLC, is considered a person and is separate from its shareholders (in the case of corporations) or members (in the case of LLC’s). If a corporation or LLC fails, it will probably have to deal with creditors who may sue the business, obtain judgments and levy on the business assets. This can be a long, drawn out procedure. As an alternative, that failed business entity may file bankruptcy. The entity will be the debtor. If the plan is to shut down the business and walk away (as opposed to a restructuring and continuation of business), then Chapter 7 can be a useful vehicle. Upon the filing, the automatic stay goes into effect as to the business entity. A trustee is appointed who literally changes the locks on the door, deals with the landlord and other creditors, assembles and liquidates the assets, and pays off the creditors.
How does a business chapter differ from a personal Chapter 7? In a personal Chapter 7, the debtor gets a discharge of many debts, and is allowed to keep a certain amount of property which is exempt. The discharge and keeping a baseline of property is part of the concept of giving the debtor a fresh start.
However, there are no exemptions for the business in Chapter 7. The trustee sells everything. I could understand that concept because if you are going out of business, you do not need assets for a fresh start. However, in Chapter 7, the business entity does not get a discharge. I always thought that was strange and looked at the legislative history behind this rule. The legislative history stated that discharges are not given to corporations (there were no LLC’s back then) so that people could not traffic in corporate shells??? My initial thought was, it only costs a few hundred dollars to set up a new corporation with no debt. So, why traffic in corporate shells? More history. It was only about 100 years ago that state legislatures passed business corporation statutes like the one’s we have today. Before that, if you wanted to incorporate, you would have to get your local State representative to sponsor a bill to establish your corporation. The legislature actually voted on it. It was an expensive and time consuming activity. Not surprisingly, there were not that many corporations. So, back in the day (as my kids would say) discharging debt within a corporation through bankruptcy could conceivably lead to a lucrative side deal if you were allowed to sell the debt free entity to a third party.
The bottom line is that business entities can file under Chapter 7. However, business Chapter 7’s tend to be more complicated because assets are involved, and the Trustee is usually more involved than in personal Chapter 7’s. If you are the owner of a failing business, it may be a good idea to consult with an experienced bankruptcy attorney.
Posted by Kevin on September 9, 2017 under Bankruptcy Blog |
You wanted to follow the American dream and set up your own business. Two years down the road, however, you realize that you are working 70 hours per week and the business is not making money. You have exhausted all your savings and the business has incurred debt out the wazoo. You just want out, and you have heard about Chapter 11 or Chapter 7. What to do?
While you can liquidate your business in a Chapter 11 (liquidating plan), this is very expensive and time consuming. Unless, the business is very large, this may not be the way to go. But what about a Chapter 7?
The first question you have to answer is who (or what) is going into Chapter 7? To a degree, it may depend on how your business was set up. If you have a sole proprietorship (DBA), then under the law of New Jersey, you are the business. So, if the business fails and you want out, you will have to file a Chapter 7. A trustee will be appointed and will administer not only your business assets and liabilities, but also your personal assets and liabilities.
If the business is a corporation or LLC, then under the law, the business is considered an entity separate and apart from you. So, now the issue is who files bankruptcy? One of the primary reasons to file bankruptcy is to get a discharge of your debts. However, the Bankruptcy Code states that a discharge in a Chapter 7 is limited to individuals. The Code defines “individuals with regular income” but not “individuals”. The Code also defines “persons” which includes people but also includes corporations and partnerships. Well, without going into too much more detail, the bottomline is that people can get discharged in a Chapter 7 but corporations and partnerships and LLC’s cannot. So, if you put your LLC into Chapter 7, it does not get a discharge.
But, the analysis does not end there. Your LLC may be have sued by numerous creditors so you have lawsuits pending. Also, these creditors have a penchant for not only suing the LLC but suing the principal and that is you. You have other creditors who have not sued yet but are hounding you on phone. You have inventory and accounts receivable. You have the bank pressuring you on that line of credit which you guaranteed.
Even though the LLC does not get a discharge in Chapter 7, it may be worthwhile to file a Chapter 7 for the business. First of all, because of the automatic stay, all pending lawsuits are put on hold, and your creditors cannot file any new actions unless they get the permission of the bankruptcy court (relief from automatic stay). Also, the trustee takes over and chases the business’s creditors, deals with the landlord and liquidates the inventory. You must cooperate, but the trustee does the heavy lifting.
If you cannot work a deal out with lenders on guarantees, or if the collection lawsuits naming you become too much of a hassle, then the owner should seriously consider an individual Chapter 7.
Bankruptcy issues involving a failing business are complicated. You should seek experienced bankruptcy counsel work work you through the process.
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 December 13, 2014 under Bankruptcy Blog |
Careful: if your business is not a sole proprietorship, legal disputes against your business are not “stayed” by your personal bankruptcy’s “automatic stay.”
This series of blogs has been about the benefits of filing a bankruptcy case when closing down your business. Through the power of the “automatic stay”— any ongoing lawsuit against you or your property must stop. But there are some important exceptions to this, situations in which the automatic stay would not apply
Bankruptcy and its automatic stay protect the “person” filing bankruptcy and his, her, or its assets. Other “persons” are generally NOT protected. The issue is whether you and your business are considered to be the same or separate “persons” for this purpose.
If your business is a sole proprietorship, the law considers you and your business to be the same “person.” So a lawsuit against the business would be stopped by your personal bankruptcy filing. But what if your business was set up as a corporation, a limited liability company (LLC), or a partnership, and you are dealing with a lawsuit against both you and the business?
Disputes Against Your Corporation, LLC, or Partnership
- If your business was set up as a corporation or LLC and it is still operating when you file a personal bankruptcy, that filing does not “stay” any litigation against the corporation because it is a separate legal entity, a separate “person.” To the extent the dispute and/or lawsuit is against you personally, that portion would be stayed. But this may not help much if the lawsuit continues to disrupt and threaten your business.
- Even if your business in the form of a corporation or LLC is no longer operating, but itself still owns some assets, those assets are not protected by your personal bankruptcy filing. This includes assets that the business might own outright—such as receivables that it was waiting to receive, or business assets that are the collateral on business loans—such as vehicles or equipment.
- If your business is or was a formal or informal partnership, the partnership’s creditors or adversaries would very likely be able to continue pursuing the partnership and its assets, as well as pursuing your partner and his or her assets, regardless of your personal bankruptcy filing. That’s because partners are generally jointly liable for the obligations of a partnership, and your partner and the partnership itself are both “persons” separate from you. So you have the same problem just outlined above as to partnership assets.
That leads to the main lesson here. If your business legally qualifies as a separate “person,” and has assets that need to be protected, it may need to file its own separate bankruptcy. Since we are focusing on closing down your business in this series of blogs, the filing would be under Chapter 7.
You should really consult with a bankruptcy lawyer on these issues.
Posted by Kevin on October 1, 2014 under Bankruptcy Blog |
There are pros and cons to the above statement. That is why we say “Can Help” as opposed to “Will Help”
What happens when a small business goes under. It usually means that not enough money is coming in to pay bills and employees (much less the owner). This can lead to collection efforts from vendors which go from holding back product to suing the business entity and perhaps even the owner for money. Multiple, disgruntled vendors lead to multiple, usually unwinnable lawsuits. Ultimately, you realize that you cannot stay open any longer.
Shutting down a business can be very time consuming and emotionally draining, especially when the vendors are suing the company and you. You have to deal with vendors and suppliers, advertisers, workers, customers, etc. You may have physical plant which will be subject to foreclosure or tenancy action. You may have product that needs to be liquidated. You may need to go after accounts receivable. That is a lot of work, and your inclination is to put everything behind you and move on.
If your business is incorporated or an LLC, it cannot receive a discharge under Chapter 7. For that reason, many of my colleagues at NACBA believe that you should not put a small corporation (sometimes called a close corporation) or an LLC in bankruptcy. However, if the corporation is being sued by multiple creditors and needs to be liquidated in an orderly fashion, a Chapter 7 may be helpful. The automatic stay will stop the lawsuits. The trustee will be responsible for the liquidation. This can free up the owner to move on to new pursuits. (In NJ, this process can be accomplished also but means of a State court Assignment for the Benefit of Creditors.)
On the other hand, if the corporation or LLC is service oriented as with few assets, bankruptcy may be an unnecessary expense.
Under either scenario, a possible issue can be what to do if the principal of the corporation or LLC finds himself as a defendant in multiple lawsuits. If the principal guaranteed the obligation, then he is SOL. Even if principal did not guarantee, a favorite tactic of NJ collection attorneys is to sue the entity and sue the principal under theory of piercing the corporate veil. This is usually a bogus lawsuit but requires that you interpose an answer and move for summary judgment. This can be a major expense especially if you get sued by 10-12 aggressive creditors and may lead to consideration of filing a individual 7. This decision, however, would have to be made on a case by case basis.
If the business entity is a sole proprietorship (d/b/a), then the debtor is really the owner. d/b/a’s can fail for the same reasons that close corporations or LLC’s fail. But, in this case, it is the owner of the business that is on the hook so the owner files the Chapter 7. Filing a Chapter 7 will stop most collection actions because of the automatic stay, and the owner/debtor can receive a discharge. Of course, the bankruptcy will include both the business assets and the personal assets. Most, if not all, of the business assets will probably be sold and the proceeds will be used to pay the trustee and the creditors. The debtor is able to utilize his or her exemptions to save many of his or her personal assets such as the house, car, household furniture and furnishings, clothing and other things.
If you are running a small business that is failing, you need to speak with your accountant first, and then an experienced bankruptcy attorney.
In the next few blogs we will discuss this issue: after closing down a business and filing bankruptcy, when would Chapter 7 be adequate vs. when the extra power of Chapter 13 would be needed, in dealing with particular debt and asset issues. We’ll start the next blog on dealing with taxes.
