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 April 24, 2017 under Bankruptcy Blog |
A business Chapter 13 case does not have to be complicated. Here’s how it can work.
It’s true that if you own a business that usually means you have a more complicated financial picture than someone punching a time clock or getting a regular salary. So usually if does take more time for an attorney to determine whether and how bankruptcy could help you and your business. But saving a business in the right circumstances can be relatively straightforward and extremely effective.
A good way to demonstrate this is by walking through a realistic Chapter 13 “adjustment of debts” case.
Mike’s Story
Mike, a single 32-year old, started a handyman business when he lost his job a little more than three years ago. A hard worker and self-starter, he’d been itching to run his own business. He had decent credit at the time, owing nothing except his modest mortgage that he had never been late on plus about $2,800 spread out on a number of credit cards. Mike had always lived in the same area along with most of his extended family, so he had tons of contacts, and had a great reputation as a responsible guy who could fix anything. So Mike decided to take the risk of starting his business in spite of having very little working capital. He had $8,500 of credit available on his credit cards if he got desperate.
His business started off slowly, partly because he didn’t have the cash to invest in advertising. But he was creative in setting up a website and using social media, and worked very hard building a customer base and a good business reputation. His income crept steadily upwards, but way too slowly. Over the course of the first year, Mike maxed out his credit cards to keep current on his mortgage, feed himself, and keeps the lights on. But he simply didn’t have enough money to pay any estimated quarterly income taxes to the IRS, falling behind $3,500 to them that year.
Then during the second year of his business, Mike managed to keep current on the increased payments on his credit card debts but couldn’t pay them down any. Plus he fell behind another $6,000 in income taxes. Then recently, towards the end of his third year of business, after again failing to pay any estimated quarterly income taxes and falling another $4,500 behind, the IRS required him to start making $400 monthly payments on his $14,000 debt, plus to pay his estimated quarterly payments going forward. As a result he started not being able to keep current on his credit card payments, leading to ratcheted-up interest rates, pushing him over the credit limits and into the vicious cycle of large extra fees piling up. And now he’s missed two payments on his mortgage, putting him $3,000 in arrears.
In spite of all these distractions Mike’s business now has reasonably steady income, which continues to increase, slowly but quite consistently. His accumulated debt problems ARE taking a toll on his ability to focus on growing his business. In spite of this he still very much likes his work and being his own boss, and realistically believes he can keep increasing his income, especially as the economy improves. He very much wants to keep his business going. But his creditors have him in an impossible situation.
The Chapter 13 Solution
If Mike met with an experienced business bankruptcy attorney, this is likely what the attorney would tell him that a Chapter 13 case would accomplish:
- Cancel the $400 monthly payments to the IRS, giving him 5 years to pay that debt, with no additional ongoing interest or penalties during that whole time.
- Pay the $3000 mortgage arrearages over the term of the plan.
- Stop all collection efforts by the credit card creditors and any collection agencies. They would only receive any money after Mike caught up on the house arrearages and paid off the income taxes, and then only to the extent that Mike’s budget would allow.
- Immediately protect all his business and personal assets—tools and equipment, his business truck and/or personal vehicle, receivables owed by customers for prior work, and his business and personal bank and/or credit union accounts.
- Enable Mike to concentrate on his business by greatly relieving his month-by-month financial burden, as well as save him a lot of money in the long run.
- At the end of his 3-to-5 year Chapter 13 case, Mike will be current on his mortgage, owe nothing to the IRS, and he would have paid as much as he could afford on the credit cards, with any remaining amount discharged (legally written off).
As a result the business that Mike loves and in which he has invested so much hope and effort would be thriving and providing him a decent livelihood.
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 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 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.
