Bankruptcy: a Tool for Business Success

Bankruptcy doesn’t just clean up after the failure of a business. Bankruptcy can also prevent that failure in the first place.

 

General Motors: 2009 vs. 2013

When General Motors filed bankruptcy in 2009, it was insolvent: it owed about $173 billion and had assets of less than half that, about $82 billion. It was not able to pay its bills when they became due.

Through bankruptcy the business shed a significant amount of its debts, reduced its U.S. plants from 47 to 34 and its U.S. employees from 91,000 to 68,500.  It sold or closed the following vehicle brands: Hummer, Pontiac, Saturn, and Saab. In return for a $50 billion loan from the U.S. government, the nation’s taxpayers became 60.8% owners of G.M.

Now, four years later G.M. is profitable again. By the end of 2013 the government is expected to sell the last of its common stock in the company. According to the Center for Automotive Research, the rescue of the U.S. auto industry—including G.M.—saved 1.14 million jobs at automakers and other companies that rely on them.

If you own and operate a small business, maybe a bankruptcy could save that business, and your job in that business.

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.

 

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Business Litigation Worth Fighting About in Bankruptcy

The closing of your business, followed by your personal bankruptcy filing, often ends threatened or ongoing business litigation against you. But here are three situations where that litigation could well continue regardless of the bankruptcy.

What is No Longer Worth Fighting About

Most debts or claims against you at the time of your bankruptcy filing are resolved for all legal purpose by the filing of your bankruptcy case. Now there is no longer any benefit for the creditor to initiate previously threatened litigation or to continue the pending litigation. If you filed a Chapter 7 bankruptcy case, most if not all of your business and personal debts which you want to discharge will in fact be discharged. The creditors will either receive nothing or will receive a pro rata portion of any of your non-exempt assets. If you filed a Chapter 13 case, your creditors will receive whatever your court-approved plan provides, often pennies on the dollar of whatever you owe. There is usually not much worth starting or continuing to fight about.

What IS Worth Fighting About

But there ARE some types of debts or claims that DO still need court resolution. In these situations the creditor or adversary would likely get permission from the bankruptcy judge to either continue the pending litigation or initiate it.

1) Determining the Amount of a Debt

If a debt or claim is being discharged in a no-asset Chapter 7 case, the amount of that debt makes no practical difference. But in an asset Chapter 7 case, in which the bankruptcy trustee is anticipating a pro rata distribution of assets to the creditors, the amounts of all the debts need to be determined in order for that distribution to be fair to all the creditors. Same thing occurs in Chapter 13 cases in which the creditors are being paid a portion of their claims but not in full, since the amount of any allowed claim affects the distribution received by all the creditors.

Usually disputes about the amount of a the claims are resolved in bankruptcy court, by the creditor or trustee objecting to a proof of claim filed by the creditor. But in relatively complex disputes, especially ones already pending in another court, , the bankruptcy court may allow the amount of the debt to be resolved in that other court.

2) Potential Insurance Coverage of the Debt

If a claim against the debtor is potentially covered by insurance, then often all the affected parties want the dispute to be resolved. Issues needing resolution include whether the debtor is liable for damages, whether those damages are covered by the insurance, and whether the policy limits are enough to cover all the damages or instead leaves the debtor personally liable for a portion. Examples include:

• vehicle accidents involving the business’ employees or owners, especially those with multiple drivers

• claims on business equipment damaged by fire or flood

• various business losses potentially covered by your business owner’s policy, such as an employee’s embezzlement, or an injury to a non-employee on the business premises

In these situations the bankruptcy court will likely give permission for the litigation to proceed outside of bankruptcy court, with appropriate conditions about not pursuing the debtor for any amount not covered by insurance.

3) Nondischargeable Debts

The biggest fights about business-related debts arise when a creditor or claimant argues that its debt or claim should not be discharged in the bankruptcy case. This challenge goes to the heart of the bankruptcy case—the debtor’s desire to get a fresh start without being burdened any longer by the debts connected to the failed business.

These discharge fights apply to both Chapter 7 and Chapter 13. In the past, Chapter 13 did not allow creditors to raise many of the kinds of challenges to the dischargeability of debts allowed under Chapter 7. But the major 2005 bankruptcy amendments for the first time opened the door in Chapter 13 to many of those same challenges. Because Chapter 13 is often a better solution for debtors who have closed a business (for example, it is often a better way to deal with certain business-related debts such as nondischargeable taxes), in the last few years there have been a significant number of dischargeability challenges by creditors in Chapter 13.

 

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A Big Benefit to Owing Lots of Business Debt: Skip the “Means Test” and Qualify for Chapter 7

If you owe more business debt than consumer debt, then you avoid not only the “means test” but also some other roadblocks to a successful post-business Chapter 7 bankruptcy case.

What’s the “Means Test” and Why it Matters?

Bankruptcy law says that if your income is more than a certain amount, you have to pass a “means test” to be able to go through a Chapter 7 case successfully. One way to avoid this “means test” is by having less income than the permitted “median family income.” But the “median family income” amounts are relatively low. If your income is at all above the applicable median amount, you have to go through the “means test,” with a significant risk of being forced into a 3-to-5-year Chapter 13 payment plan instead of three-month Chapter 7 “liquidation.”

Debtors with More Non-Consumer Debts than Consumer Debts

You can skip the “means test” altogether if your debts are NOT “primarily consumer debts.” This way you could be eligible for a Chapter 7 case even if your income is above the median level. Indeed, you avoid other kinds of “presumptions of abuse” as well, not just the formulaic “means test,” but also the broader “totality of circumstances” challenges. Congress has seemingly decided that if your debts are mostly from a failed business venture, you should be permitted an immediate Chapter 7 “fresh start,” regardless of your current income and expenses.

What is a “Consumer Debt”?

The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.”

The focus is on the purpose for which you incurred the debt in the first place. If you made a credit purchase or took out the loan exclusively, or even mostly, for your business, then it may well not a “consumer debt.” That is a factual question that must be decided separately for each one of your debts.

“Primarily Consumer Debts”?

The Bankruptcy Code does not make this crystal clear, but generally if the total amount of consumer debt is less than the total amount of non-consumer debts, your debts are not “primarily consumer debts.” And then you do not have to mess with the “means test.”

Seemingly Consumer Debts May Not Be

Small business owner often financed the start-up and ongoing operation of their businesses with what would otherwise appear to be consumer credit—credit cards, home equity lines of credit and such. Given their purpose, these may qualify as non-consumer debts in calculating whether you have “primarily consumer debts.” This is definitely something to discuss with your attorney to consider how the local judges are interpreting this issue.

Unexpectedly High Business Debts Can Help

Sometimes business owners have business debts larger than they thought they had, which could push their non-consumer debt higher than their consumer debt. For example, if you had to break a commercial lease when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Or your business closure may have left you with other hidden debts, such as obligations to business partners or unresolved litigation, with tremendous damages owed. The silver lining to these larger-than-expected business debts is that they may allow you to skip the “means test” and other grounds for dismissal or conversion to Chapter 13, allowing you to discharge all your debts through a Chapter 7 case when you could not have otherwise.

 

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Getting a Handle on Your Income and Business Taxes Through Bankruptcy While Your Business Forges Ahead

Could your small business survive and even thrive if you could just get better terms for payment of your back tax debts?

The owners of just about every struggling sole proprietorship have income and business tax problems. When you are barely scraping by, needing every dollar to pay the absolutely necessary keep-the-business-running expenses, you can find yourself unable to scrape together the money to make your estimated personal income tax payments each quarter. If you have an employee or two, it can be all too tempting to use the withheld payroll tax money for some critical business or personal expense instead of paying it over to the IRS. So even when business improves, once you fall behind with your taxes it’s terribly difficult to catch up, to be simultaneously paying both your current and past tax obligations. This especially true considering accruing late charges and interest, which can greatly increase the amount you must pay to catch up.

Add to the mix the IRS’ limited flexibility on payment terms for back taxes, plus its extraordinary collection powers against you and against your business and personal assets, and it’s no wonder that back taxes are often the most urgent problem for a business owner trying to figure out what to do.

If your business is a sole proprietorship in your name, or in your name and that of your spouse, a Chapter 13 case would very likely give you a series of advantages in dealing with your past due tax liabilities, while allowing your business to continue to operate. (If your business is instead in the form of a corporation, or if your debt amount is larger than a certain threshold, you may not qualify for Chapter 13 but instead need to consider Chapter 11 or other options, a discussion which is beyond the scope of this blog.)

A Chapter 13 bankruptcy could help your business survive by significantly reducing both your business and personal monthly debt obligations, and the tax debts themselves as well as the rest of your debts. As for the back taxes:

• some of the taxes or penalties may be written off (“discharged”) altogether;

• payments on the remaining tax debts would usually be stretched out over a much longer period than the taxing authorities would otherwise allow, thereby greatly reducing the amount you would need to pay each month; and

• ongoing interest and penalties usually stop accruing, so that the payments you make pay the tax debts off much more quickly.

So Chapter 13 almost always gives you both immediate month-to-month relief easing your business and personal cash flow, and long-term relief reducing what you must pay before you are tax debt free, and completely debt free.

 

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Dealing with Accusations of Business Fraud through Bankruptcy

When a small business fails, its owner or employer is sometimes accused of causing or hastening that failure through fraud or intentional bad behavior. If that person is already considering filing a bankruptcy to deal with the financial fallout of the closing of the business, how are those accusations going to be handled in that bankruptcy case?

A bankruptcy filed after the failure of a business tends to be more acrimonious than in a straight consumer bankruptcy because:

• The relationship between debtor and creditor is often more personal and intense—such as between business partners, between a key employee and the owner, or between the owner and investors who were friends or a relatives. So the failure is taken more personally, and the person who lost money is more likely to feel a sense of betrayal.

• The business context often provides many all-too-convenient opportunities for the debtor to bend the rules or behave underhandedly, especially “when desperate times call for desperate measures.” On the other hand, actions that the debtor took in good faith at the time may simply look inappropriate in hindsight.

• There is often more money at stake, money which these kinds of creditors can less afford to lose than a conventional commercial creditor. So it’s harder for these creditors to just write it off and walk away.

So if you have been accused by a former business partner, investor, or similar business creditor of some sort of business fraud, or fear that you will be so accused, does this mean that you should avoid filing bankruptcy? Of course you will want to discuss a serious matter like this very thoroughly with your bankruptcy attorney, perhaps in consultation with your business or litigation attorney if those accusations have already ripened into a lawsuit against you. But, interestingly, there are a set of practical reasons why those kinds of accusations often go away, or at least are reduced in seriousness, when you file a bankruptcy.

1. Automatic stay

The filing of your bankruptcy case stops, at least temporarily, any litigation against you already in process, and prevents a lawsuit from being filed or any other collection action to be taken against you. This pause in the action at least gives your adversary the opportunity to consider whether continuing to pursue you would truly be worthwhile.

2. More difficult to make a case against you

That pause is valuable because your bankruptcy filing changes the rules of the game, mostly in your favor. When you file your bankruptcy, you make it harder for your creditor to win against you. It’s no longer enough to merely establish that you owe him or her some money. Once you file bankruptcy, for the debt not to be discharged the creditor must also establish that the debt is based on one of a relatively narrow set of facts involving fraud, misrepresentation, embezzlement or theft, fraud in a fiduciary capacity, or an intentional and malicious injury to person or property.

3. Proof of your true finances

The documents you are required to file under oath in your bankruptcy case should show your angry creditor, and maybe more importantly his attorney, that even if the case against you was successful, you have no pot of gold with which to pay a judgment. Most sensible people do not like “spending good money after bad”—paying thousands of dollars to their attorney only to get a judgment that could never be collected, or only so slowly that the additional expense would simply not be worth all the risk and effort.

So, notwithstanding the tendency for small business-spawned bankruptcies to be more contentious, filing such a bankruptcy can create decisive advantages for you if you are being pursued for an alleged business fraud—you decrease your opponent’s odds of winning and increase his costs of pursuing you.

 

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Protecting Yourself When Your Business Has to Throw in the Towel

If you’re seriously considering closing down a struggling business, you are likely very concerned about personal damage control: how do you end the business without being pulled down with it?

My last blog was about saving your business through a Chapter 13 case. I can explore that option with you when you come in to see me, but let’s assume here today that either before or after talking with me you’ve made up your mind to close the business. And let’s keep it simpler by assuming that your business is or was a sole proprietorship, as I did in the last blog, and that you truly need bankruptcy relief because of the totally unmanageable size of the debts.

Lots of considerations come into play, but let’s focus on two main ones—assets and debts—in looking at three options: 1) a no-asset Chapter 7 case, 2) an asset Chapter 7 one, and 3) a Chapter 13 case.

No-Asset Chapter 7 for a Fast Fresh Start

After putting so much effort and hope into your business, once you accept the reality that you have to give up on it, you understandably may just want to clean up after it as fast as possible. And in fact a “straight bankruptcy” may be the most consistent with both your gut feelings and with your legal realities.

IF everything that you own—both from the business and personally—fits within the allowed asset exemptions, then your case will likely be relatively simple and quick. A no-asset Chapter 7 case is usually completed from start to finish in about three months. And if none of your assets are within the reach of the trustee, there is nothing to liquidate and distribute among your creditors. The liquidation and distribution process can take many additional months—or even years, so avoiding that streamlines a Chapter 7 case greatly.

But this assumes that all your debts can be handled appropriately in a Chapter 7 case—the debts that you want to discharge (write off) would be discharged and those that would not are ones that you either want to or are able and willing to pay. The debts you want to pay may include secured debts like vehicle loans and mortgages; debts you are able and willing to pay may include certain taxes, support payments, and perhaps student loans.

Asset Chapter 7 Case As a Convenient Liquidation Procedure

If you do have some assets that are not exempt, that alone may not be a reason to avoid Chapter 7. Assuming that those are assets that you can do without—and maybe even are happy to be rid of, such as if they came from your former business—letting the bankruptcy trustee mess with them instead of you doing so may be a sensible and fair way of putting the past behind you.

That may especially be true if you have some debts that you would not mind the trustee paying out of the proceeds of selling your non-exempt assets. You can’t predict with certainly how a trustee will act and how much if any would trickle down to which creditors, but this is something to keep in mind with this option.

Chapter 13 to Deal with the Leftover Consequences

Even if you’d prefer putting your closed business behind you quickly, there may be fallout from that business that a Chapter 7 would not deal with adequately. For example, if the business left you with substantial tax debts that cannot be discharged, non-exempt assets that you need to protect, or a significant mortgage arrearage, Chapter 13 could sometimes save you thousands of dollars and provide you protection from and a better way of dealing with these kinds of creditors. Deciding between Chapter 7 and 13 when different factors point in different directions is where you truly benefit from having an highly experienced bankruptcy attorney help you make that delicate judgment call.

 

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Your Sole Proprietorship Business Rescued by Chapter 13

Do you have a small business in your own name that would be successful if it only got a break from its debts? A Chapter 13 case would likely greatly reduce both your business and personal monthly debt service while you continued to run your business.

Although Chapter 13 is sometimes called the “wage earner plan,” it is not at all restricted to wage-earning employees. In the Bankruptcy Code Chapter 13 is actually titled “Adjustment of Debts of an Individual with Regular Income.” That word “Individual” makes clear that a corporation cannot file under Chapter 13. But if you are a person who owns a business that is operated in your own name, or that of you and your spouse, then you and business are treated as a single legal entity. The business’ assets are just part of your personal assets; its debts are just part of your debts. This is true regardless if your business is operated under an assumed business name, as long as you have not gone through the formalities of creating a corporation, a limited liability company, or other separate legal entity for your business.

Here’s how Chapter 13 works to help your sole proprietorship business:

1) Chapter 13 deals with your business and personal financial problems in one package. In a sole proprietorship you are individually liable for all debts of your business, along with your personal debts. So as long as you qualify for Chapter 13 otherwise, you can simultaneously resolve both business and personal debts with that one option.

2) Stop both business and personal creditors from suing you 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 bankruptcy case will stop personal creditors from hurting your business, and business creditors from taking your personal assets.

3) Keep whatever your 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 designed to allow you to keep what you need and continue operating your business.

4) Keep critical business and personal collateral. If you are behind either on business or personal loans secured by either business or personal collateral, Chapter 13 will at least temporarily stop the repossession of the collateral, and often give you an opportunity to either lower the payments or at least have some time to catch up on your late payments. In certain limited situations—such as some judgment liens and some 2nd/3rd mortgages—the liens can be gotten rid of altogether. Overall, through Chapter 13 you are provided ways to keep collateral that you would otherwise lose, and often do so under much better payment terms.

5) Solve both business and personal tax problems. Business owners in financial trouble are often in tax trouble, which Chapter 13 addresses well. The program is designed so that at the end of a successful Chapter 13 case, you will have either written off or paid off all your tax debts and will be tax free.

 

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Business Disputes that Get Dragged Into Your Bankruptcy Case

Creditors can challenge your ability to legally discharge your debts in a bankruptcy case. These challenges happen more so in bankruptcy cases filed to clean up after the close of a business. Avoid the creditor challenges for a cleaner case.

Bankruptcies filed after the close of a business seem to attract more creditor challenges to the discharge of debts for a number of reasons:

1. The amounts at issue tend to be larger, making litigation more tempting for the creditor.

2. Certain debtor-creditor relationships can become deeply personal, and so when things go badly, can turn very antagonistic. So in debts between ex-business-partners, or between a business owner and his or her financial supporter or investor, or the buyer and the seller of a business, the aggrieved creditor is more reluctant to let the debt be discharged without a fight.

3. For business owners trying to keep their businesses afloat, desperate times call for desperate measures, so they edge into risky behavior that exposes them to future challenge in bankruptcy court.

4. In these kinds of close creditor-debtor relationships, the creditor often knows something about the debtor’s risky behavior, making it more likely to be raised later in court.

On the other hand, when former business owners considering bankruptcy hear that any creditor can raise challenges to the discharge of its debt, they often feel that will inevitably happen in their case. But such challenges are in fact relatively rare, for the following legal and practical reasons:

1. The legal grounds under which challenges to discharge can be raised are relatively narrow. Instead of just proving the existence of a valid debt—as in a conventional lawsuit to collect on a debt—the creditor has to prove that the debtor engaged in behavior such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property.

2. In bankruptcy, the debtor files under oath a set of extensive documents about his or her finances, and is also subject to questioning by the creditors about those documents and about anything else relevant to the discharge of the debts. When these documents, along with any questioning, reveal that the debtor genuinely has nothing worth chasing—as is most often the case—this tends to cool the anger of most creditors. Only the most motivated of creditors will be willing to throw the proverbial good money after bad in the hopes of getting nothing more than a questionably collectible judgment.  

So in a closed-business bankruptcy case we have these two opposing tendencies—more likely to have challenges to the discharge of significant debts, 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. It is impossible to predict perfectly something that is largely outside of the control of the debtor. But a good bankruptcy attorney will give you good counsel about this, prepare your paperwork in the best possible way to counter any such challenges, and may even be able to defuse them before they are raised. A dischargeability challenge is very expensive to defend and can turn a relatively simple bankruptcy case into a very involved one. So avoiding one if possible, or positioning well for it if it is raised, are important reasons to have an experienced and conscientious bankruptcy attorney in your corner. That’s all the more true if you have reason to believe that any of your business creditors are in fact considering raising such a challenge.

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Taxes in a Closed-Business Bankruptcy Case

Dealing with taxes from a failed business through a bankruptcy—that sounds complicated. But I’m going to keep it simple here. What are your basic options if you owe taxes after closing down a small business?

You have two choices (once it’s clear that you need to file a bankruptcy because of the amount of your debts):

1. File a Chapter 7 case to discharge (legally write-off) all the debt that you can, perhaps including some of the taxes, and then deal directly with the taxing authorities about the remaining taxes.

2. File a Chapter 13 case to discharge all the debt that you can, perhaps including some of the taxes, and then pay the remaining taxes through that same Chapter 13 case.

In real life, especially after a messy situation like the shutting down of a business, many factors usually come into play in deciding whether a Chapter 7 or 13 is better for you. But focusing here only on the taxes, it comes down to this core question: Would the amount of tax that you would still owe after completing a Chapter 7 case be small enough so that you would reliably be able to make reasonable arrangements with the Internal Revenue Service (or other applicable taxing authority) to satisfy that obligation within the following two years or so?

Chapter 13 protects you from the collection powers of the taxing authorities during the usual three to five years while you are fulfilling your obligations under the case.  You should be in a Chapter 7 case only if you don’t need that protection. That means your attorney needs to be able to tell you 1) what tax debts will not be discharged in a Chapter 7 case, and 2) what payment or other arrangements will you likely be able to make to take care of those remaining taxes.  

How reliably anyone can predict how a particular taxing authority will respond about a surviving tax debt depends on the circumstances. For example, the IRS has some rather straightforward policies about how long a taxpayer has to pay off income tax obligations below a certain amount. In contrast, predicting whether or not the IRS will accept a certain “offer-in-compromise” can be much more difficult to predict.  If you cannot get rather strong assurances that you will be able to reasonably handle what the taxing authorities will require, you may well be better off within the protections of Chapter 13.

Not only does Chapter 13 give you protection from the tax authorities, you would likely be permitted to pay less to them per month towards the not-discharged taxes. That’s because your living expense budget in a Chapter 13 case will likely be more reasonable than when you’re dealing directly with the IRS after a Chapter 7 case. Furthermore, unlike the after-Chapter 7 situation, penalties would not continue to accrue, and in most cases neither would interest. As a result, in a Chapter 13 case most likely you would pay less money to finish off the tax debt.

Again, the bottom line: once you know how much tax debt will survive a Chapter 7 case, do you have a reasonable and reliable means of paying it off or settling it within about two years? If so, do the Chapter 7 case. Otherwise, take advantage of the greater protection and likely more reasonable budgeting in Chapter 13.  

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“Asset” and “No Asset” Closed-Business Chapter 7 Cases

When the sole proprietor of a just-closed business files a personal Chapter 7 bankruptcy case, the trustee may or may not have assets to liquidate and distribute to the creditors. If NOT, the case will more likely be finished faster. But if the trustee DOES collect some assets, the extra time may be worth it for the former business owner.  

If you’ve closed down your business and as a result are now personally liable on large debts that you cannot pay, you may well be wondering whether bankruptcy is your best option. Assuming that you qualify for a Chapter 7 “straight bankruptcy,” one important issue to consider is whether your case would likely be an “asset” or “no asset” one.  An “asset case” is one in which the Chapter 7 trustee collects assets from you to sell, and then distribute their proceeds to your creditors. A “no asset case” is one in which the trustee does not collect any assets from you because your assets are either protected by “exemptions” or are not worth the trustee’s efforts and expense to collect.

Generally a “no asset case” is simpler and quicker than an “asset case,” although not necessarily better. It’s simpler because it avoids the entire liquidation and distribution process. A simple “no asset case” can be completed about three months after it is filed (assuming other kinds of complication do not arise).  In contrast, it takes at least a number of additional months for a trustee to take possession of an asset, sell it in a fair and open manner with notice to all interested parties, give creditors the opportunity to file claims on the sale proceeds, object to any inappropriate claims, and then distribute the funds to the creditors.  Some assets—especially intangible ones such as a debtor’s disputed claims against a third party—can take several years for the trustee to negotiate and/or litigate in order to convert it into cash, with the bankruptcy case kept open throughout this time.

In spite of this seeming disadvantage, an “asset case” can be better for a former business owner in certain circumstances.

First, a business owner may decide to close down a business and file a bankruptcy quickly afterwards to hand over to the trustee the headaches of collecting and liquidating the remaining assets and paying the creditors in a fair and legally appropriate way. After fighting for a long time to try to save a business, the owner may well be emotionally spent and in no position to try to negotiate work-out terms with all the creditors. There is unlikely sufficient money available to pay an attorney to do this. And if there are relatively few assets compared to the amount of debts—the usual situation—it’s likely that after all that effort the former owner will still owe an impossible amount of debt.

And second, that former business owner may want his or her assets to go through the Chapter 7 liquidation process if the debts that the trustee will likely pay first are ones that the former business owner especially wants to be paid. The trustee pays creditors according to a legal list of priorities. Without going here into the details of that long priorities list, at the top of the list are child and spousal support arrearages. Also high on the list are certain employee wage, commission, and benefits claims, as well as certain tax claims. He or she may well feel a special responsibility to take care of the ex-spouse and children, former employees, and taxes. And the fact that he or she would likely continue being personally liable on these obligations after the bankruptcy is over undoubtedly adds some motivation.

A “no asset” personal Chapter 7 case can be a relatively quick and efficient way for a former sole proprietor to put the closed business legally into the past. While an “asset” case can take somewhat longer, it can help pay some of the special creditors you want to be paid anyway.

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