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Close Your Business But Protect Yourself

Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” can prevent you from harm when you decide to close down your business.


My blog post last week explained how to save your sole proprietorship business through a Chapter 13 case. But now let’s assume that you’ve instead made up your mind to close down that business. And let’s also assume that you need bankruptcy relief because of the unmanageable amount of debts you are personally liable for.

Many, many considerations come into play in deciding on your best course of action, but let’s focus here today on two main ones—assets and debts—as we consider 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 Gets You a Fast Fresh Start

Once you decide that your business is not worth keeping alive, you may just want to clean up after it as quickly as possible. For that a “straight bankruptcy” may well be the best way to go.

If everything that you own—from both your business and you individually—falls within the allowed asset exemptions, then your case will more likely be relatively simple and quick. You will have a “no asset” case—one in which you keep everything you own and nothing goes to the Chapter 7 trustee to liquidate and distribute among your creditors.

A “no asset” Chapter 7 case is usually completed from start to finish in three or four months. And if none of your assets are within the reach of the trustee, there is nothing to liquidate and then distribute among your creditors. Because the liquidation and distribution process can take many additional months, avoiding that usually shortens and simplifies a Chapter 7 case greatly.

However, this assumes that all your debts can be handled appropriately in a Chapter 7 case. Specifically, the debts that you want to discharge (write off) would in fact be discharged. And those that would not be discharged are ones that you 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—after discharging the rest of your debts—may include certain taxes, support payments, and maybe student loans.

Asset Chapter 7 Case as a Convenient Liquidation Procedure

If you do have some assets that are not exempt—not protected from the trustee—Chapter 7 may still be a good option. Assume that those unprotected assets are ones that you can do without—and maybe even are happy to be rid of, like assets from your former business that you no longer need. Letting the bankruptcy trustee collect and sell them and distribute the proceeds among the creditors instead of you going through that hassle may be a sensible, convenient, and fair way of putting your business behind you.

That may especially be true if you have some “priority” debts that the trustee would likely pay out of the proceeds of sale of your unprotected assets. For example, if you owed child or spousal support arrearage, or recent income taxes, those would likely be paid ahead of your other creditors. Your Chapter 7 trustee would be paying debts that you would have had to pay anyway, and is doing so out of the proceeds of sale of assets that you don’t need. Not a bad deal.

Chapter 13 for Flexibly Addressing Special Types of Debts

Chapter 7 does not deal well with certain important kinds of debts. However, Chapter 13 gives you a 3-to-5-year program to pay all or part of those debts while you are protected from your creditors.  

An example of an important kind of debt for owners of recently closed businesses is income taxes. Chapter 13 provides a way to potentially discharge (write-off) older taxes, pay off more recent taxes while being protected from the IRS and/or state taxing authority, and deal favorably with tax liens.

Chapter 13 can often also protect otherwise unprotected assets, for example the closed business’ assets that you now need as your tools or equipment for employment in the same field.

In the right circumstances Chapter 13 can save you thousands or even tens of thousands of dollars, while giving you protection from and a better way of dealing with important kinds of creditors. 

 

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The Benefits of Both “Asset” and “No Asset” Chapter 7 After Closing Down a Business

A Chapter 7 case will wipe out all or most of your personal liability from a closed sole proprietorship, corporation, LLC, or partnership.

 

If you have closed down a business, or are about to do so, filing a Chapter 7 “straight bankruptcy” case can be the best way of putting the debts of that business permanently behind you.

That Chapter 7 case will likely be a simpler one if you have a “no asset” case instead of an “asset” one. But an “asset case” may be worth the extra time it would likely take.

“Asset” and “No Asset” Chapter 7

Chapter 7 is sometimes called the liquidation form of bankruptcy. That usually does NOT mean that if you file a Chapter 7 case something you own will be liquidated, or sold. Most of the time you can keep everything you own. That’s if everything you own is “exempt”—included within a set of property “exemptions,” those types and amounts of property that are protected from your creditors. If everything is exempt, you would have a “no asset” case, so-called because the Chapter 7 trustee has no assets to collect.

In contrast, if you own something that is not exempt, and the trustee decides that it is worth liquidating and using the proceeds to pay a portion of your debts, then your case is an “asset case.”

The Quick “No Asset” and the Drawn Out “Asset” Case

Generally, a “no asset case” is simpler and quicker than an “asset case” because it avoids the asset liquidation and distribution-to-creditors process.

A simple “no asset” case can be completed in about three to four months after it is filed (assuming no other complications arise).  That’s in contrast to an “asset” case which always takes at least a few months more, easily a year or so, sometimes even multiple years.

Why does an “asset” case take so long? Because it can take time for a trustee to locate and 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 to get paid out of the sale proceeds, for the trustee to object to any inappropriate claims, and then to distribute the funds as the law provides.  Each of these steps can take extra time. Especially if you have unusual or intangible asset, such as a disputed claim against a third party—a claim arising from an auto accident, for example—it can take a few years for the trustee to resolve and convert such a claim into cash, keeping the bankruptcy case open throughout this time.

The Potential Benefits of an “Asset” Case

If the trustee does have some asset(s) to collect from you, that can be turned to your advantages.  Two situations come to mind.

First, you may decide to close down your business and file a bankruptcy quite quickly after that in order to hand over to the trustee the headaches of collecting and liquidating the assets and paying the creditors in a fair and legally appropriate way. If you’ve been fighting for a long time to try to save your business, you may well find it not worth your effort to negotiate work-out terms with all the creditors. And you likely have no available money to pay an attorney to do this for you.

Second, you may particularly want your assets to go through the Chapter 7 liquidation process if the debts that the trustee will likely pay first out of your assets are ones that you especially want to be paid. The trustee pays creditors according to a legal list of priorities. For example, at the top of that list are child and spousal support arrearages, with certain tax claims not far behind. You may well want to take care of claims by your ex-spouse and/or children and the tax authorities. That’s especially true if you would continue to be personally liable on these obligations after the bankruptcy is over. 

 

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Choosing the Right Solution in a Closed-Business Bankruptcy Case

Whether to file under Chapter 7 or Chapter 13 depends largely on your business assets, taxes, and other nondischargeable debts.

 

Hoping to File a Chapter 7 “Straight Bankruptcy”

Once you’ve closed down your business and are considering bankruptcy, it would be understandable if you preferred to file under Chapter 7 instead of under a Chapter 13 “adjustment of debts.”

After all you’ve been through the last few years trying to keep your business afloat, you just want a fresh, clean start, as quickly as possible. You likely feel like just putting the debts behind you. The last thing you likely want is to do is stretch things out for the next three to five years that a Chapter 13 case would usually take.

Likely Can File Under Chapter 7 Under the “Means Test”

The “means test” determines whether, with your income and expenses, you can file a Chapter 7 case. In my last blog I described how you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts.

But even if that does not apply to you, the “means test” will still not likely be a problem if you closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income. So, there is a very good chance that your income for “means test” purposes is less than the published median income amount for your family size, in your state. If your prior 6-month income is less than the median amount, by that fact alone you’ve passed the means test and qualified for Chapter 7.

Three Factors about Filing Chapter 7 vs. 13—Business Assets, Taxes, and Other Non-Discharged Debt

The following three factors seem to come up all the time when deciding between filing Chapter 7 or 13:

1. Business assets: A Chapter 7 case is either “asset” or “no asset.” In a “no asset” case, the Chapter 7 trustee decides—usually quite quickly—that all of your assets are exempt (protected by exemptions) and so cannot be taken from you to pay creditors.

If you had a recently closed business, there more likely are assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, discuss with your attorney where the money from the proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that result is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: It seems like every person who has recently closed a business and is considering bankruptcy has tax debts. Although some taxes can be discharged in a Chapter 7 case, many cannot. Especially in situations in which a lot of taxes would not be discharged, Chapter 13 is often a better way to deal with them. Which option is better depends on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses get more than the usual amount of challenges by creditors. These challenges are usually by creditors trying to avoid the discharge (legal write-off) of its debts based on allegations of fraud or misrepresentation. The business owner may be accused of acting in some fraudulent fashion against a former business partner, his or her business landlord, or some other major creditor.  These kinds of disputes can greatly complicate a bankruptcy case, regardless whether occurring under Chapter 7 or 13. But in some situations Chapter 13 could give you certain legal and tactical advantages over Chapter 7.

These three factors will be the topics of my next three blogs. After reviewing them you will have a much better idea whether your business bankruptcy case should be in a Chapter 7 or Chapter 13.

 

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