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When Chapter 7s Are Not So Simple

The goal of most Chapter 7 cases is to get in and get out—file the petition, go to a simple 10-minute hearing with your attorney a month later, and two months later get your debts written off. Mission accomplished, end of story. And usually that’s how it goes. So when it doesn’t go that way, why not?

Four main kinds of problems can happen:

1. Income:  Under the “means test,” If you made or received too much money in the 6 full calendar months before your Chapter 7 case is filed, you can be disqualified from Chapter 7. As a result you can be forced instead into a 3-to-5 year Chapter 13 case, or have your case be dismissed altogether—thrown out of court. These results can sometimes be avoided by careful timing of your case filing, or by making changed to your income beforehand, or if necessary by a proactive filing under Chapter 13. Or sometimes it’s worth fighting to stay in Chapter 7 by showing that it is not an “abuse” to do so.

2. Assets:  In Chapter 7, if you have an asset which is not “exempt” (protected), the Chapter 7 trustee will be entitled to take and sell that asset, and pay the proceeds to the creditors. You might be happy to surrender a particular asset you don’t need in return for the discharge of your debts, in particular if the trustee is going use the proceeds in part to pay a debt that you want paid, such as a child support arrearage or an income tax obligation. But instead you may not want to surrender that asset, either because you think it is worth less than the trustee thinks or you believe it fits within an exemption. Or you may simply want to pay off the trustee for the privilege of keeping that asset. In all these “asset” scenarios, there are complications not present in an undisputed “no asset” case.

3. Creditor Challenges to Discharge if a Debt:  Creditors have the limited right to raise objections to the discharge of their individual debts, on grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. In most circumstances the creditor must raise such objections within about three months of the filing of your Chapter 7 case. So once that deadline passes you no longer need to worry about this, as long as that creditor got appropriate notice of your case.

4. Trustee Challenges to Discharge of Any Debts:  If you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the hearing with the trustee, or if you fail to cooperate with the trustee’s investigation of your financial circumstances, you could possibly lose the ability to discharge any of your debts. The bankruptcy system is still largely, believe it or not, an honor system—it relies on the honesty and accuracy of debtors (and, perhaps to a lesser extent, of creditors). So the system is quite harsh towards those who abuse the system by trying to hide the ball.

To repeat: most of the time, Chapter 7s are straightforward. No surprises. That’s especially true if you have been completely honest and thorough with your attorney during your meetings and through the information and documents you’ve provided. In Chapter 7 cases for my clients, my job is to have those cases run smoothly. I do that by carefully reviewing my clients’ circumstances to make sure that there is nothing troublesome, and if there is, to address it in advance in the best way possible. That way we will have a smooth case, or at least my clients will know in advance the risks involved. So, be honest and thorough with your attorney, to greatly up the odds of having a simple Chapter 7 case.

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Keeping Everything You Own Through Chapter 13 Bankruptcy

One good reason that people filing Chapter 7 don’t lose any of their stuff to the bankruptcy trustee—if they did have something to lose, they  likely file a Chapter 13 instead. How does Chapter 13 protect what you’d otherwise lose in a Chapter 7 “straight bankruptcy”?

As I said at the beginning of my last blog, protecting assets that are collateral on a loan—like your home or vehicle—is a whole different discussion than protecting what you own free and clear. Chapter 13 happens to be a tremendously powerful tool for dealing with secured creditors—especially with homes and vehicles. But that’s for later. Today I’m talking about using Chapter 13 as a way to hang onto possessions which are worth too much or have too much equity so they exceed the allowed exemption, or simply don’t fit within any available exemption.

Right off the bat you should know that if you have possessions which are not exempt, you may have some choices besides Chapter 13. You could just go ahead and file a Chapter 7 case and surrender the non-exempt asset to the trustee. This may be a sensible choice if that asset is something you don’t really need.  There are also some asset protection techniques—such as selling or encumbering those assets before filing the bankruptcy, or negotiating payment terms with the Chapter 7 trustee —which are delicate procedures well beyond what I can cover today.

But depending on your overall situation, if you have an asset or assets which you really need (or simply want to keep), you can file a Chapter 13 and keep that asset by paying for the privilege of not surrendering it.  You do that by paying to your creditors as much as they would have received if you would have surrendered that asset to a Chapter 7 trustee. But you have 3 to 5 years to do that, while you are under the protection of the bankruptcy court. Your Chapter 13 Plan is structured so that your obligation is spread out over this length of time, making it relatively easy and predictable to pay (in contrast to, for example, negotiating with a Chapter 7 trustee to pay to keep an asset).

Whether the asset(s) that you are protecting is worth the additional time and expense of a Chapter 13 case depends on the importance of that asset. Often people with assets to protect have other reasons to be in a Chapter 13 case, and the asset protection feature is just one more benefit. And believe it or not, depending on the amounts and nature of your assets and debts, you may be able to hang onto your non-exempt assets in a Chapter 13 case without paying anything more to your creditors. This tends to be more likely if you owe taxes or back support payments. One of the biggest advantages of Chapter 13 is that it can play your financial problems—like having too much assets and owing back taxes—against each other. So that you get an immediate solution—assets protected right away and the IRS off your back–and a long-term solution, too—assets protected always and IRS either written off or paid for, until you’re done and are free and clear.

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Can an Individual Chapter 7 Case Ever Save Your Business?

Chapter 13 can be a great way to keep certain small businesses afloat, but how about Chapter 7? Can’t it ever be a simpler and cheaper way to do so?

In my last blog I said that Chapter 7 is “seldom the right option if you own a business that you want to keep operating.”  The reason I gave for this is that Chapter 7 is a “liquidating bankruptcy,” so the bankruptcy trustee could make you surrender any valuable components of your business. These comments deserve more of an explanation.

At the moment a Chapter 7 bankruptcy is filed, all of the assets of the debtor (the person on whose behalf the case is filed) are automatically transferred to a new legal entity called the bankruptcy “estate.” A trustee is assigned to oversee this estate, which in most cases means that the trustee focuses on whether or not there are any estate assets worth collecting and distributing to creditors. The debtor can protect, or “exempt,” certain categories and amounts of assets, which remain the debtor’s and can’t be taken by the trustee. The idea is that people filing bankruptcy should be allowed to keep a minimum threshold of assets upon which to base their fresh financial start. In the vast majority of consumer Chapter 7 cases, the debtor can “exempt from property of the estate” all of the assets, leaving nothing for the trustee to collect.  This is called a “no-asset” estate.

If you own a business, can you file a Chapter 7 case and still continue operating the business?  That breaks down into two questions.

The first question is whether you can exempt all of the value of the business from the property of the bankruptcy estate, with the business either as a “going concern” or broken up into its asset components.

Many very small businesses are operated by and are completely reliant for their survival on the services of its one or two owners.  IF so, they cannot be sold as a “going concern”—an operating business—separate from their owners. So when faced with this kind of situation, a Chapter 7 trustee must consider whether he or she can sell any of the various assets that make up the business, or whether instead the debtor can exempt all of these business assets.

The assets of a very small business can 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 will have some value in a brand name or trademark, a below-market lease, or 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 apply to them. By way of examples, it is not unusual for a small business to own nothing more than a modest amount of business equipment, and in such cases the applicable state or federal “tool of trade” exemption may well cover all that equipment. So indeed, it is possible for a debtor who owns a business to have a no-asset Chapter 7 estate.

But that’s when we get to the second question: is the trustee willing to let the business continue operating in spite of its potential liability risks for the estate?

What’s this about “liability risks”? Remember that everything you own, including your business, immediately becomes part of the bankruptcy estate when your bankruptcy case is file. So in effect, your business becomes the trustee’s to operate. And that means that the estate becomes potentially liable for damages caused by the business. The classic example: a debtor who is a residential roofing subcontractor, drops a load of shingles on someone the day after filing a Chapter 7 case, and is then sued by the injured party. The bankruptcy estate, and arguably the trustee, may well be liable. That is why the Chapter 7 trustees’ mantra about an ongoing business is “shut it down.”

There may be exceptions. It depends on the trustee, the nature of the business, and whether the business has sufficient liability insurance. It is their judgment call, and so this is very much area where you want to be represented by an attorney who knows all of the trustees on the local Chapter 7 trustee panel and how they will respond to this issue.

 So, there’s no question that 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 the trustee will not require the closing of the business to avoid any potential business liability.

And that’s without even getting into details such as your potential loss of control of the business to the trustee, and the potential loss of business’ ongoing income to the estate.

I might well have not stated it strongly enough when I said that Chapter 7 is “seldom the right option if you own a business that you want to keep operating.”  It would take a rare set of circumstances for Chapter 7 to be the best way to go.

 

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Bankruptcy Can Save Your Business

Bankruptcy isn’t just for cleaning up after the death of a business. It can keep your business alive.

Bankruptcy saved General Motors. That business got out of a lot of it debt and restructured its operations, and ended up saving a lot of jobs. If you operate your own small business, bankruptcy may be able to save your job, too.

Let’s assume you have a very small, very simple business. One so simple that you did not form a corporation or any other kind of legal entity when you set up the business. And to keep this blog simple, assume you don’t have any partners.  You own and operate your business by yourself for yourself, in what the law calls a sole proprietorship.

There are advantages and disadvantages of operating your business this way. For better or worse you and your business are legally treated pretty much as a single unit—unlike a corporation which owns its own assets and has its own debts distinct from the owner(s). In the right circumstances, a sole proprietorship is a much easier type of business to deal with in a bankruptcy.

Chapter 7, “straight bankruptcy,” is seldom the right option if you own a business that you want to keep operating during and after the bankruptcy. Chapter 7 is also called “liquidating bankruptcy.” You can write off (“discharge”) your debts in return for liquidation—the surrender of your assets to the trustee to sell and distribute to your creditors. Except that in most Chapter 7 cases everything you own is protected–“exempt”—so that you lose nothing or very little. But if you own an ongoing business, although some of the assets of an ongoing business may be exempt, usually not all of them are.  So the Chapter 13 trustee could require you to give crucial parts of your business to him or her to liquidate.

Instead, a Chapter 13 case—ironically sometimes misnamed a “wage-earner plan”—is much better designed to enable you keep your personal and business assets. You get immediate relief from your creditors, and for a much longer period of time, 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 business’ long-term prospects. It is also an excellent way to address tax debts, often a major issue for struggling businesses. Overall, it is a relatively inexpensive tool that combines the discipline of a court-approved plan of payments to creditors with the flexibility of allowing you to continue operating your business.

In the next few blogs I’ll explain some of the most important benefits of filing a business Chapter 13 case. But in the meantime, please understand that when you own ANY kind of business, solving your financial problems will be more complicated.  Sometimes only a little more complicated, other times much more so. Because we’re not just dealing with the size and timing of a paycheck, but rather with all the financial and practical aspects of running a business. Plus, issues of timing are often important in business bankruptcy cases, requiring more pre-bankruptcy planning to chart the best path for you. So, no matter how small your business, be sure to get competent legal advice, and do so as soon as possible. You have a lot at stake.

 

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