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A Sample Simple Save-Your-Business Chapter 13 Case

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.

Jeremy’s Story

Jeremy, a single 32-year old, started a handyman business when he lost his job a little more than three years ago. He had ten years steady experience before that in construction and maintenance work. A hard worker and self-starter, he’d been itching to run his own business. He’d slowly accumulated the tools and equipment he needed, and had taken some courses at the local community college in small business management. 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. Jeremy 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. He had begun to accumulate some money to get him past the start-up of his business, but then his employer ran into financial problems and he was reluctantly laid off. So Jeremy 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 Jeremy 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, Jeremy 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 Jeremy’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. If he misses a payment, the IRS could levy on his business equipment or even garnish his business customers—requiring them to pay the IRS instead of him and trashing his very hard-won reputation. A couple credit cards creditors are sending their accounts to collection agencies. He not too far behind on his mortgage but still doesn’t see how he could catch up on even just two missed mortgage payments considering his other financial pressures.

The Chapter 13 Solution

If Jeremy 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. This would significantly reduce the amount that he would need to pay each month and overall.
  • Stop all collection efforts by the credit card creditors and any collection agencies. They would only receive any money after Jeremy caught up on the house arrearage and paid off the income taxes, and then only to the extent that Jeremy’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 Jeremy 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, Jeremy will be current on his mortgage, he would 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 he loves and in which he has invested so much hope and effort would be thriving and providing him a decent livelihood. 

 

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Some General Guidance about Business Bankruptcy

If your business needs bankruptcy relief, you have to start with basic questions about how your business was set up and its debt amount.

 

The Sole Proprietorship Business

The most straightforward business bankruptcies tend to be those in which the business is a sole proprietorship. Your business is operated through you, not through a separate formal business entity. In other words, you and the business are legally a single entity because you have NOT set up that business as a separate legal entity–a corporation or limited liability company (LLC), or a partnership. You operate it under your own name, or through an assumed business name but not a corporation, LLC, or partnership.

Other Forms of Business

But what if your business is not a simple sole proprietorship, but instead is in one of these separate legal entities, and you are contemplating bankruptcy relief (for either the business, you personally, or both)?

If so, if you have not already done so, you should quickly find and sit down with a competent business bankruptcy attorney.  There are advantages and disadvantages to every form of doing business. But one practical disadvantage of running your business as a corporation/LLC/partnership is that this can make things more complicated in the bankruptcy world. This CAN give you more flexibility—you can file a bankruptcy for yourself without directly filing for the business, and the other way around. But with more flexibility and more options come more complications.

The General Guidance

Beyond these initial points, here are some basic rules for background purposes. They will help you be a bit more prepared when you come to meet with me or another attorney.

1. A corporation, or LLC, or partnership cannot file a Chapter 13 “adjustment of debts.”

Only an “individual” can. This means that you and your sole proprietorship can together file a Chapter 13 case. And if your business is a corporation, LLC, or partnership, you (and your spouse) can file a personal Chapter 13 case to deal with your own liabilities, but that will almost never be adequate for dealing with the business’ own liabilities if you are trying to keep operating that business.

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 $383,175 or more, or if your total secured debt is $1, 149,525 or more. (Note: these were adjusted for inflation as of April 1, 2013 and are valid for the following 3 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 unsecured debt amounts can include less obvious ones such as the portions 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. Also some debts—especially business ones—can be much higher than you’d expected, such as damages from the terminated lease of business premises, or resulting from business litigation. This can also be pertinent if your business is not a sole proprietorship, because you are likely personally liable for most or all of your corporation’s or LLC’s debts through personal guarantees and otherwise. Either way, add up your potential debts carefully before assuming that you can file a Chapter 13 case.

4. If your debt totals are above one of the above debt limits, you can still file a Chapter 7 “straight bankruptcy” case, but that is very seldom an effective way to keep a business operating. Chapter 7 tends to be a better option for cleaning up after a closed business, whatever its legal form.

5. 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.” Also, a business corporation, LLC, or partnership can file a Chapter 11 case to keep the business afloat. The disadvantage of Chapter 11 is that it is a hugely more complicated repayment procedure than Chapter 13, and therefore many times more expensive. This, and the many times higher filing fee, plus significant ongoing court and U.S. Trustee fees, unfortunately makes Chapter 11 a practical solution in only limited small business situations. Bankruptcy courts have tried to address this shortcoming with streamlined “fast-track” Chapter 11s, but they are still often prohibitively expensive.

6. 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.

To repeat, 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 very likely now need a solid game plan for using the bankruptcy and other laws to your advantage.

 

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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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