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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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Whether or Not You Can File a Chapter 7 Case Changes on Nov. 1–Slightly

It will be just a little bit easier or a little bit harder to qualify to file a Chapter 7 “straight bankruptcy” as of November 1, 2011. Whether it’ll be easier or harder for you depends on the state where you reside and on your family size.

What changes on November 1? The bankruptcy system looks to the U.S. Census to calculate each state’s median income, as applicable to each size of family. Median income is the amount at which half of the state’s families have incomes higher and half have lower. If your income is below your state’s median income for your size of family, then in almost all situations you can file a Chapter 7 case. But if your income is above that median income amount and you still want to file a Chapter 7 case, then you have to fill out a long and rather complicated form about your allowed expenses to determine whether or not filing a Chapter 7 case would be “abusive.” So if you want to file a Chapter 7 bankruptcy, it’s a lot easier if you’re below the median.

On November 1, new median income amounts become applicable. Some people were predicting these amounts would be lower because of the faltering economy. But in many states the income figures went up instead of down. For example, among single-person families, 31 of the states’ median incomes went up and only 19 went down. Remember, if the median income goes up, that makes it a little more likely that your income will fall below that median, and you’ll have smoother sailing qualifying for Chapter 7.

So, if your income is close to the applicable median amount, and the median is increasing for your family size in your state on November 1, then you have a better chance at falling under the median if you file on or after that date. But if the applicable median is decreasing, then you have a better chance of falling under the median if you file your bankruptcy before then, by no later than October 31.

I’m about to give you the two lists of median income amounts—the one applicable through October 1, and the other starting November 1. But before you start comparing those annual income amounts to your income, please understand that the meaning of “income” in this context is quite different than conventional meanings of that word. “Income” here is calculated using a six-calendar-month look back period that is doubled and then divided by 12 for an average monthly income. It includes all sources of income from all family members other than social security, not just taxable income.

Because of this and many other sorts of complications, yon truly need to consult with a bankruptcy attorney about whether this November 1 median income changes matter to you, and whether you should try to file before then or instead after. But to get you started, here are the two median income lists: the one to use until October 31, 2011, and the other to use after that.

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