Sometimes businesses could find themselves choking on debt. Closing the firm is sometimes the only choice when the flow of cash is unable to meet all of the financial commitments, including repayment of loans, and vendor bills, among other obligations. By filing for Chapter 7 bankruptcy, failing businesses and their associated debts can be liquidated and the owners are given the chance to start over.
If you are considering bankruptcy for your business, contact the Los Angeles Business & Real Estate Law Firm today to understand your options.
An Overview of Chapter 7 Bankruptcy
Once a debtor declares bankruptcy, one of two things happens: either its assets are liquidated or its debts are reorganized. Chapter 7 of the US Bankruptcy Code oversees the liquidation process.
During the liquidation process, the debtor’s assets are liquidated little by little or as an ongoing business to repay the creditors.”
The liquidation is overseen by a trustee by collecting every available asset, turning it into cash, allocating it to lenders, and closing the business. The proceeds from the disposal of the borrower’s assets are split among those who have a claim in it. The order of claimants’ rights determines how the revenues are divided.
In contrast, no actual sales happen when a bankrupt debtor goes through restructuring under Chapter 11. Rather, the business is fictitiously “sold” to current creditors who cover it using their current interests and claims. Creditors’ interests and claims are canceled as part of this transaction, and in return, they get interests in or claims against the newly restructured business.
The most popular bankruptcy filing option in the US is Chapter 7. Individual debtors are handled differently under the Code than non-individuals, for example, corporations, business partnerships, and limited liability companies (11 United States Code Section 109).
Small Business Sole Proprietorship under Chapter 7
Chapter 7 could be quite helpful for sole proprietors who want to start over. It discharges both business and personal debt. It’s similar to receiving two Chapter 7 bankruptcies for the cost of one.
Debt Under Chapter 7
Both consumer or business debts, including balances on credit cards, medical expenses, overdue lease obligations, outstanding utility payments, personal obligations, as well as gym memberships, could be discharged under Chapter 7 for sole proprietorships. Even secured debts like auto loans, mortgages, and other installment payments could be discharged, but you will have to return the property that served as security.
However, bankruptcy does not discharge all debts. Most support and tax obligations, fines, penalties, and student loans that are payable to the authorities, and debts accumulated through fraud are examples of nondischargeable debts.
Property under Chapter 7
After filing under Chapter 7 bankruptcy, sole proprietors do not lose everything. Sole proprietors are allowed to keep their assets protected by bankruptcy exemptions, unlike other kinds of businesses. Exemptions differ by jurisdiction but often include things essential for maintaining a home and job, such as a portion of a home equity and vehicle, furniture, clothes, and retirement savings accounts. In contrast, luxury items like yachts, RVs, or shares in a company are rarely excluded.
Keeping Your Business Under Chapter 7
Whether or not the assets required for the firm to continue operating will be protected under bankruptcy exemptions will rely on the kind of business. In particular, provided the trustee does not sell off a crucial piece of the firm or the business itself, you will be eligible to continue running it.
Your Future Services Cannot Be Sold By the Trustee
If you’re the provider of a particular service, you stand a good chance of keeping that service business going. One could continue to provide their skills as an attorney, gardener, or babysitter, for example. However, sometimes trustees will demand evidence of liability coverage.
The Trustee is Permitted To Sell Products, Contact Lists, Equipment, and Goodwill
For you to be eligible to retain these items, you ought to exempt them from being liquidated through the bankruptcy process. Most states allow filers to retain certain property needed to run a business utilizing the exemption for tools of the trade. If it’s insufficient, a wildcard exception could cover another sum. Wildcard exemptions are not available in all states, and they can cover a variety of different values and amounts of property.
Making the Decision to File
You might be concerned about losing assets under Chapter 7 bankruptcy, and it is possible because the trustee often sells assets in cases of small business. However, that isn’t the main issue at hand. You should ascertain whether there would be a general financial gain for you. For example, filing could be a good idea if the entire value of dissolved debt could somewhat outweigh the cost of the assets that you’d lose. However, you would have more luck settling your financial obligations with lenders personally if you paid off what you owed in Chapter 7.
As an illustration, let’s say you want to discharge your debt of $300,000 and possess assets such as
- Home equity of $400,000
- A vehicle you own worth $30,000
- A $250,000 vacation home in Mexico
- A one-third ownership stake in a limited liability company that now oversees property worth $600,000
- Three exotic pets worth $80,000
If you have over one million dollars in personal property, declaring bankruptcy is not a good idea since, in almost all jurisdictions, the trustee will list most of your possessions at fire prices to pay off your $300,000. Additionally, trustees are compensated for selling assets, so you would lose a significant amount to the trustees.
Debt Negotiation Outside of Bankruptcy
When you have a significant amount of valuable property and you have reached the conclusion that declaring Chapter 7 bankruptcy will not work in your favor, you should prepare yourself for the possibility that your creditors may attempt to collect from you shortly. It can be a wise idea to take the initiative and start settling your debts for a lesser amount than what you are due. If you’re successful, you will probably have to dispose of some assets to pay off the negotiated obligation. However, you can also make savings there. This way, you can sell the property without having to pay the trustee’s fee, and you could even be able to achieve a better price compared to what the trustee will.
Although bankruptcy or debt settlement attorneys can negotiate for you with creditors, as a company owner you’re probably a skilled negotiator. However, you might wish to refresh your memory on a few of the more recent tactics since debt-collecting techniques have changed with time.
Getting Approved For Chapter 7
The discharge of debts under Chapter 7 is not available to everyone. If a business has been involved in a bankruptcy case, there is an exception to the requirement that its revenues be sufficiently low to satisfy the Chapter 7 bankruptcy means test. You won’t need to do the means test and you’ll be immediately eligible for Chapter 7 if your company’s debt is more than the consumer debt (debts for household goods instead of costs made to make a commercial profit).
If you’re debating whether or not to give up your company in place of a high-paying position working for another person, this perk may sway your decision. It’s the sole “loophole” that allows someone filing with a high income to swiftly pay off debt without filing under Chapter 11 or 13. Consult a business bankruptcy attorney as soon as possible since it could become complicated.
Procedures for Filing Under Chapter 7
Business owners must prepare additional paperwork before declaring bankruptcy under Chapter 7 since the trustee is going to require personal and company financial records. Once you submit the bankruptcy application and an official document proving you passed a course for credit counseling, the bankruptcy proceeding will officially begin.
Next, you will present the bankruptcy trustee with documentation to support the figures presented in the motion. (known as “521 documents.”) The plan to offer includes:
- Your latest tax return
- Retirement and banking statements for both individuals and businesses
- Evidence of self-employment earnings, such as paycheck stubs
- Statements showing the profit and loss accounts
- Any additional records the bankruptcy trustee deems relevant to your financial status.
You will also be required to show up for the 341a Meeting of Creditors. The bankruptcy trustee will verify your identity, inquire about your petition’s requirements and relevant information, and will provide any lenders who appear the opportunity to raise questions. If the bankruptcy trustee finds no issues, the hearing would be concluded. If not, the bankruptcy trustee would postpone the meeting until a later date.
After satisfying your final obligation—taking a debtor educational program and submitting the certificate with the bankruptcy court—you will be granted a debt clearance. Read on and learn about the procedures involved in Chapter 7.
Duration of a Chapter 7 Case
This bankruptcy is considered more expedient than other types of bankruptcy since the borrower does not have to come up with a repayment plan to pay back creditors. Most debtors often get their debts discharged after 3 to 4 months.
A Chapter 7 case normally ends shortly after a bankruptcy court grants the discharge, but this is often not the case. If a bankruptcy trustee calls for additional time to put up real estate for sale or the case features active bankruptcy court proceedings, the asset case would continue to be active for a maximum period of one year after the court grants the discharge. An asset case involves a bankruptcy case in which the proceeds are available to pay lenders.
Chapter 7 Bankruptcy and Small Business Partnerships
Business partnerships don’t often file under Chapter 7. It’s rarely used for a variety of reasons, including:
- The business partners are still responsible for paying back their company’s debt because the bankruptcy does not dismiss it
- The trustee has the authority to go after the business partners directly by seizing their assets, including home equity and bank accounts.
It’s often not an option to file for personal bankruptcy while a partnership is still in operation because many agreements on partnerships have provisions that call for the dissolution of the business partnership if one of the partners declares bankruptcy.
Individual Chapter 7 Bankruptcy
Once a partnership dissolves, an individual Chapter 7 could offer the relief that is needed. Not only does it prevent financial liability arising from the firm and former partners (assuming the liability is not linked to fraud), but it could also enable a business partner to escape an individual guarantee issued on behalf of the business. If a partnership were to dissolve, the evaluation would continue similarly.
Small Corporate Businesses and Chapter 7 Bankruptcy
Declaring Chapter 7 bankruptcy can serve as an ideal option for corporations to close down operations since a bankruptcy trustee has the responsibility to liquidate corporate assets like real estate, inventory, and accounts receivable. After selling the property, the trustee forwards the proceeds to the lenders. Transparency gives most creditors the reassurance that they will be served fairly, which in itself is a positive thing.
Opening a Channel to Potential Cases
The drawback of declaring bankruptcy is that it allows creditors to issue complaints. Misappropriating corporate funds for personal expenses is an example of a cause of action also known as an “alter ego,” which is a common shareholder complaint. The plaintiff in an alter ego case tries to “pierce the corporate veil” that exempts shareholders from being held responsible for company debt. Declaring bankruptcy allows a frustrated creditor to express their displeasure and seek other options for debt repayment.
It involves a lot of work to get a case started, but once it’s in the judicial system—as it usually is after a bankruptcy filing—a creditor can file an alter ego lawsuit with little additional work required.
However, it’s unusual for the benefits of this bankruptcy to surpass the potential risks.
For instance, a shareholder who cosigned a debt would still be responsible for the obligation. Most businesses could negotiate a lesser debt with lenders and liquidate the possessions for more funds. This could ease the financial strain on individuals who are held responsible for business debts.
Limited Liability Companies
Regarding debt obligation and bankruptcy, LLCs function almost the same as corporations. However, you have to terminate your obligation for business debts via personal insolvency to close down the company. The same risks also apply.
Advantages of Declaring Personal Chapter 7 Bankruptcy
Many shareholders believe that declaring personal Chapter 7 after a business falls is an effective approach to seeking debt relief. Even though it is possible to declare Chapter 7 bankruptcy while the company or LLC is still operating, most jurisdictions do not protect the corporate shares or LLC interests. Therefore, the trustee is likely to liquidate your company interest if you can protect your ownership by using a wildcard exemption.
Things to Consider Before Filing For a Chapter 7 Business Bankruptcy
Although bankruptcy can be beneficial in some instances, it is not always recommended. Here is an outline of a few of the things you should think about. There are plenty more; if you’re thinking about filing for bankruptcy for your company, consult with an experienced business lawyer.
You Cannot Go Back
Under Chapter 7, you will not have access to any sort of safety net. When you file, the only way to withdraw it is with permission from the court, which might not be a good thing to place your trust on. The basic point is that when you’re there, you ought to prepare yourself to be there forever. Even though you discover you are unable to keep assets that you believed to be secure.
Taxes
Bankruptcy and business taxes raise a wide range of complex problems. To avoid being caught off guard after the proceeding, speak with your financial advisor before filing.
Lawsuits
Only when you are being sued for funds does the automatic stay apply. This is the process that prevents your lenders from proceeding with their collection efforts after you file. If a regulatory body alleges that your company is harming the environment, for example, it won’t have any bearing on criminal or civil enforcement activities. Despite your insolvency, that litigation will proceed. Therefore, be aware that your insolvency might not accomplish much more than giving the prosecutor access to another venue for discovery.
Improper Purposes
People who file lawsuits for unscrupulous reasons, such as to delay the process of foreclosures or to conceal misconduct that is the fault of the proprietors of a firm, are looked down upon severely by the courts. It’s ideal to enter bankruptcy court with a spotless record since the consequences are severe.
Find a Business Bankruptcy Lawyer Near Me
Filing for bankruptcy can be a useful tool when dissolving a struggling business or discharging personal liability for business obligations. Getting skilled counsel is crucial since bankruptcy cases involving businesses almost typically involve more complications than typical cases. If you want to know your options for filing for business bankruptcy, you can contact the Los Angeles Business & Real Estate Law Firm. We have extensive experience resolving business and personal bankruptcies at the earliest stages. Call us today at 310-796-7794.
