Should my business file for bankruptcy?

From time to time, I get a client who asks me whether their business needs to file for bankruptcy.  Generally, the answer is no.  But there’s a few things to ask yourself…
Is your business its own legal entity (such as an LLC or corporation) or is it a sole proprietorship?  If the latter, then there is no separate legal entity that can file for bankruptcy.  In other words, there is no legal distinction between you – the person – and your business.  If your company is a formal registered entity, such as an LLC or corporation, then the business could file its own separate bankruptcy.
Next, do you intend to continue business operations, or do you intend to shut the business down?  If you intend to keep the business going, you need a reorganization bankruptcy.  Corporate entities cannot file for Chapter 13 (13 is restricted to individuals).  Corporate entities have to reorganize under Chapter 11 – a topic I leave to attorneys who specialize in Chapter 11.
A corporate entity is technically eligible to be a debtor in Chapter 7 Bankruptcy, however, a discharge in Chapter 7 is limited to individuals.  Therefore, there isn’t much point in a company filing for Chapter 7.  However, if the business is going to dissolve anyway, it has the same effect as death of an individual.  There’s no point to filing for bankruptcy, because dissolution of the business entity terminates the ability for anyone to pursue the business for debt.  (Although, most banks and lenders require business owners to personally guarantee their debts, so it often behooves the owners of a failed business to file a personal bankruptcy to discharge their personal liabilities for the business debts.)
Which isn’t to say that there is NEVER a good reason for a business to file a Chapter 7.  For example, if there are substantial tax debts and assets available for liquidation, a Chapter 7 Bankruptcy could prevent other lenders from seizing assets so that the IRS and state taxing authorities can be paid first, limiting the personal liability of individuals for those taxes.

Lessons learned the hard way: don’t sell stuff.

Each of my clients – upon retaining our firm – receives a sheet with 10 Commandments – or 10 things not to do that would totally screw up your bankruptcy case.  Among them are such pearls of wisdom like “Don’t sell or gift anything you own.” or “Don’t pay money to relatives.”  I’m disheartened by the number of my clients who don’t follow these directions and do these things anyway.
Most of the time, they’re not a big deal, and the trustee ignores the transfer or preference.
But not always.
An old friend of mine called me up with this scenario…  His mother had sold him real estate a little more than a year before she filed for Chapter 7 Bankruptcy.  She sold the property for at least $50k less than what it was actually worth.  Now, the trustee was seeking to avoid the transfer, or alternatively, to collect $50k against my friend.  Keep in mind, my friend is not the one who filed for bankruptcy!
Now, the reason the trustee has the authority to void the transfer or sue my friend to recover the $50k is the same basis of reasoning that I explained in my article re: Osberg v. Halling.
Fortunately, we were able to settle the case for substantially less than $50k.  But what a lousy result.  Someone who doesn’t file bankruptcy having to fork out thousands of dollars for someone else’s bankruptcy.  And his remedies are limited – he can try to sue his own mother – the number of problems with that option I can’t even begin to fathom – or, he can try a malpractice claim against his mother’s attorneys (assuming he can prove that they gave mom bad advice, as opposed to mom just ignoring good advice).
The lesson to be taken here: your bankruptcy can have adverse impact on other parties.  You’re not doing anyone any favors by selling your assets prior to bankruptcy, and you’re not doing any favors by paying money to relatives prior to bankruptcy.
And for heaven’s sake – follow your attorney’s instructions!

Answers for Creditors

Someone who owes me money filed for bankruptcy.  What should I do?
So, you received an official letter from the Bankruptcy Court informing you that someone – who presumably owes you money – has filed for bankruptcy.  The notice also states that you may appear at the meeting of creditors.  What should you do?
First of all, STOP.  If you are taking any actions to collect the debt (be it a lawsuit, phone calls, collection letters, etc.), those actions need to terminate immediately.  99.9% of the time, the debtor is protected by an automatic stay that prohibits you from taking any actions to collect a debt outside of formal bankruptcy procedures.  If you do so anyway, you could be sued for violating the automatic stay.
The next thing you should do is contact an attorney experienced in bankruptcy law to determine your rights and responsibilities.  This way, you don’t waste your time and money, nor will you waste the bankruptcy court’s time chasing down something you can’t get anyway.  But assuming you can’t afford to hire an attorney, here are some general principles that you should know…
Most people want to know one thing above all else: “Will I get paid?”
First, look to see if the debtor has filed a Chapter 7 or Chapter 13 Bankruptcy.  If they filed a Chapter 13 Bankruptcy, there will be a 3-5 year repayment plan.  You can file a proof of claim in this case in order to be paid out of the bankruptcy estate.  No creditor gets paid if they don’t file a proof of claim on-time, and you will have a limited amount of time to file a claim.  Only certain types of creditors are entitled to be paid in full.  The majority of creditors fall within a class of creditors referred to as “general unsecured”.  These creditors are typically paid a percentage of their claim based on the debtor’s income and other factors.  These creditors are also paid last, after any priority and secured creditors.
If the debtor filed Chapter 7 Bankruptcy, chances are that you are not going to get paid – at least not through the bankruptcy.  The only time creditors get paid in a Chapter 7 Bankruptcy is if the trustee finds assets that he can liquidate for the benefit of creditors.  If the trustee finds assets, you will be sent a separate notice informing you to file a proof of claim.
If you do not get paid in the bankruptcy, can you collect outside of bankruptcy?  Generally not.  If the debtor receives a discharge, you cannot pursue him for the debt unless the debt falls within one of the types of non-dischargeable debts.  You should consult an attorney to determine if your debt meets the criteria for an exception to discharge.  If the debt is discharged but you try to collect anyway, you could be sued for violating the discharge injunction.
“But I have a judgment in state court!”
Sorry, but that doesn’t matter.  Most civil judgments are no different than a credit card or personal loan.  They are dischargeable.  Of course, there are exceptions, but having a judgment doesn’t automatically entitle you to get paid.  To find out if your judgment is non-dischargeable, speak to an attorney.
Remember that if you choose not to hire an attorney, that doesn’t mean the judge or the trustee can give you legal advice.  If you choose to act alone and without seeking legal advice, you are responsible for the consequences.
“Should I attend the meeting of creditors?”
You certainly have the right to.  But most people show up thinking that they’re going to get something out of it, and wind up walking away empty handed and irritated that they wasted a trip.  Here are some pointers for the sec. 341 meeting of creditors…
The purpose of the meeting of creditors is not to determine whether your debt is dischargeable, and the trustee doesn’t have the authority to make that determination anyway.
The purpose of the meeting of creditors is not to file a claim or to get paid.  At best, the trustee can tell you if he thinks there will be funds available for your claim, but he won’t be able to say that with absolute certainty.
Don’t go to the hearing just for the purpose of humiliating or berating the debtor.  At best, you’re wasting your time.  You’re probably going to piss off the trustee for wasting his time.  And if you go overboard, you could wind up in trouble.
The best reason to go to the meeting of creditors is if you believe the debtor has concealed income or assets.  You don’t have to have proof, but it would certainly help if you do.  Without proof, the trustee may assume you’re trying to stir up trouble and waste time.  You may also ask questions of the debtor if you believe it may have some impact on dischargeability or your claim.  Again, it’s best to speak to an attorney before doing this.

MMMP Change

One of the struggles of the Mortgage Modification Mediation Program has been with the transmission of documents.   Sometimes, debtors are not submitting the paperwork, or they are making incomplete or improper submissions.  Other times, the lenders claim to have not received documents or – in the mass confusion – require updated documents that wouldn’t have to be updated if not for delays.
To combat this problem, I and several other colleagues suggested use of an online document storage program which would be accessible by the mediator, the debtor, and the lender – in order to facilitate and track document transmission.
Recently, Judge Kelley announced that the such a document portal has been tested and will be made available.  In fact, use of the document portal will be mandatory, and carry with it a $25 fee per case.  Implementation of this new program will commence sometime after June 4 – when training will be held on the new system.