Discharge Violations and the Collection of Business Debts

From time to time, I will receive a phone call or letter from a former client of mine, concerned that they are still receiving billing statements in violation of the discharge they received in bankruptcy.  Sometimes, these are legitimate complaints.  Sometimes, the creditor wasn’t listed on the bankruptcy schedules (and for no-asset Chapter 7 cases, that’s not a big deal under Judge Kelley’s Guseck case).  In either case, we send a polite reminder to the creditor, and 99% of the time, that’s the end of it.  Very rarely do discharge violations need to be litigated in front of a bankruptcy judge.

It’s worth pausing to note that, unlike stay violations, which have a clear statutory basis for the recovery of damages – 11 U.S.C. § 362(k) – there is no such provision in § 524.  To receive awards and sanctions in a discharge violation, you must invoke the court’s general powers and authorities in § 105 and case law.  The standard of proof is ‘clear and convincing’ evidence.  And if the violating creditor is the IRS – administrative remedies at 26 U.S.C. § 7433(3) must first be exhausted.

Sometimes, the creditor that the client is complaining about was listed on their schedules, was discharged, and yet – I have to tell my client that there is no violation of the discharge.  Why?  Because my client owned a business – either a corporation, partnership, LLC, or other separate legal business entity.  Let’s consider a very common example, so we don’t wander off into the land of abstracts.,,
John Doe is the sole owner, operator, and representative of Acme, LLC.  Acme LLC incurred a business loan through Moneypenny Bank, which John Doe was required to personally guarantee.  Acme LLC doesn’t do very well, and as a result, John Doe ceases business operations and files an individual bankruptcy case.  He does everything his lawyer tells him to do, he receives his discharge, and a month later, he starts receiving bills from Moneypenny Bank.
What went wrong?
Well, nothing, actually.  John Doe filed for bankruptcy.  Acme LLC did not.  The bankruptcy discharge protects John Doe from being personally collected against from Moneypenny Bank.  However, Moneypenny Bank can still attempt to collect against Acme LLC.  John Doe continues to receive correspondence because he is the owner and representative of Acme LLC.  John Doe looks at the billing statements again and realizes that the bills are not addressed to him (John) but to his business (Acme).
While this is not a violation of the discharge, John is annoyed by the billing statements.  Is there anything he can do to stop the billing statements?
Moneypenny can continue to collect against Acme LLC until one of three things happens…
Option 1:  Acme LLC pays the debt, as agreed.  This option is the likely route if John Doe intends for Acme LLC to continue to exist and operate.  Since John Doe is the sole owner of the LLC, this means that the money is ultimately coming out of his own pocket.  But that is the consequence of owning the LLC.
Option 2:  Acme LLC can file bankruptcy.  This is generally an unnecessary step if John Doe intends to fold the business.  There may be certain benefits to liquidation under Chapter 7 (such as the distribution of assets to priority creditors).  If Acme LLC is to continue operating but needs to file bankruptcy, it would have to do so under Chapter 11.  In either event, I leave it to bankruptcy attorneys who specialize in business filings to explain those benefits.
Option 3:  Formally dissolve Acme LLC.  Dissolution of a business is the corporate equivalent of death of an individual.  Creditors can’t collect against dead people (though they can collect against probate estates).  Nor can Moneypenny Bank collect against an LLC that doesn’t exist.  Again, I leave it to business attorneys to discuss the proper steps to formally dissolve a business (you want to make sure your LLC is dissolved properly to avoid issues with government agencies and taxing authorities).  But this is the simplest and most straightforward way to deal with the problem if John Doe does not intend to continue on with Acme LLC.
Of course, Moneypenny Bank will retain certain rights.  For example, if they have a lien on assets – they will be able to exercise those security rights.  They may also have rights if Acme LLC owns non-pledged assets.  To determine specific consequences of dissolution, speak to a competent business attorney.

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.

I own a business. How does that factor into bankruptcy?

Most people asking this question are concerned about whether they can continue to operate their business, and so we need to analyze two aspects: business assets and business debts. Before we can do that, we need to determine the legal status of the business entity. As always, bear in mind that the types of business entities and their nature will vary among jurisdictions, so it is important to speak to a competent attorney in your state who can analyze the specific facts of your case.
There are several types of business entities out there. Some examples include corporations, limited liability companies, partnerships, and a sole proprietorship. I’m going to over-simplify things just a bit here – for our limited purposes, all of these entities are identical except the sole proprietorship. The corporation, LLC, and partnerships are separate legal entities that exist separately from the individual(s) who formed it. The sole-proprietorship is not a separate entity – in other words, the individual is engaged in business and operates as the individual.
In the sole proprietorship, all of the assets of the business are the assets of the individual, because there is no separate legal entity. The business assets are listed on bankruptcy schedules along with the debtors’ other personal property and taken as exempt to the extent possible.
If the debtor is an owner of a separate business entity, then the debtor has a membership/stock/shareholder interest in the business. In that case, the business assets are totaled up, the business debts are deducted, and what remains is the net value of the business. The debtor will own that value or a percentage thereof, and that would be listed on schedules and taken as exempt to the extent possible.
As for business debts – again, because a sole-proprietorship business is not a separate legal entity, the debts incurred in the course of business are the debtor’s personal debts. To the extent they are dischargeable, they are included in the debtor’s bankruptcy. The business can continue to operate, because there never was any sort of entity to be shut down.
In the case of separate legal entitites, the business debts are the responsibility of the business, and are not included in a debtor’s personal bankruptcy. Business debts are still usually listed on schedules in case the debtor has made any personal guarantees – the personal bankruptcy relieves the debtor of any personal responsibility for the business debt, but the business remains liable. Again, business operations are largely unaffected in this case.
In order for a business to discharge its debts, it can either fold and/or file under Chapter 7. Filing a Chapter 7 will trigger liquidation and the cessation of business operations. Business entities are not eligible debtors in Chapter 13. If a business wishes to reorganize without stopping operations, it must file under Chapter 11.