Business Bankruptcy Issues

Business entities such as corporations and limited liability companies can file bankruptcy under one of two different chapters, depending upon the goal or goals of the bankruptcy case.     Businesses mired in debt can  may be able to reorganize their debts in a Chapter 11 bankruptcy case.    A business that cannot or does not wish to reorganize can file to be liquidated in a Chapter 7 bankruptcy case.   For many individuals who do business, the result of business troubles strain personal finances and may force the filing of a personal bankruptcy.

Business Chapter 7 Cases

In some instances, there is a benefit to the owners or stockholders of  business to terminate its existence by filing a Chapter 7 case.    In instances where there are assets to be liquidated,  business owners can place the responsibility for determining whether or not and how to dispose of business assets.   Principals must provide reasonable cooperation to the trustee.  This would include providing business records and access to assets to the trustee.   Trustees may arrange to auction or otherwise sell business assets to satisfy the claims of creditors.  (The trustee may need the cooperation of a secured creditor to sell pledged assets).   Trustees may also seek to recover monies owed to the business.   Trustees may also be able to recover monies from creditors who were paid shortly before the bankruptcy case and got more than their fair share.

Caution should be exercised by the owners of a business filing for bankruptcy.    The rights of the trustee to sue and recover for creditors may include the right to sue the owners of the corporation if there was any form of mismanagement or failure to follow the corporate rules.    This can be problematic where the assets of the corporation have been co-mingled with personal assets and it is difficult to distinguish between business and personal assets.   It can also be problematic when individuals pay personal expenses from the corporation instead of maintaining separate accounts for business and personal expenses or even re-pay debts that principals are personally liable for at the expense of other creditors.   Some business debtors simply lack the proper records or have resorted to failing to pay sales or payroll taxes, which can have serious consequences for the owners of the corporation.  Even where the owners intend to file bankruptcy, any discussion should include careful analysis of potential dischargeability issues.

Some of the advantages of  Chapter 7 can also act as disadvantages.   For instance, it can have the advantage of obtaining closure for the owner, having a third party take responsibility for determining the value of and best means to liquidate assets for the creditors .   Or, it can provide a profit motivated trustee with all of the information necessary to file suit against the   of the debtor.    This can even happen in instances where the Debtor has done nothing morally wrong.   The trustee initiating the suit also has the benefit of hindsight in evaluating the judgment of the Debtor’s owners.

The filing of a Chapter 7 bankruptcy for a business should only be filed after obtaining the advice of a qualified bankruptcy attorney.    Your attorney should be able to look at documents related to the business and advise you as to your liability for business debts, based upon business documents.   The trustee will have the ability to obtain all documents related to the business.   The debtor is required to have, preserve and turnover all records of the business requested by the trustee, including business computers and customer lists.    The trustee will have control of these assets.    In some instances, the trustee will sell such assets, even to your competitor.

Business Chapter 11 Cases

There are also business entities that may be struggling with debt but that can and want to remain in business for a variety of reasons.   Sometimes, the Debtor has been subject to some sort of crisis such as an unanticipated lawsuit, an industry-wide adjustment to businesses, the failure or bankruptcy of a customer, the loss of a sole or significant customer, a bad business deal or deals, a market value adjustment, excessive rent, a natural disaster or even a casualty such as a theft, fire, computer virus, insurance coverage or payment dispute or combination of the above.

As a result of some of the above, a business may be unable to pay its bills as they come due resulting in the danger of loss of income or other assets.    Creditors may have powerful tools that have the effect of making it impossible for the Debtor to move forward without bankruptcy court or other protection.    It may be better for both the Debtor and the Debtor’s Creditors for the Debtor to be able to stop a repossession, foreclosure, levy or other loss of a vital asset or income.   Bankruptcy provides Debtors with the opportunity to determine whether they can find a solution agreeable to interested creditors that will allow for a somewhat consensual resolution controlled by various rules that balance the interests of various creditors.   Many of the rights of secured creditors are protected by strict controls over the Debtor’s assets during the bankruptcy case depending on such factors as how well the creditor secured their position before the bankruptcy case, the ability of the debtor to pay, the value of collateral for the Debtor’s debts and balancing the interests of other creditors and the Debtor.

A business that faces repossession, foreclosure, garnishment or levy of a major and necessary asset, may want to discuss their situation with a business bankruptcy attorney as quickly as possible.   Major rights can be lost very quickly if creditors are ready to take action and they often do so without warning, intentionally.    So, once a debtor is in default with a creditor or creditors, they should seek the guidance of an attorney with respect to which debts to prioritize, when to discontinue lending money to the business, the optimum time to file a bankruptcy.    These are all items that should be discussed with a bankruptcy attorney to maximize the options available in a Chapter 11 case.    They can also prevent problems that are created when principals are paying themselves instead of creditors or their accountant is treating all or some of the money they pay themselves or take out of the business  as “loan repayments” instead of income.

Personal Business Bankruptcy

Many individuals whose business ends up in bankruptcy often have the financial problems affect them personally.    Creditors will hold the principals responsible for debts when possible by contract or law.   They know that this provides them with additional leverage in most instances with their debtors.   It means that the creditor can pursue the personal assets of the principals, in addition to the assets of the business.   This means that the principals may be forced to file a bankruptcy case of their own.  In the situation where the business is to continue, the principals would likely need to file Chapter 13 or Chapter 11 cases, as opposed to Chapter 7 cases.   Debtors who operate their businesses as sole proprietors will also likely be required to file a Chapter 13 or Chapter 11 Case to resolve business debt issues.

The principals of a business that is suffering a downturn should speak with a qualified bankruptcy attorney about both the business and their personal financial situation.    The principals of the business may already be aware that they will have some personal liability because they signed personal guarantees.   We also often see situations where individuals associated with a business guaranteed a debt without realizing that is what they were doing.   For instances, the agreements most companies that will provide a credit card for a small business provide that the individuals guarantee the debt but many individuals sign these agreement unawares.    Also, failure to pay taxes such as sales and employment taxes can result in personal responsibility for all or a portion of these debts.      Speaking with a qualified lawyer can help business owners understand their responsibilities and the protections available for themselves and their business.