Business Owners Declaring Bankruptcy

I have been seeing a number of business owners who need to declare bankruptcy but they are still surviving off the income their business is generating. The business isn=t generating enough income to enable my client to pay his credit card bills but it=s putting food on the table.

Perhaps it’s allowing him to pay the home mortgage (or rent) – but maybe not. He might be in foreclosure.

These clients tell me that they want to get a fresh start. They want to cut their expenses and rebuild economically. But they feel that they can’t rebuild with the mountain of debt they have accrued during these tough times.

They want to discharge all their debts in a Chapter 7 bankruptcy and get a fresh start but they want to keep their business going.

A person can keep property (including business property) in bankruptcy so long as the property he wishes to keep is Exempt. The particular exemption that the business owner would use would be the so-called Wild Card Exemption.

If the debtor hasn’t used the Wild Card exemption for any other purpose then he can keep the property of the business to the extent that it is worth less than the amount of the exemption which is around $26,000.

You might be thinking: My business, as a whole, is worth much less than $26,000 when you consider all the debt the business has run up.

But if the business is a sole proprietorship then the assets of the business are considered separately. The business is not considered as a whole entity.

Let me give you an example to explain what I am talking about. Let’s assume you own a restaurant. Your equipment – stove, oven, tables, cash register, etc. are worth, all together, say $35,0000. But you owe $45,000 to suppliers, the bank that gave you a line of credit, and other debts.

If you declare bankruptcy the trustee will look at the $35,000 in property and conclude that some of it is beyond the exemption amount. You will lose some property in the bankruptcy because you have assets in excess of the amount of the exemption.

You will probably have to sell off some of the property before you can declare bankruptcy. You will have to bring down the value of the property below $26,000. Of course, if you have cash left over after the sale of those assets you will have to spend the cash before you file for bankruptcy.

Now let’s assume you are incorporated. Very likely you, the business owner, do not own all that restaurant equipment. The corporation owns it. You own the stock.

So the questions then become: What is the stock worth? Is the stock exempt?
The value of stock is equal to the assets of the corporation minus its liabilities.

In the example above, the stock would be worth nothing since the corporation owns $35,000 in property but owes $45,000 in debts. Since the stock is worth nothing, it is exempt and the trustee can’t touch it. The trustee abandons the stock and you keep the business.

Therefore if you are incorporated the business loses no property. But if you are not incorporated you may very well lose property in the bankruptcy.

There is another issue to contend with if you are the owner of a business that needs to declare Chapter 7 bankruptcy.

When you file for bankruptcy a bankruptcy estate is created. The trustee does not want you to impair the value of the bankruptcy estate. That’s one of his jobs – to preserve the bankruptcy estate for the creditors.

What are some ways a business owner could impair the value of the estate? A restaurant owner might allow his liability insurance to lapse and then serve tainted food for which he gets sued. Or he could fail to pay his worker’s compensation premiums and an employee could get hurt on the job.

In San Diego the trustees have the following rule:

If a debtor is operating a business or conducting a profession utilizing property of the estate, at the commencement of his or her case, it is necessary for the business to be suspended and the Trustee contacted immediately upon filing. No business or profession utilizing property of the estate is to be conducted absent an Order of the United States Bankruptcy Court.@

This could be a disaster. If you are surviving off the income your business is providing, you file for bankruptcy, and have to shut your business down while you wait for court approval to start up again you could be in very serious financial trouble.

But this rule only applies to sole proprietors. If your business is operating as a corporation then the trustee’s rules do not require you to shut down. You may continue operating.

I have been counseling people for years that is often wise to incorporate. I have usually focused on two reasons: Limiting liability and saving on self employment taxes. It turns out that incorporating your business can provide tremendous benefits if you need to declare bankruptcy.

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