Liquidating in Chapter 11 versus Chapter 7

So you have a business that needs liquidating?  What's the best way to do it?  There is the classic Chapter 7  route, which after all is the liquidating chapter of bankruptcy, but there is also something known as a "liquidating Chapter 11" bankruptcy. Why would anyone choose to use the reorganization chapter of bankruptcy to wind down a business?  The answer is that sometimes there is more value for everyone when business assets are sold off as part of a going concern rather than at a bankruptcy garage sale by an trustee in Chapter 7.

First the basics: if you do it correctly, Chapter 11 allows the existing business owners to stay in control while the business is marketed for sale. Business owners often like this because they can remain in control and keep existing employees on staff (including themselves).  The advantage to creditors is that the business owners are often the only ones who can really run the business as a going concern.  Chapter 11 is premised on the concept that there is sometimes more value in an operating business than in a sale of its parts.  That's why reorganization exists in the first place.   If this is true in a particular case, that's why selling all the assets of business in a Chapter 11 is permitted: the net proceeds, even after factoring the increased costs of case administration, are greater than a straight liquidation.

The process of selling the assets of a business in Chapter 11 includes many challenges.  Here are some:

• Any blanket lien holder, like a bank with an interest in cash collateral, must be dealt with.  Usually it's necessary to convince such a lender that Chapter 11 route will result in full payment of their claim.
• The business may need cash to operate after filing bankruptcy.  In which case, debtor-in-possession financing must be obtained.  This is sometimes comes from the proposed buyer of the business assets.  However, there obviously timing issues at play when a business is running so low on cash that basic operations are imperiled.
• A buyer must be found and the procedures for counter-bids must be fair.
• The price for the assets must in most cases must pay off all secured debt.  That is because of, among other things, credit bidding, but there is a possible exception for sales via a confirmed Chapter 11 plan.  
• The debtor may have to negotiate a deal with the committee of unsecured creditors to pay them a partial dividend from the sale or the sale may be tied up in litigation in the bankruptcy court.
• The estate must be administratively solvent.

This is just a quick treatment of some of the issues involved in selling a business through a Chapter 11 plan. If a business has real value it makes sense to consider this option. In the right case, everyone can benefit.

Fraudulent Transfers and Closing a Business

I previously wrote about closing down a small business in Massachusetts. One of the point I alluded to, I am going to expand on a bit here. What happens to the assets of the business when the small business folds? There is a temptation for the business owners to just keep the assets for their personal benefit after closing the doors and leaving business debts unpaid. This is what is called a fraudulent transfer, and a business creditor can make you personally pay the value of these assets over to them if you just keep them in this manner. The reason for this is the Massachusetts Fraudulent Transfer Act. The big picture is that the law does not permit giving away the assets of a business that can't pay its debts: the business creditors are entitled to get the value of those assets before anyone else does. It usually makes sense to administer and distribute assets to creditors in a fair and transparent manner, such as via a business bankruptcy. However, not all transfers of assets to business owners are problematic.

In Massachusetts, generally, an insolvent business can transfer assets to a business owner if the owner pays a fair price in cash to the business. Any such transfer and accompanying valuation must be well documented and supported, and the "payment" to the business must not simply be debt forgiveness by the business owner. It is also important to document transactions of this type because if the insolvent company ends up in bankruptcy, the trustee can sue the owner to recover the value of the assets if they are sold for less than reasonably equivalent value.

Winding Down a Business in Massachusetts

There are many reasons why you might want to close a business. It may just be the time in your life to move on. However, if there's no way to sell your business and there's not enough money to pay the debts off, what do you do? This "insolvency" can create challenges in winding down a business in a way that allows you to move on.

Here are a few key questions to consider:

1. Have you personally guaranteed business debts?

This is a key consideration. Any debts you, your spouse, or partners guaranteed will have to paid by the guarantor(s) should the business close without satisfying these debts. Business credit cards are typically personally guaranteed by the owners. The same with most bank debt. Trade credit (vendor debt) usually is not personally guaranteed, but sometimes it is. Personal guarantees are common and can end in the bankruptcies of individual business owners if these debts cannot be paid. I call these business-personal bankruptcies and have written a bit more about them here.

2. If there are no personal guarantees or the personally guaranteed debts have or will be paid, does the business have valuable assets?

Some examples of assets include inventories, equipment, cash, and accounts receivable. If the business has assets, it can't just close its doors and leave debts unpaid. Where would the assets go? The business owner can't just keep them. In theory at least, these assets must be distributed equitably to creditors before the business owner can just take a dividend. So, if the business is operating in the red and there is not enough money to pay all the debts, who should get what? Lien holders should receive their collateral or its value. Taxes and employees should be paid in full. (It is important not to leave employee wages unpaid in Massachusetts). But after the secured and priority creditors receive their share, who should be paid what if there is money or assets left over? The answer to this depends on the goals of the business owner and the extent of the assets, but it may at this point make sense to file bankruptcy for the business so that the assets can be distributed fairly to creditors by a trustee. Whether to do this or not depends on a few factors, like the exposure of the business owners to suit by the trustee (like if they have unpaid debts to the business), but it sometimes is the best way to clear the assets in a transparent fashion so that creditors get their satisfaction and stop pursuing the business and its owners for the unpaid debts. Once this bankruptcy process is finished, the business can be formally dissolved with the Secretary of the Commonwealth and the matter can be put to bed. The cost of bankruptcy usually comes from the business assets.

3. What if there are no business assets?

If the business has not assets, you still need to make sure you deal with personally-guaranteed debt and any priority debts, like taxes and wages. Once you do this, an old legal maxim comes into play: you can't get blood from a stone. Creditors will try, however, and many an asset-less business winds up in bankruptcy just to satisfy the creditors that there are indeed no assets to be found. However, this is not always necessary. Blood can truly not come from stones and so, although annoying and time-consuming, dunning efforts by angry business creditors will come to naught if the business has nothing. In this case, letting the business die a natural death (non-payment of debts and administrative dissolution by the Secretary of the Commonwealth) should be considered.

It's probably obvious, but it makes a lot of sense to retain an attorney to guide you through the process of winding down a business in Massachusetts. There are several strategic options to consider that will affect the speed of the process and the overall cost to the business owners.

Massachusetts Personal Injury Bankruptcy Exemption

Here in Massachusetts, we can choose between the federal and state bankruptcy exemptions. Exemptions are laws that allow you to keep property you have when you file bankruptcy. A personal injury lawsuit is "property" that you will lose to a Chapter 7 bankruptcy trustee if it is not exempt. So, when are personal injury suits--for car accidents, slip and falls, etc.--exempt?

It's fairly simple: There is no Massachusetts exemption for injury awards in bankruptcy, but since we have the right to choose exemptions under federal law, we have the following:

Effective April, 2010, the federal personal injury bankruptcy exemption is $21,625 for "personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor or an individual of whom the debtor is a dependent."

There are various complications when it comes to exempting personal property awards in bankruptcy, mainly involving liens. Seek out experienced bankruptcy counsel if you wish to attempt to exempt an injury suit.

Payment Plans in Chapter 13 Bankruptcy

I previously wrote about payment plans in Chapter 7 Bankruptcy, and now I'm going to explain a bit about Chapter 13 payment plans. Chapter 13 payment plans are the same as Chapter 7 payment plans with one important difference. A bankruptcy attorney can accept payment from you after a Chapter 13 case is filed if the money comes from your Court-ordered Chapter 13 payment.

Here's a key point: Total Chapter 13 bankruptcy fees are generally $4,000 ($3,500 plus $500) here in Massachusetts because of a Court rule (you can read the Court rule here--this link will open a large PDF document on the Court website and the rule is on pages 83 and 84). Virtually all bankruptcy lawyers in Massachusetts charge this amount for a standard Chapter 13 case because of the rule. However, the key is this: the amount you pay out of your pocket varies. Lawyers who do a lot of Chapter 13 will sometimes only take part of the $4,000 upfront and let the rest be paid via your plan. This is good for you because the remainder that your lawyer collects normally just reduces the money that your creditors get without requiring that you pay more. We will sometimes charge people as little as $1,750 before a case is filed (which itself can be paid via a payment plan in the Chapter 7 style) and take the rest via their Court payment.

Contact us if you'd like to discuss your bankruptcy options in Massachusetts.

Another question you might have: How is my Chapter 13 payment determined?

Payment Plans in Chapter 7 Bankruptcy

Some bankruptcy attorneys hide the ball when it comes to the true cost of bankruptcy. We do not and you can get some real numbers about bankruptcy fees in Massachusetts on our website. However, I wanted to write here about payment plans. My experience is that more than half of consumers these days do not have sufficient funds to pay for bankruptcy upfront and need a payment plan. We work with people in this situation every day and offer payment plans that are clear and honest manner--but they work differently in the different chapters of bankruptcy.

Chapter 7 Bankruptcy Payment Plans
The key with payment plans for Chapter 7 cases are that all fees and costs must be paid before the case is filed. At first glance, this may disappoint you, but for 99-plus percent of people it's not a problem. There are a couple of factors to keep in mind.

• First, this is the only legal way to offer a Chapter 7 payment plan. If an attorney extends a payment plan into the period after a Chapter 7 is filed, he or she is breaking the law. This is because unpaid, pre-filing fees cannot be collected after a Chapter 7 case is filed due to the automatic stay. Any bankruptcy lawyer who would consider offering an illegal payment plan is either ignorant about basic bankruptcy law or is playing fast and loose with the rules. You do not want this. In general, the Court will not excuse you from the law just because you were following the advice of an unethical lawyer.
• Second--and this is key--the payment plan period usually overlaps with the pre-filing process. In other words, you and your lawyer need time to prepare your case for a successful filing. This work is done along side the payment plan. Once the payments are made and the work is completed, the case is filed. One extra thing we provide is a service to handle creditor phone calls while you are in the pre-filing process. This makes the payment plan process comfortable by giving you some breathing room. Ask about this if you decide to call us.

For my next installment in this two-part series, I will explain how payment plan work in Chapter 13 bankruptcy. You can read more about us and Massachusetts bankruptcy in general here.

Charged Off, Zombie Debts and Bankruptcy

Someone recently wrote me and asked whether he had to pay a debt that was charged off years ago and sold to a debt collector. Of course, the answer is it depends, but this is what it depends on. The key points:

1. The tough news is that after a debt is charged off, you still owe it. Charging off a debt is an accounting practice meant to give a fair picture of the value of a business (by taking bad debt off its books). Charging off an account does not affect the legal obligation to pay it, and the business must account for money they earn once they sell the debt to a debt buyer to collect the defaulted debt. Often there will be a gap between when the debt is charged off and when a debt buyer emerges to contact you for payment. This is where the "zombie debt" term comes in, i.e. you think the debt is dead, but then it resurrects and attacks you.

2. The (possible) good news is that the gap is sometimes too long, and the debt too old, to make it collectible in court. Just because a debt is sold to a zombie debt buyer, it doesn't mean that the statute of limitations is revived if it already has lapsed. Generally, the statute if limitations in Massachusetts for debt collection is six years from the date of the original default. If you make any partial payments later, this will usually re-start the clock, but if you don't the six-year rule usually applies.

3. If the debt is still good once it's in the hands of a debt buyer, you must pay it, settle it, or file bankruptcy. We specialize in affordably accomplishing the last two options for Massachusetts consumers and small to medium-sized businesses. Give us a call or send us an email if you would like our help with your debt problem.