Businesses & Filing Bankruptcy
A consumer debtor can file a personal bankruptcy even if engaged in business. However, the bankruptcy process becomes complex and there are certain inherent risks involved. Any business debtor that is contemplating a chapter 7 or chapter 13 bankruptcy should seek bankruptcy attorneys that have specific experience in filing such cases. The bankruptcy code and Arizona’s exemptions do not protect business assets or business income and the businesses are not eligible to receive a discharge. However, a consumer bankruptcy can eliminate a debtor’s personal liability and many businesses can survive a bankruptcy.
If a business owner is contemplating bankruptcy, the first consideration is whether the business is expected to continue or to be dissolved. If the business is sustainable, a careful business valuation should be completed. There are several professionals that provide such services. The purpose is to determine an estimated liquid value. Some bankruptcy trustees will look to “goodwill” and “client lists” as settlement chips during bankruptcy. A debtor’s counsel needs to be able to counter with actual figures. It helps the client and trustee to have an accurate business valuation.
If the business has a large liquid value, the debtor must be prepared to lose the business or to negotiate a large Rule 1019 compromise with the trustee’s counsel. If a debtor wishes to keep the business and does not have the funds to settle the trustee’s interest, bankruptcy may not be a viable debt relief option. Also, if the business in encumbered with debt, a consumer bankruptcy will not discharge the business’s liability. Both of these considerations may make debt settlement a better option.
If the case is filed, a debtor’s attorney should promptly file a motion to abandon the business. This will expedite a settlement and limit post-petition issues. Two common problems arise with business income and exemption issues. Upon filing, business income becomes property of the estate. Therefore, a debtor must consider how they are deriving revenue from the business, such as through wages versus dividends. Post-filing wages are not property of the bankruptcy estate. Business assets also become property of the estate, but can offset with business debt. As a word of caution, businesses cannot claim exemptions.
This is a common mistake where a consumer debtor claims a “tools of the trade” exemption for business assets, however, the debtor does not actually own the property. When the ownership of property is in question, it is helpful to look at business taxes to see if the property has ever been claimed and depreciated. In addition, if the property has ever been insured under the business policy, it is a good indicator that the business owns the asset, versus the debtor. A debtor can reclaim ownership through an exchange for value.
Self-employed debtors are often advised to temporarily close their business for purpose of filing bankruptcy. The business is then opened under a new name after filing. This path can create fraudulent transfer issues and breach of fiduciary duty concerns. By closing a business and opening a new one, the debtor inadvertently undermines their present business by transferring business assets (such as tools, computers, client lists, contracts, etc) into a new company without having received reciprocal value. If the trustee expresses an interest in the business, the debtor may be in a worse position. Often, it is better to keep the business operating and filing the motion to abandon after commencing the bankruptcy case.
These are some of the more common issues with a business debtor filing bankruptcy. With careful legal guidance, a business debtor can successfully file bankruptcy and secure debt relief. The outcome of the case will depend on the case trustee, which attorney is representing the trustee, the type of business, the value of the business, and the timing of filing the case. It is advisable that a business debtor not attempt to file bankruptcy without experienced counsel.