Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box

Closing Up Shop

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What can you/should you do when it becomes obvious that your start up business should wind down?

The hardest part of being in business is recognizing when the business has no future.  Yet the overwhelming majority of new businesses fail within 5 years.

So you’re not alone.

Shutting down an insolvent business presents a tough challenge: honoring the legal rights of creditors while minimizing the damage to the founders and employees.

Not to mention the emotional hit.

Separating the owner from the business

Unless you are a sole proprietor, you and your business are two separate legal entities.

Whether your business operates as a corporation or an LLC, it has its own rights and obligations.  Those rights and obligations  may be different from yours as the shareholder.

For the purposes of this discussion, we’re going to assume the business is a corporation. If you operated as an LLC, the issues are essentially the same as those of a corporation.

  • The board of directors of an insolvent corporation owes its duty of loyalty to the creditors, not the owners.
  • Creditor claims get paid before the shareholder’s ownership claims.
  • Shareholders can be creditors as well as owners.
  • Management can legally pay some creditors and not others.

Keep these precepts in mind once you see the business needs to close.

Bankruptcy or not

There is no clear or universal answer to whether a failed business should file a Chapter 7.

A corporation does not get a discharge in a Chapter 7 case; only a Chapter 11 reorganization erases the debts of a corporation.  And a Chapter 11 is worth the significant time and expense only if the business has a future, or some valuable asset salable only if the business continues until the sale.

So the only purpose a business bankruptcy serves is to liquidate the business assets and satisfy creditors as far as possible.  The unpaid debts will remain enforceable against the corporation for as long as the law allows.

Companies can go out of business without filing bankruptcy: they liquidate their assets and cease operations. Creditors have a right to recover their claims from the assets of the corporation.

If there are no assets, the corporation cannot be further harmed by lawsuits that try to collect from the corporation: a judgment against a company without assets is worthless.

Closing without bankruptcy

It’s perfectly legal and rational to simply close the doors and cease business without involving the courts.

The danger to management in this approach is the tendency of some creditors to assume that the business’s failure to pay means that there is some sort of skullduggery afoot.  Those creditors don’t recognize the legal distinction between the corporation that runs the business and the people who work for and own the corporation.

It becomes easy and reflexive for such creditors to sue the officers as well as the corporation to collect the debt.  The corporation may have no remaining assets but the officers have both assets and future earnings at stake.

While the claim against the individuals may be invalid, the individual has to appear and defend in the lawsuit, or a judgment will be entered against him.

And sometimes, the individuals are liable because the individual guaranteed the debt or even the individual opened the account before the corporation was formed.

Why doing it yourself can work

Personally managing the wind up has advantages, if you are willing to devote the time and energy to the process.

Management can usually get a better price for assets since they know the market, know the asset, and are motivated to get highest recovery.

Outside of bankruptcy, you control who gets paid with the available funds.
You can act swiftly to limit exposure of management or investors by paying first debts guaranteed by insiders, subletting leased space, returning leased equipment, etc.

Creditors are protected from having to give back preferential payments to the bankruptcy trustee.

Assets can be sold to insiders so long as the price is fair.

All desireable outcomes, if it’s possible.

DIY isn’t all roses

But…
Handling the shut down yourself has some down side:

  • May prevent management from accepting new employment
  • May require cooperation from creditors and lessors
  • May increase likelihood that disgruntled creditor will sue individuals too

Bankruptcy is simple

In Chapter 7, the bankruptcy trustee becomes responsible for liquidating assets, returning equipment, and dealing with creditors, freeing management to turn to other endeavors

The trustee has powers under Bankruptcy Code to sell leases despite anti assignment provisions and to avoid levies and writs of attachment, recovering value for creditors that isn’t possible outside of bankruptcy.

Filing bankruptcy seems to reduce the instance of creditors suing individual managers for corporate debt.

The automatic stay prevents aggressive creditors from diverting cash that could be used to pay taxes, employees, and guaranteed debts or recovering property needed for wind up.

But….
If the bankruptcy trustee winds up the business:

  • Trustee unlikely to get top dollar for saleable assets.
  • Insiders may be prohibited from buying technology, intellectual property or projects in development
  • Trustee’s fees and expenses are paid off the top
  • Trustee can recover preferences to trade creditors and to insiders and challenge pre petition transfers of assets if legally fraudulent
  • Bankruptcy process frequently slow and inexact
  • Claims are paid according to priorities in the Bankruptcy Code

Try some of each

The choice of how to wind up doesn’t have to be an either/or decision.

Management can liquidate assets as far as feasible, and file bankruptcy thereafter to let the trustee mop up.

Step back and look at the issues of timing, asset value, and creditor claims.

If the answers seem complex, consult a bankruptcy lawyer for help weighing the alternatives.

More

Payroll tax trouble

Separating the business from the business owner

Myth of the corporate business card

Know who you are when the business files bankruptcy

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While knowing who you are may be central to philosophy and mental health, you wouldn’t think it poses a difficult question in a business bankruptcy.

You wouldn’t think the word “you” would be so challenging.

Yet, small business owners find it hard to separate themselves from the business, even when that business is incorporated.

After all, the owner’s financial livelihood rises and falls with the success of the corporation’s business.

You and your corporate business

Twice in the past two days, I had occasion to point out to clients who own small corporations that when the bankruptcy trustee says “you”, the trustee is talking about you, the individual, not the business that you have been immersed in.

How to sign for your corporation and not be personally on the hook

But the distinction is important.

In the law, the corporation that owns the business is a separate legal “person” from the flesh and blood human being who owns the stock in the corporation and serves as its officer and director.

The debts of the corporation are not necessarily the debts of the shareholder. The corporation can file bankruptcy without the shareholder, and conversely, the shareholder can file bankruptcy without impacting the day to day operations of the corporation.

In analyzing a bankruptcy filing or answering questions from a bankruptcy lawyer or bankruptcy trustee, make sure you know who you are.

More about struggling businesses

Individual bankruptcy and business debts

Is it safe to file corporate bankruptcy

The unexpected benefits of incorporating

When your business needs to wind down

 

More on business bankruptcy on Bankruptcy in Brief.

New California Bankruptcy Exemptions

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california exemptions

Californians filing bankruptcy got an increase in the exemptions that protect their assets on April 1, 2019.

Every three years, the dollar amounts are adjusted for changes in the cost of living.

Californians don’t get to protect possessions under the Bankruptcy Code’s exemptions.  Instead, a California resident who files bankruptcy must use California exemption law. That’s the case even though bankruptcy is governed by federal law.

Don’t shed a tear for the bankruptcy exemptions:  the state exemptions are arguably better.

You have a choice of two exemption systems.  One choice is the standard California state law exemptions found in Code of Civil Procedure 704.  These are the exemptions  applicable in state law collections as well as bankruptcy.

The second choice, appealing to those without significant equity in their home, is the California bankruptcy exemptions found at CCP 703.140(b).

What do debtors get to keep

Here’s the new  list of increasedCalkifornia bankruptcy exemptions

Principal residence$29,275
Vehicles$5,860
Household goods per item$725
Jewelry$1,750
Grubstake$1,550
Business assets$8,725
Loan value of life insurance$15,650
Personal injury claims$29,275
Other misc. exemptions703.140

Californians, because they are required to choose one state exemption system or the other rather than the federal bankruptcy exemptions, can also use the federal list of non bankruptcy exemptions.

Bankruptcy wild card exemption

The trickiest part of the California bankruptcy exemptions is what’s called the “wild card”. (It’s also called the “grubstake”.)    When 703.140(b)(1) and (b)(5) are added together, the debtor can protect $30.825 of equity in any asset or combination of assets.  That’s the wild card.wild card exemption

The wild card amount can be parceled out to protect some cash in a bank account;  some equity in a vehicle that exceeds the car exemption; stock; a  business or whatever else you have.

The point is that the exemption isn’t restricted to a certain kind of property.  It can be used to protect anything.

How exemptions work

Exemptions protect the specified amount of equity in an asset.

If it’s a house, the exemption protects a certain amount of value in the property that exceeds the liens on the property.  It doesn’t matter if the value of the house is $200,000 or $1,200,000.  The exemption protects the specified amount of equity in the house.

If there is equity in a house over and above the total of liens and the homestead, a Chapter 7 trustee can sell the house and give the debtor the homestead exemption in cash.

That doesn’t happen very often.  Because, there has to be enough equity to pay the costs of sale, any capital gains taxes and the trustee’s commission before the sale benefits creditors.

More about secret exemptions

If neither California exemption system adequately protects your  assets, consider Chapter 13.

More

Exemptions in Chapter 13

Debts of spouses

Image courtesy of Flickr and k2d2vaca.

Wild card:

Can I Sell Stuff Before I File Bankruptcy

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insect-in-amberThinking about filing bankruptcy?  

Folk wisdom supplies many “rules” about the time leading up to actually filing bankruptcy:

  • Don’t sell anything
  • Don’t pay anyone
  • Don’t make any money

This kind of thinking will have you frozen in time and space like this insect in amber.

Only, this folk “wisdom” is all wrong.

Here are the real concerns about your pre bankruptcy actions.

Sell stuff for what it’s worth

Bankruptcy law objects if you dispose of assets for less than they are worth.  It’s not the sale that might be objectionable, it’s the price.

When you transfer an asset for less than its real value, there is less for your creditors.  And  Anglo Saxon law since the Statute of Elizabeth in 1571 has prohibited gifts, bargain sales, or sham transfers that have the effect of reducing your assets.

Transfers where you dispose of an asset for less than its fair market value are called fraudulent transfers.

The transfer can be actually fraudulent, where you intended to hide an asset from creditors.  Or, constructively fraudulent.  Those transfers  can be innocent or even benevolent, as when you make a donation to charity.

But, if you got less in return than you gave up, it may be a fraud on creditors.

Fraudulent transfers in bankruptcy

Bankruptcy law frowns on fraudulent transfers.

The bankruptcy trustee is empowered to recover the assets or money transferred within 2 years of the filing from the recipient  if the transfer was fraudulent.

That strips the benefit of the transfer from the transferee.

In many cases, even when a transfer is fraudulent, it isn’t worth the expense to the bankruptcy trustee to recover it.  The benefit to creditors as a group is just too small or too tenuous to make it worthwhile.

But for the debtor in bankruptcy, significant transfers of assets with intent to hinder, delay or defraud creditors constitute a ground to deny an individual a discharge in bankruptcy. 11 USC 7272(2).

Sales for today’s value

You are absolutely free to dispose of assets before your bankruptcy is filed if you get “reasonably equivalent value” in return.  That’s legalese for getting what it’s worth.

Remember, it’s only worth what a buyer will give you for this particular asset, on this day, in this market.

The stuff may be worth far less now than it was when you bought it.  It may be that the market is glutted or the thing is obsolete, worn, or out of fashion.

If you get about what the market says it’s worth, you’re OK.

If you are selling on the eve of bankruptcy, just make sure that you expose the asset to the market.  That may be Craig’s List;  e Bay; Auto Trader or like marketplaces.  Even a garage sale will do.

Keep a record of the steps you took in your sales campaign.

Disclose the transfer in the bankruptcy schedules and the Statement of Financial Affairs.

And if it genuinely doesn’t have any market value, you’re free to donate it or junk it.

More

What not to do before bankruptcy

Image licensed by Anders L. Damgaard  under Creative Commons license 3.0.

Do It Yourself Bankruptcy Software Is A Trap

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bankruptcy trapGood intentions and a good education are apparently not enough for Upsolve to get the means test right.

Upsolve describes itself as a non-profit, created by Harvard Law School graduates, whose mission is to “help low-income Americans in financial distress get a fresh start through Chapter 7 bankruptcy at no cost.”

Admirable, so far.

Until you read this drivel about the means test.

When Congress changed the bankruptcy laws in 2005, income requirements were added to prevent bankruptcy abuse. You can file under Chapter 7, but if your income exceeds a certain amount in California, you are not eligible for a bankruptcy discharge.

Poppycock.  A good bankruptcy lawyer could tell you so in a heartbeat.

And yet,  someone with a heart beat wrote this promo for a piece of software. (“Software” wasn’t my first choice of words, here.)

Sadly, the public will be mislead to their detriment.

Means test misrepresented

The means test is a formula, not a table of income.  Even families with generous gross incomes pass the means test if their allowable expenses and the composition of their debt consumes that income.

Not everyone has to take the means test.

Whether you are above or below the median income is just the first sort.  Above median, you have to supply further information about your actual expenses for things beyond food, housing and transportation.

It’s your net income, according to the means test formula, that decides whether you are eligible for Chapter 7.

So, Upsolve’s statement that with a high income you can’t get a bankruptcy discharge is simply flat wrong.  And what’s the point of telling the public “you can file, but you can’t get a discharge”?

I have other bones to pick with Upsolve’s presentation about bankruptcy options and choice of chapter.  I’ve written about my take on those issues here and at Bankruptcy In Brief.  

For starters, the discussion of the choice between Chapter 7 and Chapter 13 is shallow.  But hey, these people are peddling Chapter 7, so why muddy the waters with complexity.

Wrong remedy for real problem

Upsolve does address a genuine and serious aspect of bankruptcy law since “reform” in 2005. Bankruptcy law today is unnecessarily complex.

BAPCPA, touted as “abuse prevention”, succeeded only in making bankruptcy for most consumers more complex and much more expensive.  While those with business debt or unpaid taxes got a pass.

The consequences of errors in bankruptcy became more onerous.

Yet there is no evidence that “reform” (or “deform” as I liken it) lead to better outcomes for our economy as a whole.  The means test itself was predicated on a fabrication that high income individuals were abusing bankruptcy.

Pre-deform, I occasionally recommended to clients that they forgo a lawyer and file their case themselves.  No longer; it’s not safe.

But until the law is simplified, to suggest to average folks that a software program can guide them through the bankruptcy thicket is itself dangerous.

What recourse will bankruptcy filers have when the program oversimplifies, or the vocabulary or legal constructs is just beyond their understanding?

Let’s tackle the problems in the law such that it’s safe and inexpensive for families to file for bankruptcy the way they file their taxes.

 

Bank Account Safe From Credit Card Debt

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credit card offsetPossession is 9/10th of the the law, we’ve always been told.

With overdue Bank of America credit cards, my client worried that her new deposit at B of A would be seized by the bank to pay the cards.

After all, the bank would have possession of the commission check and a common law right to set off the deposit against the credit card debt.

Not to worry.  There’s a federal law  that protects bank accounts from credit card debt.

Credit cards can not offset

Federal Truth in Lending regulations explicitly prohibit a bank who is a card issuer from appropriating your deposit account to pay your debt on a card it issued.

(d)Offsets by card issuer prohibited.

(1) A card issuer may not take any action, either before or after termination of credit card privileges, to offset a cardholder‘s indebtedness arising from a consumer credit transaction under the relevant credit card plan against funds of the cardholder held on deposit with the card issuer.

All you need to know about judgments

12 CFR 1026.12 goes on to make clear that if the card issuer gets a judgment, this provision doesn’t insulate a deposit account from a judgment levy.

Nor does it keep the bank from depleting your account if you’ve agreed to pay the card automatically by electronic transfer.

Credit cards exception to common law rule

Offset, or setoff, (they seem to be interchangeable terms) means to net out what one party owes another against a debt that runs in the other direction.

Merriam Webster defines it  this way:

the reduction or discharge of a debt or claim by setting against it a distinct claim in favor of the debtor or party who is the object of the first claim (as in a lawsuit)

This principle is a mainstay of common law.

So, the Truth in Lending provision creates a statutory exception.

Bankruptcy discharge prohibits set off

At the end of a bankruptcy case, the provisions of the bankruptcy discharge prohibit a creditor from offsetting a pre bankruptcy debt against money the creditor owes you.

Section 524 of the Bankruptcy Code reads

(a)A discharge in a case under this title—

(2) operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived;

So, if you discharged a personal loan from Bank of America, say, the bank cannot take your post bankruptcy deposits into your account to pay for the discharged debt.

All’s well

With federal law in mind, my client was able to deposit her check into her bank account, secure in knowing the bank couldn’t apply the money she needed to live on next week to pay overdue bank-issued cards.

And her bankruptcy case will wipe out the credit card debt altogether.

What You Think About Chapter 13 Is Dead Wrong

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bankruptcy misunderstanding

The difference between bankruptcy’s Chapter 7 and Chapter 13 is often expressed this way:   

Liquidation: the process of turning assets into cash

Chapter 7 is a liquidation proceeding

Chapter 13 is a repayment plan

 

And therein lies the biggest misconception about Chapter 13: 

13 does not repay everything you owe.

It’s a repayment plan alright, but not necessarily a 100% repayment .

You may not pay much at all, to any creditor.  It depends.

How much you repay

The amount you repay to creditors through your plan is determined by comparing

Rough and dirty, you calculate the number for each of these factors, and your plan must pay the largest of the three tests.  That payment is spread over 3 to 5 years.

Which creditor gets 100%

Bankruptcy law gives special standing for repayment to two common kinds of creditors.

  • Family support (alimony, child support, or other Domestic Support Obligations)
  • Recent income taxes or payroll taxes

These creditors have a priority for payment,  ahead of all other unsecured creditors.  They get paid in full.  The interest that accrues on family support obligations even survives the Chapter 13 discharge.

Therefore, to get court approval of a plan, the plan payments must be sufficient to make these payments, along with any fees of the Chapter 13 trustee and any of your attorneys fees to be paid through the plan.

Unsecured creditors out of luck

The brutal truth is that general unsecured creditors holding medical bills, personal loans, judgments for money, and credit card debt may get nothing in Chapter 13.

That’s because the available money is paid first to priority claims and the costs of administration of the case.  So a debtor with little disposable income may propose a plan that pays only the costs of the plan and the priority creditors.

Chapter 13 makes creditors face reality

The strength of Chapter 13 is that it often forces unsecured creditors to accept that there simply isn’t enough money to pay their claim.

The bankruptcy schedules show it, and the bankruptcy judge enforces it.

It is that coercive effect that makes Chapter 13 so much more effective than debt settlement:  if the numbers support it, the plan can pay them little or nothing.

So, don’t be put off by the phrase “repayment plan”.

Chapter 13 pays creditors only what you can afford, over a limited period of time, in the order of the importance of the debt.

That’s why I love Chapter 13.

More

Debt settlement is a dud

How secured debt can scuttle a Chapter 13

What bankruptcy should cost

 

 

 

 

 

 

 

Double Dipping On Retirement Savings

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double dip retirement

Any time you can double your savings and protect your money from creditors is a good time of the year.

The period between New Years and Tax Day is my favorite time of the year, just for that reason.

You can make contributions to your IRA last year AND contribute to this year’s IRA allowance.

You get a scoop of last year’s tax benefits, topped with a scoop of this year’s tax break.

You don’t have to be filing bankruptcy for this to be important.   But, this trick is a favorite of mine when I have my bankruptcy-lawyer hat on.

IRAs in bankruptcy

My goal is to maximize the value a bankruptcy client can keep through the case.

Everyone in bankruptcy can protect over a million dollars in IRA  savings.  Not that I’ve seen an IRA anywhere near that number.  But Congress says IRA savings are a good thing, and beyond the reach of your creditors.

And I’ve never faced challenge from a bankruptcy trustee when a client contributed the maximum allowed by tax law to a retirement account, even if they sold other assets to make the contribution.

IRAs for all

Tax advantaged retirement plans are grounded in federal tax law and are available to the solvent as well as the insolvent.  

IRA’s are asset protection on the cheap

Too many Americans seem to want to live in a little bubble that tells us that old age will work out OK, (somehow) whether we take responsibility for making it happen or not.

That’s magical thinking at its worst.

Unless you expect to inherit a fortune, you need to take steps now so that you are financially independent then.

Tax break opportunity is fleeting

Old age is inevitable and the tax code has an annual limit for how much you can contribute to a retirement vehicle to grow tax free.  If you don’t make a contribution equal to the limit for last year, that unused tax break is lost forever.

Between now and April 15th, take two scoops of retirement savings.  Or seed your retirement account with any tax refund from this  year.

Bankruptcy Discharge Slays IRS Form 1099

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In a duel between a Form 1099 and a bankruptcy discharge, bankruptcy wins every time.

The prize?  no tax on debt discharged in bankruptcy.

So, if you’ve already gotten your discharge, the creditor’s 1099, with your social security number on it, is no threat.

But you do need to file another form to secure the prize.

Bankruptcy is exception to tax

Normally, when an obligation is forgiven, the tax code treats the amount of forgiveness as if it were income.  And income is exposed to tax.

Insolvency is another exception to tax on forgiven debt

But forgiveness in bankruptcy in the first exception to the rule.

Debt forgiven in bankruptcy is not treated as income.

Creditor is clueless

So, if bankruptcy is outside the IRS rule, why are you getting a form 1099?

Because there’s another rule, requiring creditors to report to the IRS, just the way your employer is required to send the IRS your W-2.

And seemingly, the creditor can’t figure out that the reason its claim is worthless is because of the bankruptcy discharge.  So it’s easier for the creditor to just send out Form 1099, and make it your problem.

Fixing the 1099 problem

The solution is simple:  file IRS form 982.

Title 11 is the part of the United States Code on bankruptcy.  Cases are filed under different chapters of that title

Form 982 is your rebuttal to the report that you have taxable income because your debt was forgiven.  Check the very first box on the form claiming the bankruptcy exception.

This debt is excluded from income because of  Discharge of indebtedness in a title 11 case 

The IRS provides a set of instructions for filing  your “get out of tax” form.  Form  982 Instructions.

Other tax consequences of discharge

If you have real property, you may have to reduce your basis in assets by the amount of debt discharged in your bankruptcy.

But thankfully, there is an exception to this rule too:  no reduction in basis is required with respect to your principal residence claimed exempt in your bankruptcy case.  IRC 1017(c).

Tax action plan

So there you have the skinny on form 1099 and your bankruptcy discharge.

Bankruptcy has other tax implications:

Taxes dischargeable in bankruptcy

Unfiled tax years are never dischargeable

Chapter 13 gets an interest-free tax repayment plan

Your accountant needs to know about your bankruptcy

What to do with a flat-wrong 1099

 

No Foreclosure If Loan Modification In Process

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foreclosure roofline 650 taberandrew

The cruelest trick played on homeowners trying to modify their mortgage was dual tracking.

One side of the bank assured the borrower that their loan modification application was being considered and they didn’t need to worry.

All the while, the other side of the bank was conducting a foreclosure sale.

The borrower wakes up to find that they are no longer homeowners.

No more.

New federal rules prohibit dual tracking

Mortgage lenders are now prohibited by federal law from conducting a foreclosure while a mortgage modification application is under consideration.

Regulation X – Real Estate Settlement Procedures Act

Before a foreclosure is begun, the lender or their servicer must take steps to let the borrower know what options exist to keep the house.  The mandated timeline creates a four month interval between delinquency and starting the foreclosure in which alternatives can be explored.

Live contact with borrower

Mortgage servicers must attempt to make live contact with borrowers who become delinquent within 36 days of the delinquency.  A voicemail message doesn’t cut it.  Reg. X §1024.39

The servicer must describe the kinds of loss mitigation options that are available and they must establish a single point of contact for the borrower with the servicer.  Reg. X § 1024.40

No foreclosure can be instituted until 120 days have passed from the first delinquency.  More importantly, if a complete loan modification application has been submitted to the the servicer by the 120 day point, no foreclosure can be begun.  Reg. X §1024.41

Last minute help

If the borrower misses the 120 day deadline for submitting a loan modification application, there’s still protection in the new rules.

If a loan mod application is made more than 37 days before the foreclosure sale, the servicer cannot conduct a foreclosure sale until it issues a decision on the application.

The new rules deal with a myriad of variations on these timelines.  The theme in the rules is consistent:  federal law requires a decision on a loan modification application before the foreclosure train chugs down that track.

If the servicer breaks the rules

The new rules have teeth.

Borrowers who believe their servicer has failed to follow the rules can sue the servicer.  If you can prove your case, you can collect your actual damages as a result of the violation; your costs of suit; and your attorneys’ fees.

These regulations implement provisions of the Dodd Frank legislation; they became effective January 10, 2014.

Another arrow in homeowner’s quiver

These rules do not preempt other rights that homeowner’s have in this arena that give them greater rights.

Like any new law, we will have to see how they work over time.

While the rules don’t require servicers to modify loans, they do require servicers to refrain from foreclosing while a loan modification application is pending.

Image courtesy flickr and taberandrew.

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Suite 403
Redwood City, CA 94063
Phone: (650) 694-4700

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