Chapter 7 Bankruptcy Options for Business Owners - Part I

In Part 1 of a 2-part series discussing Chapter 7 bankruptcy options for business owners, I will discuss options available for self-employed business owners in California that need to file for bankruptcy but who may not be good candidates for repayment plans under Chapter 11 or Chapter 13 of the Bankruptcy Code. Part 2 will discuss how owners of an existing corporation might be able file personal bankruptcy and form a new corporation in order to stay in business. This article is intended primarily for debtors and business owners in California because it is based on my experience with California law and the bankruptcy exemptions available to California residents.

As the economy continues to worsen, I am seeing an increasing number of self-employed business owners facing a crushing amount of debt and no place left to turn. In some cases, my clients have owned their businesses for 20 years or more and have no sense of what the job market might hold for them if they were to close the doors of their business. As a result, I find many business owners in a position of owning a business that could generate a reasonable income…except for that little inconvenience called debt.

Where I practice, self-employed debtors are not allowed to use property of the bankruptcy estate to generate income without the express written consent of the trustee or a court order. Shutting down for an indefinite period of time is not an option for business owners because they could quickly lose their customer base and a viable alternative is needed.

With few exceptions, most self-employed debtors I see would be better off incorporating to take advantage of tax deductions not available to sole proprietors. After incorporating the business, the debtor then transfers all of the business assets to the new corporation in exchange for the issuance of the corporate stock. The value of the new corporation is typically very small and the debtor can usually claim the shares of stock as exempt when filing for bankruptcy.

Under the law, a corporation is a separate entity from the debtor and can continue to operate despite the bankruptcy of the owners. Unless the bankruptcy trustee decides to run the corporation to generate income for the creditors or to sell the business, the debtor will remain in control of the business and continue to receive a salary as an employee. The valuation of the new company and the risk of it being sold for the benefit of creditors is something that should be discussed with a qualified bankruptcy attorney prior to filing for bankruptcy. I have employed this strategy successfully for a number of Chapter 7 debtors.

When the bankruptcy is filed, the debtor will list the shares of stock in the new corporation as an asset. The transfer of assets to the corporation will also be disclosed. In most cases, the corporation will be of little value to the trustee. Upon completion of the bankruptcy, entry of a discharge and closure of the case, the corporation will belong to the debtor. The debtor will have their business and a fresh start on a pathway to success.

The information provided in this article is general information only and is not intended as legal advice. DO NOT use this information as a substitute for obtaining qualified legal advice or other professional help. If you are a business owner in Southern California with debt problems, please contact us for a free consultation to see how we might be able to help you.

About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar, the San Diego County Bar Association and the National Association of Consumer Bankruptcy Attorneys. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.

Getting What You Need From Bankruptcy

The United States Supreme Court once said that the principal purpose of the Bankruptcy Code is to grant a ‘fresh start’ to the ‘honest but unfortunate debtor’. This reminds me of a Rolling Stones song that tells us that “You can't always get what you want. But if you try sometime, you find you get what you need.” This sentiment is often true in bankruptcy and sometimes debtors have unreasonable expectations of what bankruptcy can do for them.

In any type of bankruptcy, I tell potential clients that the 4 most important elements of any possible bankruptcy case are: (1) income; (2) expenses; (3) assets; and (4) debts. This information tells me what type of bankruptcy the debtor may wish to file, what property they might lose in a bankruptcy proceeding and what debts the court will discharge. While the vast majority of my clients keep nearly all of their assets, there are limits to what bankruptcy can do and sometimes debtors must make necessary sacrifices.

I have seen debtors fall behind on their house payments while paying hundreds of dollars per month keep luxury items such as a motor home, a boat or a vacation home. Bankruptcy is a court of equity and clean hands, so debtors cannot expect to walk away from tens of thousands of dollars in credit card debt while shelling out excessive payments to keep luxury items like a yacht or a second home. If a debtor is unwilling to make the necessary lifestyle changes and budgetary adjustments, then qualifying for bankruptcy will be an uphill battle.

If an “honest but unfortunate debtor” files for bankruptcy, chances are they won’t get everything they want. The desert toys and the fancy SUV with the $950 payment may need to go away. But if the debtor follows the rules, they make get what they need: debt relief and a fresh start.

About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar and the San Diego County Bar Association. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.