Bankruptcy is a very
complicated interplay of several laws and should not be
undertaken without adequate representation. Do not use
document preparers or attorneys who do not practice
bankruptcy law full time. Most bankruptcy lawyers
offer free or very low cost initial consultations.
Is your business is in trouble? How
do you determine if bankruptcy is necessary or even helpful in
your situation?
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Type of Entity: is the business a corporation, partnership
or a sole proprietorship?
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Challenges of a
partnership bankruptcy
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Should the business be reorganized or liquidated?
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Possible pitfalls for management
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Does management have the resources and desire to engage
in the reorganization process?
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Is the business one that the owners could start up again
after a liquidation of the current business?
◙
When Chapter 7 the bests choice for the
company/shareholders/owners
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Bankruptcy and Taxes - An Accountants Viewpoint, © by Greta
P. Hicks, CPA
Type of Entity:
is the business a corporation, a partnership, or a
proprietorship?
Corporations and partnerships are
legal entities separate from their shareholders or partners.
They can file Chapter 7 or Chapter 11 bankruptcy in their own
right.
Proprietorships are just an
extension of the owner: they can't file bankruptcy alone: the
proprietor must file bankruptcy, since the assets and the
liabilities of the business are really just one form of assets
of the proprietor. The individual owner may file Chapter 7,
Chapter 11 or Chapter 13 (if the debt limits are met).
Challenges of a partnership bankruptcy
In a partnership's Chapter 7 case,
the trustee can sue the general partners of the partnership if
the partnership's assets are insufficient to pay all claims
for the amount by which the partnership assets fall short of
partnership debts. 11 U.S.C. 723. As a result, partners may be
facing a suit by a trustee suing for the benefit
of all creditors of the partnership.
Should the business be reorganized or liquidated?
To answer this question, you have
to know what has caused the problems the business now faces
and what are the prospects for change:
-
Reorganization can't create a
market; increase gross revenue, or make up for a poor fit
between the skills available and the skills required to run
the business.
-
Reorganization could free up
cash from servicing the old debt to permit current
operations; permit rejection of leases or contracts that are
no longer advantageous (an expensive facility lease or
improvident equipment purchase); or prevent the loss of
vital assets or cash to creditor collection actions.
In between Chapter 7 liquidation
and reorganization, a Chapter 13 or Chapter 11 could provide a
breathing space for the owners to sell the business as a going
concern or or its assets in something other than a fire sale.
The resulting proceeds could pay taxes or unpaid salaries;
sale of the business could provide ongoing jobs for the work
force under new ownership. The bankruptcy could then be
converted to Chapter 7 or dismissed if bankruptcy protection
is no longer needed. The court will probably condition
dismissal of the case on payment to creditors of the sale
proceeds.
Possible
pitfalls for Management.
The companies owners and officers
need to know when business isn't going well. When
management is evaluating survival strategies and contingencies
for closing, consider the following:
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How much of the business debt is
secured? The division of debt between secured and unsecured
guides what reorganization can do for the business.
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Is this debt secured? Hidden
traps in proceeds from collateral Misuse of the the proceeds
of a secured creditor's collateral can create a non
dischargeable debt for the individuals involved.
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Trust fund taxes are non
dischargeable: When an employer deducts taxes and social
security contributions from employee wages, the employer
becomes a fiduciary for that money which belongs to the
employee. "Loaning" the business the money due Uncle Sam
from employees' paychecks makes the responsible corporate
officers personally liable for the trust fund taxes not paid
to the taxing authority. Sales taxes are trust fund taxes in
some jurisdictions, as well.
Payments to insiders on old debts
may be recoverable as preferential payments once the
bankruptcy is filed. Repayments to relatives and
business decision makers on their claims against the debtor
can be recovered by the bankruptcy trustee under certain
circumstances.
Does management have the resources and desire to engage in
the reorganization process?
Bankruptcy reorganization in
Chapter 11 requires significant time on the part of the owners
and managers to comply with the requirements of the bankruptcy
system. This option is far from inexpensive. The
business must have a very viable future in order to seek this
remedy. Most reorganizations fail, usually for lack of
the ability to stick to a budget, or to control the events and
costs that forced the company into a bankruptcy. Many
times the Debtor's owner has no real idea how much time and
effort goes into a successful chapter 11.
The value of the bankruptcy for
the company and its owners/shareholders is that, in exchange
for the protection of the automatic stay and other bankruptcy
protections, the debtor provides full disclosure of its
financial condition to creditors and the court, both at the
beginning of the case and on a monthly basis in a form of a
income and expense statement, and operates as a fiduciary for
its creditors while the bankruptcy is ongoing. Meaning
that the owner of the company must make decisions for the
benefit of the creditors, not for his own benefit.
Is the business one that the owners could start up again after
a liquidation of the current business?
Businesses that require little
capital, have few assets, or are really just extensions of the
owner's skills and personality are ones that it may not pay to
reorganize. The owners may be better off liquidating the
business, in or out of bankruptcy, and starting over in a
fresh entity.
This can be a complex issue and
requires good professional advice to do correctly.
When Chapter 7 the best choice for the
company/shareholders/owners?
A Chapter 7, whether for the
individual or a corporation, may be the best choice when
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the business has no future,
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it has no substantial assets or
qualities that cannot be reproduced, or
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the debts are so overwhelming
that restructuring them is not feasible.
Individuals can get a discharge of
the dischargeable debts and a chance to start over.
Corporations don't get discharges, but a Chapter 7 can provide
an orderly liquidation under the direction of the trustee and
at no expense to the debtor. Creditors are assured that they
will be paid to the extent of the assets available and the
priority of their claim. Former management is assured that the
assets that are available go (after the expenses of the
Chapter 7) to pay taxes for which the individuals may be
liable.
Copyright 1999-2000
Cathleen Cooper Moran of
The Moran Law Group,
Findlaw
