What Courts Look For In Chapter 13 Bankruptcies

This blog was originally posted on Forbes. Click here for the original link

Small business owners contemplating bankruptcy typically have two choices: filing under Chapter 7 of the U.S. Bankruptcy Code, which means liquidating your business and walking away, or using Chapter 13 to reorganize personal debts, allowing you to leave more money in your business so you can make it through the lean times. (Sole proprietors may be able to use Chapter 13 to reorganize their business debts, not just their personal debts, but that’s a subject for another article.)

If you’ve decided you’re done with your business and are ready to wind it up as painlessly as possible, Chapter 7 is the clear choice for you. If you’d rather use bankruptcy to get through a rough patch so you can keep your business alive, finding a way to file a personal bankruptcy while keeping your business intact is the way to go

However, Chapter 13 might not be right for every business owner, and may not be available, either. Here are some points the courts will consider in weighing your Chapter 13 proposal. They’re worth your consideration before you file, too.

Strict Eligibility Requirements

First, it’s important to note that you can only file a Chapter 13 bankruptcy in your personal capacity — business entities aren’t eligible. This means, barring any business debts you took on personal liability for, you won’t be able to reduce or otherwise alter your business debts under Chapter 13. Whether you’ll be able to use a Chapter 13 bankruptcy to prop up your small business is highly dependent on your specific situation; you’ll need to speak with your accountant and an experienced bankruptcy lawyer to make that determination

Second, even for individuals, there are certain eligibility requirements. Your income has to be below your state’s median, or you need a high enough debt-to-income ratio, in order to qualify. You’ll also need to be realistically able to meet a payment plan, determined by your bankruptcy trustee, in which you’ll pay off your debts (or a reduced amount) within three to seven years.

Three Types Of Debt: Priority, Secured & Unsecured

If you qualify for a Chapter 13, your trustee will — in consultation with your creditors and your attorney — arrange a payment plan according to the various types and amounts of debt you have. At the top of the list will be your priority debts, which generally includes any taxes you owe and the cost of your bankruptcy, meaning the cost of court filings and your lawyer and accountant’s fees (otherwise, lawyers and accountants might be reluctant to take on clients going through bankruptcies)

Priority debts won’t be reduced in a Chapter 13 bankruptcy, but you’ll likely get an extended time to pay them. That is, you won’t get a tax break, but you may be able to pay them more slowly than you otherwise would — and that will mean improved cash flow, and may ultimately mean more money in your pocket.

Next in line are secured debts, which are any debts in which the creditor/lender has the right to collect property as collateral. Car loans and home mortgages are the most common type of personal secure debts; if you don’t make your loan payment, the bank can foreclose on your home or repossess your car. You’ll also typically need to pay these in full, but again, you’ll have an extended period. So while you won’t ultimately save on your home mortgage, for example, you’ll have three or more years to get current before you have to worry about foreclosure.

Note that in a Chapter 7 or liquidation bankruptcy, your primary residence is treated very differently from other property. You’ll usually be able to keep your home in Chapter 7 even if you’re never able to get current on your mortgage payments. On the other hand, you’ll likely need to liquidate most of your other assets, and there may be other complications. Deciding between a Chapter 13 or Chapter 7 bankruptcy is something you should discuss carefully with your lawyer and accountant.

Finally, there’s your unsecured debt. This is the majority of “consumer debt,” including credit card debt and personal loans, and these debts will not only receive the same extended payoff treatment as priority and secured debts, but will also likely be reduced in a Chapter 13 bankruptcy — sometimes significantly. Reduction in overall amount and monthly payments of unsecured debts is often where small business owners see the biggest advantage from filing a personal Chapter 13 bankruptcy.

The Small Business Bankruptcy Balancing Act

For independent business owners, keeping your personal and business finances in balance is difficult in the best of times. When business is slow, the shortfalls — and the decision-making — become even more fraught. Don’t let yourself feel trapped, though, no matter what the situation: There are a number of options you may not have thought of that can help get you, your family and your business through to brighter times.

No one dreams of bankruptcy when they start their own business, but bankruptcy can be a realistic way to keep your business dreams alive.

The information provided here is not legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation.