Unfortunately, owning a business doesn’t mean you can’t run into personal financial trouble. If you have too much debt to handle, a bankruptcy can help you wipe the slate clean and start over. But will a personal bankruptcy affect your business?

Personal Bankruptcy And Your Business

The effect of a bankruptcy on your business will depend on the type of bankruptcy you choose to file and the way your business is organized. Small businesses are typically organized in one of four ways:

• Sole Proprietorship: A sole proprietorship is unincorporated and has one owner. The business and owner are treated as the same entity, meaning you pay personal taxes on the income the business generates and the business doesn’t pay any taxes separately. The owner is liable for any debts the business incurs.
• Partnership: Two or more owners run the business together, with all partners contributing money, labor, property, or other assets. Each partner pays personal taxes on their portion of the income from the business. Partners are liable for the entire amount of the debts of the business – not just their proportional share.
• Limited Liability Company (LLC): An LLC is its own entity, separate from the owner(s). It must pay taxes and owners are not liable for the business’s debts.
• Corporation: A corporation is a separate legal entity owned by shareholders. Corporations pay their own taxes and shareholders are not liable for the business’s debts.

Chapter 7 Bankruptcy And Your Business

Chapter 7 is “liquidation” bankruptcy – your non-exempt assets are sold and used to pay creditors. You keep your exempt assets and the rest of your debts are discharged. Where does your business fit in?

• If you have a sole proprietorship, you and your business are considered one and the same entity. The business’s assets are also your assets. If they’re not exempt, the trustee can sell them to repay your creditors.
• If you have a partnership, you and your business are considered the same entity just like a sole proprietorship. However, you share the business assets with your partner(s). The trustee can in theory sell those assets with approval from the court, but that approval isn’t very likely to be forthcoming because it isn’t fair to the other partner(s). However, the trustee may be able to sell your entire share of the partnership if he or she can find a buyer for it.

If you own an LLC or a corporation, things are a little more complicated. The business’s assets are safe from the bankruptcy trustee. Your ownership interest, on the other hand, is part of your bankruptcy estate. If you can’t protect it with an exemption, the trustee can do one of four things, depending on what produces the most value for creditors:

• Liquidate: Sell the business assets, pay off its debts, and use the remainder to pay creditors
• Sell: If there’s a buyer, the trustee can simply sell your ownership interest
• Operate As A Going Concern: With the court’s permission, the trustee can allow the business to continue to operate so it can be sold as a going concern
• Abandon: If there’s no buyer or if the business’s debts are greater than its assets, the trustee can simply ignore the business and you’ll still own it

Chapter 13 Bankruptcy And Your Business

In Chapter 13, you’ll work with the bankruptcy court to create a 3-5 year payment plan based on your income. You’ll make monthly payments and the court will distribute it to your creditors. In general, this won’t affect your ownership in your business. However, remember that if your business is organized as a sole proprietorship or a partnership, you and your business are inseparable in the eyes of the law. That means any income the business makes will be considered your income and will be part of the payment plan.

Chapter 13 May Not Be An Option

While Chapter 13 is safe for your business, it may not be available to you. To qualify for Chapter 13, your payment plan must result in your creditors getting at least as much money as they would if you filed for Chapter 7. So, the court will look at what assets would have been sold off in Chapter 7 to pay your creditors.

Say you have a sole proprietorship with assets valued at $100,000 and liabilities of $20,000. The assets are worth $80,000. Or say you own a corporation worth $80,000. Assuming no exemption applies and there’s likely to be a buyer for the assets, that means your creditors would get at least $80,000 under Chapter 7. If your payment plan doesn’t result in at least $80,000 worth of repayment, you’ll have to file under Chapter 7.

A lot of the issue depends on how “liquid” the assets (either your business assets or your ownership) are – how easy it is to turn them into cash. Illiquid assets may be valuable, but they’re not easy to sell and the court won’t be able to say how much your creditors would have gotten in a Chapter 7. Basically, things can get complicated quickly. You’ll need to work with an experienced attorney to determine whether you’re likely to qualify for Chapter 13.

Other Complications

The effect of a personal bankruptcy on your small business is complicated enough if you’re the only owner – the value and liquidity of your assets or ownership may be very difficult to evaluate. Things get even more complicated if you have a partner or if you’re not the only owner of the LLC or corporation. If that’s the case, the court will have to decide how to handle your bankruptcy without being too unfair to the other owners – it can get very complex, very fast. You’ll need an experienced bankruptcy attorney to help you navigate the case and minimize the impact on your business.

The Bottom Line

Starting a business is no small feat, and you certainly want to protect what you’ve worked so hard to build. If you’re considering a personal bankruptcy, contact us today for a free consultation to learn about your options for handling your personal debt while protecting your business.

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Last updated March 30, 2017.

Bankruptcy procedures and rules differ for different filing parties and different types of bankruptcy. Chapter 11 bankruptcy is usually reserved for large businesses who want to rework debt. The goal is to reorganize the filing companies’ finances and let them start fresh after the bankruptcy process. In many cases, businesses who enter Chapter 11 will do so to get out from under unfavorable labor deals, or long-term contracts.

By contrast, Chapter 7 bankruptcy is reserved for individuals. While a corporation can technically file a Chapter 7 case, only individuals can receive a discharge in Chapter 7 bankruptcy, so there is rarely any point.

A Brief Chapter 7 Overview

When you file under Chapter 7, the automatic stay goes into effect to stop foreclosure, repossession, and any collection against pending against you. Your non-exempt assets are potentially subject to sale by the bankruptcy trustee.

In theory, the trustee liquidates (sells) your assets and uses the proceeds to pay your unsecured creditors. However, in most cases, our clients file for Chapter 7 and are able to retain all of their property. At the end of this 3- to 6- month process, your remaining unsecured debts are discharged. That means you walk out of bankruptcy debt free and can start again.

See also: Do I Qualify for Chapter 7 Bankruptcy in Ohio?

How Popular is Chapter 11 in Dayton?

Ohio is among the top 10 states for bankruptcy filings. Why? Well, we were hit particularly hard in the recession and took a bit of time to recover.

However, things are looking up. The amount of local bankruptcy filings have been on the decline in recent years, however, people (and businesses) still need help.

Last year, there were 4,105 new bankruptcy filings in the United States Bankruptcy Court Southern District Ohio’s Dayton office. Of those, most (about 70 percent) were Chapter 7 cases. Following that were Chapter 13 cases, which accounted for fewer than 1 out of every 3 filings. Meanwhile, just one Chapter 11 bankruptcy was filed in Dayton in 2016.

Bankruptcy Options for a Corporation

If you start a business, you may choose to run it personally as a sole proprietorship. In that case, the business is essentially an extension of you. Its assets are your assets, and its liabilities are your liabilities.

You may also choose to form a corporation or an LLC (limited liability company) to help shield your personal assets from the risk of running a business. Once you incorporate or create an LLC, the business becomes its own entity with its own assets and liabilities. You and any other owners hold stock in the company.

Although the corporate form is recognized as a separate entity that can incur debt and hold assets in its own name, as a practical matter, lenders require you, the owner, to personally guarantee corporate debts. As we mentioned above, large corporations will often seek to restructure under Chapter 11. Small business owners will likely find this to be a waste of time, especially if they don’t plan to continue operating the business.

Individual Chapter 7, Corporate Dissolution

The best play when your small corporation plans to go out of business is to file personal bankruptcy, then dissolve the corporate entity. The personal Chapter 7 will discharge your personal guarantee, and the dissolved corporation will cease to exist. From there, you can start over with a new entity, but your old business debts will no longer be a factor.

Bankruptcy is tough, but you have options. If you’re a small business or corporation owner, the last thing you want to deal with is figuring out all the paperwork and plans associated with a bankruptcy on your own.

At Cope Law Offices, we can help you decide if bankruptcy is right for you, and determine the best way to file. We have four convenient locations — Dayton, Mason, Springfield, and Vandalia — to assist you with all your bankruptcy needs. Contact us today for a free case review.

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BANKRUPTCY AND DIVORCE

When it comes to marriages, few things have the magnetic ability to drag down a relationship like the gravitational pull of debt.  Given that debt is a major contributor to marital disenchantment, it is no wonder that bankruptcy and divorce seem to intermingle like old friends.  Though divorce and bankruptcy often meet, both actions are entirely separate from each other and often create problems due to the nature of each action.  If you are considering bankruptcy and divorce—regardless of the order—be sure to consider how bankruptcy and divorce cross paths.

How does bankruptcy interact with debt and property division in a divorce?

To answer this question, the first step is to understand that a final judgment and decree of divorce divides all property and marital debt between the parties.  The court can do this in a multitude of ways, but the end result is that the court allocates specific property and specific debts to each party.  While this sounds straight forward, it is wise to remember that divorce actions bind the parties to the divorce decree, NOT the creditors.

For example, assume that Husband and Wife reach an agreement on the division of their marital debt.  Husband agrees to retain any debt incurred solely in his name and Wife agrees to retain any debt incurred solely in her name.  Prior to the divorce, Husband and Wife co-signed a loan to finance their house, and the house was used collateral for the loan (a basic mortgage).  Their divorce decree orders that Wife retain the home and that Husband transfer his interest in the home to Wife.  Wife is to hold Husband harmless on any debt still owed on the loan.  Husband transfers his interest in the property to Wife.  Subsequently, Wife misses a few monthly payments on the home loan and decides to file a Chapter 7 bankruptcy.  Wife does not reaffirm the house loan debt.  Wife’s Chapter 7 bankruptcy is successful, and she receives a discharge of the debt associated with the house loan.  Is the house loan debt fully extinguished since Wife’s debt was discharged through bankruptcy and Husband’s debt was removed in the divorce decree?  NO!!!

The divorce decree does not affect a creditor’s right to collect a debt.  Since Husband co-signed the loan, he is still responsible to the creditor for the debt.  Even though the home was likely sold by the trustee as a result of Wife’s bankruptcy, the creditor will still be able to collect any remaining deficiency from the husband.  The language of the divorce decree DOES NOT affect the creditor’s right to seek repayment of the debt.

However, Husband may be able to take Wife back to the court that granted the divorce since Wife was to hold Husband harmless on the debt.  This presents a problem for Wife because, even though her debt was discharged in bankruptcy, she has an obligation in another court to hold Husband harmless on the debt.  Essentially, Wife may still have to repay the debt, but her obligation could only be to Husband, not the creditor, since Wife’s debt to the creditor was discharged in her chapter 7 bankruptcy.

On the other hand, if the decree of divorce did not order Wife to hold Husband harmless on the debt, then Wife could discharge her debt through the bankruptcy without any obligation to Husband.  Husband would remain responsible for the debt on the loan, and the creditor could still seek a judgment against Husband for the debt.

The lesson:  The possibility of Bankruptcy should always be considered in divorce because divorce alone does not severe a party’s obligation to a creditor.  Divorce binds parties, not creditors.

Can bankruptcy discharge spousal support, child support, attorney fees, or property settlements that were ordered in a divorce decree?

Domestic support obligations are not dischargeable in bankruptcy.  Spousal support and child support are considered domestic support obligations.  Support obligations will remain after a chapter 7 or chapter 13 discharge.  Even though these obligations are not dischargeable in bankruptcy, trustees in a Chapter 13 bankruptcy may allow these obligations to be paid outside of a chapter 13 bankruptcy plan.

In general, attorney fees awarded as a result of a large disparity in income between the two parties are considered support obligations.  However, there are circumstances where attorney fees are not for the purpose of support.  Such instances are factually driven and may result in a discharge of the debt through bankruptcy.

As for property settlements, these are dischargeable through bankruptcy if the property settlement is not for the purpose of support.  For example, if Husband is to pay Wife $200 every month for ten months as part of a property settlement to compensate Wife for a car that Husband retains, then that $200 per month is dischargeable in bankruptcy.  On the other hand, if Husband is to pay $200 per month for ten months by way of spousal support, then that obligation is not dischargeable due to its classification as a domestic support obligation.

Should bankruptcy be filed prior to a divorce?

Filing for bankruptcy prior to a divorce may be beneficial.  Prior to a divorce, parties have the option of filing a joint bankruptcy as well as individual bankruptcies.  In the event that both parties owe creditors jointly, a joint bankruptcy may be a beneficial option.  If a divorce or separation action has not been filed, then bankruptcy can function as a mutual friend to eliminate joint debt.  This often aids in the distribution of property inherent to divorce actions.    Though bankruptcy does not distribute marital property, it can often eliminate substantial amounts of marital debt.  Accordingly, this simplifies the debt distribution in divorce.  Also, spouses can save filing fees and attorney fees by filing a joint bankruptcy.

Yet, filing jointly requires joint decisions.  If both parties are unable to agree upon a bankruptcy plan, then filing jointly is certainly not an option.  Once a divorce case is filed, there is a high probability that both parties will not be able to agree upon issues relating to the bankruptcy.  For example, both parties may disagree as to the length of their chapter 13 plan or as to whether to reaffirm certain debts in a chapter 7.  Further, bankruptcy attorneys are prohibited from representing clients with adverse objectives.  Thus, divorce often limits the ability of spouses to file jointly.

If one spouse does not want to file for bankruptcy, then the other spouse may still file for bankruptcy.  A divorce action does not prevent either spouse from filing a joint bankruptcy, prior, during, or after a divorce.

What happens when bankruptcy is filed during a divorce?

Many times a divorce action is filed prior to a bankruptcy.  In the event that one spouse files a bankruptcy after the filing of a complaint for divorce, the court hearing the divorce must abide by the bankruptcy court’s automatic stay.  However, the court hearing the divorce may still equitably divide property once a motion for relief of the automatic stay is filed and granted in the bankruptcy court.

Though a relief from stay may be granted, it is still important to remember to address bankruptcy issues in the final decree of divorce to avoid unexpected obligations relating to marital debt.  Even if a court of equity divides marital debt, creditors may assert claims against parties based on their rights as creditors.  Often times, a failure to properly address bankruptcy issues in divorce decrees leads to post decree motions for compensation because one spouse must hold another spouse harmless on certain debts.  This creates an obligation in a domestic relations court that is not consistent with the obligations of creditors and debtors.  Thus, one spouse could potentially be forced to reimburse a spouse for a debt discharged in bankruptcy if not properly addressed.

Image from Flickr user Rusty Clark

To schedule your free consultation, contact Cope Law Offices, LLC.

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Rule: Judgment debts incurred by defalcation of a guardian are non-dischargeable in bankruptcy, as are judgment debts for willful and malicious injury.

At the end of a successful bankruptcy process, your unsecured debts are discharged. This includes credit card and medical debt. There are exceptions, however, such as student loan debt, which is generally non-dischargeable. Another exception is debt due to a judgment against you for willfully injuring another person or his property. That judgment will stick with you through bankruptcy.

The story of In re Pierce, 2013 WL 1867606 (Bankr. S.D. Ind. 2013)

David suffered from a mental disability that made him unable to manage his personal needs or his residence without assistance. Aware that the condition of his home had degraded below acceptable standards, he sought out legal and financial help from Mary. In 2005, the court appointed her as David’s permanent legal guardian. They worked well together for a while, but David became increasingly dissatisfied with Mary’s guardianship and finally petitioned to have her removed as his guardian. The court denied his request and he appealed. In re Guardianship of Stalker, 953 N.E.2d 1094 (Ct. App. Ind. 2011).

Two weeks after David’s petition, Mary filed a complaint against him with the Board of Health. She brought a Health Department inspector to his home and the inspector determined that David’s house was “unfit for human habitation.” The Health Department notified David that had to complete certain repairs within ten days or vacate his home. When Mary received notice of the order, she moved David to an apartment in a town ten miles away, even though his only mode of transportation was a bicycle and it was the middle of winter. Id.

As spring approached, David asked for the keys to his house so that he could begin to clean and repair it. Mary refused. She wouldn’t give him the keys until he had cleaned up the outside. Friends and church members helped him clean the yard and make minor repairs. At the next court hearing over Mary’s guardianship, David presented the court with several photos documenting the progress he had made on his home. Mary admitted that he was “getting close” to a clean exterior and told the court that she would be willing to give the keys to a third party who could supervise David’s cleanup of the interior. Id. at 1099.

One week later (incidentally, the day before David’s birthday), he rode his bicycle into town to mow his lawn and work on his home. When he arrived, a wrecking crew had torn into the back of his home – Mary had ordered it demolished in order to sell the property. Id. at 1100. She told the wrecking crew it was condemned. David “found his framed World War I enlistment photo of his grandfather, which had previously hung in his dining room, lying on the ground in pieces.” Id.  David was beside himself; a nearby acquaintance heard him screaming and came running. He helped David enter the house to grab a few personal items and some family photos. Then police escorted David off the property and the wrecking crew did their work. Id.

Mary never told David that she was having his home demolished, so he had no chance to fight the demolition and no chance to retrieve his personal belongings. Mary asked for and received court approval to sell the property over David’s objections, then sold it for $37,000. She spent the proceeds on a prepaid funeral plan and a scooter, both of which David explicitly opposed. Id. at 1101.

David brought suit against Mary for violation of his personal and property rights. The evidence showed that the Health Department had never actually condemned David’s house. Mary claimed that demolition increased the property value by a factor of ten, but according to her testimony, she had only obtained a drive-by appraisal from a realtor friend. Id. at 1104. A local market analysis report indicated that the property, which was centrally located, could have been worth anywhere from $35,000 to $200,000. For something as serious and permanent as demolishing David’s home and selling the property, Mary should have sought court approval. Id. at 1107. The court found her liable to David for destroying his home. Id.

Faced with a judgment against her and other personal financial troubles, Mary filed for chapter 7 bankruptcy before the amount of damages was determined. David filed a complaint to ensure that the judgment in his favor was nondischargeable. In re Pierce, 2013 WL 1867606 (Bankr. S.D. Ind. 2013).

A debt incurred through the defalcation of a guardian is nondischargeable according to 11 U.S.C.A. § 523(a)(4). Defalcation is “something more than negligence or mistake but less than fraud.” Id. at 3, quoting Follett Higher Educ. Grp., Inc. v. Berman (In re Berman), 629 F.3d 761, 766 n. 3 (7^th Cir. 2011). Mary worked actively against David, “taking unilateral decisions without keeping [David]’s best interests at heart.” Id. at 4. She caused the loss of almost all of his personal property, including family heirlooms; David was so distraught over the destruction that he fled to Indianapolis and was homeless for a time. Id. Mary’s actions were intentional; the judgment against her was incurred through her defalcation and so was nondischargeable.

Like debt incurred through the defalcation of a guardian, judgment debt resulting from a willful, malicious injury is nondischargeable. § 523(a)(6). A willful and malicious injury is “(1) a tortious injury, (2) committed willfully, and (3) committed maliciously.” Id. at 5, quoting Birriel v. Odeh (In re Odeh), 431 B.R. 807, 817 (Bankr. N.D. Ill. 2010). The court determined that Mary had maliciously and willfully injured David and his property, acting “in conscious disregard of her fiduciary duties to [David] in circumstances in which injury was substantially certain to result from her intentional actions.” Id.

So, under both § 523(a)(4) and § 523(a)(6), Mary’s judgment debt to David was nondischargeable. She treated him badly, destroyed his home and personal property, and then tried to escape paying him what she owed. You can’t escape a punishment for breaking the law by filing for bankruptcy.

To schedule a free initial consultation with an attorney, please call 937-401-5000 or , or contact us online.

Image from Flickr user Alan Cleaver

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