Episode 445: Is Bankruptcy Right for Me or My Business?

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Bankruptcy is something the public hears about often. Most of the time, the news and media focus on big corporations or well-known wealthy individuals. Sometimes it may seem that certain corporations or individuals survive, and maybe even thrive after bankruptcy. It is not true that people or businesses can get richer through bankruptcy. Filing bankruptcy is, in fact, a serious issue.

Determining whether filing bankruptcy is the right move for you or your business is critical before moving forward. Bankruptcy is intended to be an option provided by the government to help people and businesses that are struggling to overcome large debt, but depending on the specific circumstances, bankruptcy is not for everyone.

From the moment you are even considering bankruptcy for yourself or your business, it is strongly suggested to make an appointment with a bankruptcy attorney for advisement of the right steps to take, when to take them, and what to expect.

Why Bankruptcy Exists

Bankruptcy is designed for people and businesses that are in debt to too many creditors and just cannot pay everybody. The underlying policy for bankruptcy is helping the debtor settle some, if not all of their debt in an organized fashion, attempting to ensure that most of the creditors with valid claims get something back.

For example, let’s say a debtor has several creditors. Some of these creditors could be suppliers or vendors, government taxing authorities, contract laborers or service individuals. It is not uncommon to have outstanding debt with multiple entities simply because cash-flow was not good enough to pay off everyone and the debtor prioritized some over others for whatever reason. Without bankruptcy, all creditors would likely be pursuing the debtor with their own resources and remedies, and the debtor would have to deal with each of them separately. This is a daunting task. And in some cases, the most aggressive creditors aren’t the ones that have superior right to be first-in-line to be repaid. Preferential treatment of one creditor over the other can have some long-lasting negative consequences. Instead, bankruptcy court offers an organized manner whereby the debtor and all the creditors must join together to figure things out.

The Potential Upside of Declaring Bankruptcy

While declaring bankruptcy for yourself or your business is not for everyone, there are some reasons why people tend to think it has an upside:

• Automatic stay. In bankruptcy there is something called an automatic stay. When a debtor files bankruptcy, the court will bar creditors from any further collection actions until the court eventually approves them doing so.
• Some people see a big financial mogul in the public eye that has filed bankruptcy and appears to still be doing really well with both money and even high public opinion. Individuals wonder why that person is still rich and having their image on the front of magazine covers. As glorified as some famous people make bankruptcy seem, the main thing to note is that bankruptcy is a cumbersome, expensive and stressful process. A lot of personal and financial information is shared with the court and the parties involved. And, ultimately, the debtor’s creditors still get paid something. So no matter how the media may spin it, no debtor in bankruptcy gets off scot-free.
• Immunity Toward Future Wages. When a person declares bankruptcy, it protects that person’s future wages. In other words, if I am quite talented and have the potential to earn a good wage, but I have current debts I can’t pay, I can file bankruptcy and use my current assets to pay creditors. Once my bankruptcy case is discharged, I can then go on to earn more money without having to promise those future wages to any of the previous creditors. This aspect of bankruptcy is important, because without it, productive members of society would not have incentive to continue working because their efforts would be just for the purpose of paying their creditors without having anything in it for themselves.

Can I get Rich by Filing Bankruptcy?

There is not a scenario where an individual or business can get rich by filing for bankruptcy. The system just does not work that way. A person or business may already be rich and have lots of assets, then file bankruptcy and not be forced to pay all their debtors and creditors. Add to that certain state exemptions, and the debtor may still have quite a bit leftover, such as their 40-acre ranch pursuant to the Texas homestead exemption.

While there can be good outcomes for a debtor in bankruptcy, there is no way to “game the system” so to speak. There are processes and protections in place where people are appointed to oversee, if not take control of, your assets to ensure the debtor is not doing something backwards or lying about the assets they have. For example, in a Chapter 7 complete liquidation case, a trustee is appointed. The trustee will do one of two things:

1. Make sure all the paperwork, disclosures and procedures are followed properly
2. See if there is some asset the trustee can take and sell to give the money to the creditors in the process

The bankruptcy court and the trustee will be on the lookout for recent “debts” repaid to creditors who may be a related party. For example, if on Monday I owe the bank $10,000 and I owe my mom $10,000, and then on Tuesday I get $10,000 and give it to my mom. Then on Wednesday, I file bankruptcy. The bank may say it is not fair, or legal, to show preference to my mom. That allows a trustee to sue my mom as the recipient of a fraudulent conveyance and make her give the money back so it can be divided up amongst my creditors according to the rights they had before the transfer was made.

Is Bankruptcy Right for Me and My Business?

In an effort to be transparent, debtors are often advised not to make any bankruptcy decisions on their own. It is much more prudent to speak to a bankruptcy attorney first to ensure it is in your best interest to file bankruptcy and determine under which chapter of bankruptcy to file.

If you are a person or business that is so far in debt that you may never get out (something to the tune of $100 million in debt), then bankruptcy may be right for you. If a person with this type of debt is being hounded by creditors, it can make it difficult for them to even get a bank account.

There may also be entities that cannot pay all their debts because of something that happened in the past. A good example of this can be office buildings. In most cases, these structures were worth more before the pandemic than they are now. Many of them have mortgages from the days when those buildings were more expensive, only now the owner does not have the same occupancy and thereby not enough cash flow. However, the building still exists and does not have to be built again, so it can still charge some rent and pay some mortgage. Certain mortgage lenders may be unwilling to work with the debtor. Filing bankruptcy may be the remedy. A court-approved bankruptcy plan that restructures this debt may give the creditors some continuing cash flow rather than allowing foreclosure on the real estate, which can disrupt the market and the lives of the people who work in the building.

On the other hand, there are other situations in which bankruptcy may not be recommended.

If you or your business have a limited number of creditors that you are able to work with, it may be wise to try to settle outside of bankruptcy. Bankruptcy can be long and cumbersome and potentially more expensive that simply renegotiating with existing creditors.

Someone who owes a bunch of people a little bit of money, may have at least some creditors that do not try to collect. It is possible that some of those debts may even be unenforceable or released due to the statute of limitations. It would not be advantageous for a person to file bankruptcy the month before the statute of limitations runs out on their $200,000 IRS debt.

Because every situation is different, it is best to seek professional legal counsel from an experienced bankruptcy attorney to determine the best path forward before taking action.

It is worth noting that there are more than a few types of debts that do not get discharged in bankruptcy, including:

• Employment Trust fund taxes
• Excise taxes
• Sales taxes
• Child support
• Alimony
• Certain intentional acts (such as libel and slander)

Abuse of Bankruptcy

If you are filing bankruptcy just to buy time, it is probably not the best strategy to file as it turns over a great deal of authority to the courts and trustees to do things to you or your business that would not have happened otherwise. While it may stop a foreclosure for a while, unless you can pay the debt in that ninety-day window, it is likely a mistake. It is also considered bankruptcy abuse to file simply for the purpose of invoking the automatic stay.

If you are wondering whether bankruptcy is right for you and your business, know that it is a complicated area of law. It is very strategic in terms of when you should file, what you should do beforehand, and all the processes that come during and after bankruptcy. Proceed with caution and make sure you are doing what is in your best interest by making an appointment with a reputable bankruptcy attorney today.

By Harold "Hap" May, P.C. on August 23, 2024   /   The Legal Play Podcast   /   Leave a comment