What Are Your Options If Your Small Business Is On The Brink? By Jeena Cho and Jeff Curl

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1 What Are Your Options If Your Small Business Is On The Brink? By Jeena Cho and Jeff Curl

2 Helping Small Businesses with Their Financial Situation During Tough Economic Times Copyright 2010 JC LawGroup. All rights reserved. 1

3 Let s be frank, this recession has been murder on small businesses. It has taken about every form you can imagine. Customers have delayed or eliminated purchases. Those who have purchased have negotiated the price down, then been slow to pay. Suppliers won t extend terms. Banks aren t lending. Lines of credit are not being renewed. 2

4 Business has been terrible. Meanwhile your pile of unpaid invoices piles up, and the phone calls from creditors begin polite at first, then insistent, then threatening. Finally, lawsuits and judgments loom. 3

5 What are your alternatives? Should you try to negotiate with creditors? Close the business? Go further in debt? If your small business is drowning in debt, this guide is for you. As a small business owner, you put your heart and soul into your business. You may have also put considerable amount of personal assets into the business or incurred debt to try and save your business. It s painful to see the business that you ve worked so hard on drowning in debt. But all is not lost. This guide is meant to give you information on potential solutions, the advantages and disadvantages of each. 4

6 Here s what you need to know: Personally guaranteed debt. Whether it s an SBA loan, line of credit, lease or vendor, many creditors require the owners or shareholder(s) to personally guarantee the debt. This means that should you (or your company) default on the loan, both you and your company will be responsible for this debt. If this is the case, we need to consider the implications for you as an individual as well as for your business. 5

7 Protecting you. Frequently, we meet with business owners who mistakenly believe that filing for a business bankruptcy shields his or her personal liability to the personally guaranteed debt. Unfortunately, this is not the case. The business bankruptcy will not stop a creditor from coming after you personally. For this reason, oftentimes, the best choice is to file for a business owner s personal bankruptcy. Another question is how to best deal with the business liability for the debt. 6

8 There are three options: (1) Business Bankruptcy (2) Business Dissolution/Wind Up (3) Settlement 7

9 Business Bankruptcy As counter-intuitive as this sounds, unlike individual Chapter 7 bankruptcy, in a business Chapter 7, there is no discharge. This means that a corporation won t get a fresh start in a Chapter 7, the way an individual does. A business bankruptcy may still be advantageous under certain circumstances, such as where there are assets that need to distributed to creditors as the business ceases. A Chapter 7 trustee can provide an orderly distribution in this situation. Whether this makes sense depends on the facts of your situation. 8

10 Dissolution and Wind Up Oftentimes, it is possible to simply dissolve and wind-up the business. If there are few creditors and/or assets, this can often be a faster and more cost-effective solution than corporate bankruptcy. 9

11 Settlement Debt settlement should be approached with caution. Unlike bankruptcy, there is no guarantee that a creditor will agree to a reduced amount. In addition, you will typically need lump sum cash to settle. Most creditors require the total payment to be made at once, not over time. Second, you may receive a 1099-C for the forgiven debt, and have to pay taxes on that portion. Finally, you need to get all creditors on board. If you have 10 creditors, and all but one settle you can find yourself paying out large sums to numerous creditors, and still get sued by the lone holdout. 10

12 Saving Your Business If you believe your business can thrive without all the debts, it may be possible to keep your business through bankruptcy. WARNING: The following is full of complicated rules and mathematical formulas. It isn t going to make for fun reading, but is presented in the interest of giving you a complete picture. Needless to 11

13 say, your individual circumstances will be unique, and although you have the legal right to attempt any of these solutions on your own, we think it would be both risky and foolish to do so without the help of a qualified attorney. If you don t want to read this part, skip to One Final Thought at the end of this report. 12

14 Chapter 7 If you have been operating your business as a sole proprietorship, there is no separate entity involved. You and your business are one and the same. The first step is to come up with a value for your business. This is not an exact science and most small businesses have very little in the way of actual inventory or equipment that can be sold off. Mostly, what you have is sweat equity the value of the labor you have put in to grow your business. In Chapter 7 bankruptcy, you are only entitled to keep property that can be designated as exempt. The list of exemptions is long and 13

15 somewhat complicated. See the chart on the following page. Assuming the value of your business is less than $23,250 and there are no other significant personal assets that need to be exempted, you may be able to file for personal Chapter 7 bankruptcy, get rid of all of your debts and continue to operate your business. TIP: You may have to incorporate or form an LLC for your business before filing for Chapter 7 bankruptcy. 14

16 Chapter 7 Exemptions Below is a side-by-side comparison of some of the most common exemptions available in California. A Debtor must choose either System 1 or System 2. The law does not permit a Debtor to pick and choose from each System. Property Type System 1 (CCP Wildcard Can apply up to $23,250 that debto residence, or in personal property. Residence/Homestead Household Furnishings & Personal Effects Automobile Tools of The Trade Retirement, Pensions etc. $550 in each item held primarily fo household use. $3,525 equity in one vehicle. $2,200 where used in the trade of t or a dependent. The right to receive payment to the ext for support of debtor or dependent, un under IRS Code. Earnings Jewelry, Heirlooms and Art $1,425 in jewelry only. 15

17 There are more exemptions available that are not listed below. Your Bay Area bankruptcy attorney will discuss all California Chapter 7 exemptions available to you. 703) System 2 (CCP 704) r or dependent use as r personal, family or (1) $75,000 is single debtor. (2) $100,000 if debtor is family unit. (3) $175,000 if debtor or spouse is at least 65 years old, disabled, or if annual income is less than $15,000 or $20,000 if married. Declared homestead Automatic homestead Exempt to the extent reasonably necessary for the personal use of debtor or dependent at debtor s residence. (1) $2,725 in a personal vehicle (2) $7,175 in a business vehicle he debtor ent reasonably necessary less it does not qualify $7,175 exempt to the extent necessary to and actually used by the debtor in a business or trade ($14,350 when debtor and spouse are in same trade). All amounts held, controlled or distributed from private retirement plan. 75% of paid earnings within the last 30 days. 75% of unpaid earnings unless debtor proves that some or all of excess is necessary for support of debtor s family. $7,175 in jewelry, heirlooms and art. 16

18 What if your business is incorporated? In this situation, your attorney would do the same analysis as above and come up with a value for the corporate assets. However, in this situation, you also need to consider the debts the Corporation has. The net value (assets MINUS debt) of your shares (or interest in an LLC) would be the value you need to exempt. TIP: Remember, if your business is incorporated, the debts will only be discharged as to you, personally. Your corporation will still be responsible for the debt. However, it may be possible to dissolve your old corporation and start a new one. 17

19 Chapter 13 What if your business has too much value and we can t protect it through Chapter 7? In this situation, we can consider Chapter 13. In Chapter 13, you repay a portion of your debt based on calculations from the best interest or best efforts test. 18

20 Best Interest Liquidation Analysis In this test, we calculate the value that the Trustee would have been able to retrieve in a hypothetical Chapter 7 bankruptcy. In another words, the value that we could not protect in Chapter 7. Let s assume you operate an automobile repair shop and the value of all the equipment is $50,000. Using the Wild Card exemption, we would first exempt $23,250. Hence, leaving $26,750 unprotected. We would discount this amount by the Chapter 7 19

21 trustee s commission, cost of sales, and any other related costs associated with liquidating the assets. We ll assume for the purpose of this example, the discount rate is 20 percent. The monthly minimum payment would be the unprotected amount minus discounted rate divided by 60 months. ($26, percent = $21,400/60 = $356.67) 20

22 Best Efforts Disposable Income Analysis In this test, we calculate the amount of money you have left over at the end of each month after taking all allowable deductions. Certain deductions are based on IRS standards (e.g., rent, utilities), and other deductions are based on your actual expenses (e.g., medical, mortgage, car payments.) Let s say your income minus your expenses shows that you have $300 left over each month. You must make your best efforts and pay $300 per month for life of you plan. At 60 months, that would be 21

23 $18,000. At the conclusion of making these payments, the remaining debts that are dischargeable would be forgiven. Your Chapter 13 payment would be the GREATER of the Best Interest and the Best Efforts test. In this example, the Best Interest amount of $ This is a very simplified version of calculating your Chapter 13 payments. Please consult with an attorney regarding your specific circumstance. 22

24 We hope this guide has been helpful to you, but it is only a general overview. If you would like to discuss your situation with a qualified attorney, please call our office to schedule a consultation. You may have more options than you think. 23

25 One Final Thought: The list of people who failed in business (and filed for bankruptcy) before they succeeded is long and surprising. It contains names like Henry Ford, Milton Hershey, Henry Heinz, Walt Disney, Larry King, and Donald Trump, among others. The fact that this particular business failed does not mean that your next venture won t be a great success. The important thing is to clear the decks now and get a fresh start. We can help, but only if you call us. 24

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27 Let Us Assist You With Your Business Today! 26

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