Quick overview of Chapter 13
Chapter 7 sells the filer’s assets to pay the creditors. Chapter 13 puts the filer on a payment plan to pay the creditors. Similar to how certain assets are exempt in a Chapter 7, those same assets are also exempt in Chapter 13. Unlike Chapter 7, in Chapter 13 the filer’s non-exempt assets are not handed-over to the court trustee to sell. Instead, the filer gets approval for a three to five year repayment plan. Once that plan has been completed, the debts are discharged.
Who can file a Chapter 13?
Chapter 13 is a ‘reorganization’ bankruptcy. It is often called a ‘wage earner’s bankruptcy”. In Chapter 13 the filer is an individual or married couple. The filer must have a regular income that is high enough to support the repayment plan. A business entity cannot file Chapter 13 by itself. If a business entity wants to reorganize, it uses Chapter 11. But, sometimes a Chapter 13 filer does own a business, either solely or with others. If so, the filer’s ownership interest and/or business debts will become part of their personal bankruptcy.
Repayment plans in Chapter 13
The filer submits a repayment plan to the trustee for approval. The repayment period will last three to five years. During this period the filer is applying their disposable income to repay the debts. The court has very specific formulas to determine the amount of income that will be applied to the repayment plan. But, if the creditors would recover more money in a Chapter 7, then that higher amount determines the repayment total, not the disposable income number. The repayment plan will eliminate unsecured debts and allow the filer to get current on any missed mortgage payments. Typically, Chapter 13 filers chose it instead of Chapter 7 because they want to keep their home or some other property that would otherwise be sold in a Chapter 7. The downside of a Chapter 13 is that the filer will be paying under court supervision for up to five years. If the filer’s income goes up or down, the repayment amount is adjusted accordingly.
Chapter 13, when the filer owns a business
Chapter 13 for sole proprietors
Because the individual and the business are the same in the eyes of the law, the case will encompass both the business and personal debts. It must be pointed out that it is often easier, faster and cheaper for a sole-proprietor to file under Chapter 7. Why? All the extra complexity and uncertainty, especially around income, make it difficult to successfully operate a business under Chapter 13 and to complete a multi-year repayment plan.
Chapter 13 for business entities like LLCs
This gets even trickier. A business entity, an LLC in this example, cannot by itself file Chapter 13 (it would use Chapter 11). But, a small business owner can file a personal Chapter 13 and may achieve many of the same benefits, like eliminating their personal debts. Filing a personal Chapter 13 does not have any effect on contracts and debts that are, either in whole or in part, the responsibility of the LLC. So, a lease, for example, for which both the LLC and the owner are responsible, would still be enforceable against the LLC even after the owner is personally discharged. To get rid of the lease, the LLC in this case might need to file Chapter 7.
When does Chapter 13 make sense for a small business owner?
Although Chapter 7 makes sense most of the time for most small business owners, there are times, especially in today’s unusual economy, where a Chapter 13 is preferable for a business owner. Sometimes the business owner makes too much to qualify for Chapter 7. Sometimes the owner wants to get current on car and home payments. Sometimes the owner wants to buy time until the business gets back on its feet. But, the big reason has to do with retaining assets that would be lost in a Chapter 7. Debt cramdown and lien stripping are dimensions of retaining assets. When an asset is worth less today than the debt that is still owed on it, a Chapter 13 case reduces the debt on that asset, all the way down to today’s fair market value. The fair market value is now the amount that must be repaid in the payment plan. The leftover difference becomes unsecured debt, which is usually discharged at pennies on the dollar in the payment plan. Apart from retaining nonexempt assets, another reason Chapter 13 might work better for a filer is that certain types of debts are discharged in Chapter 13 but not in Chapter 7.
When does Chapter 11 make more sense for a business than Chapter 13 or Chapter 7?
If the owner’s personal finances are good and the owner has made minimal personal guarantees for business debts, then the owner would not declare personal bankruptcy. But, maybe the business’ finances are not good, sales are way down and there's a lot of fixed monthly overhead costs that can’t be serviced. The owner doesn’t want to wind down the business and dissolve it because he thinks that the long-term business outlook is promising. The owner can’t or doesn’t want to inject their personal money to keep it afloat. If all this is true, then a Chapter 11 or 11-V accomplishes several things. First, it buys time by putting things like collections and repossessions on hold. Second, it allows the business to cramdown secured assets. Third, it allows discharge of unsecured debt. Fourth, it brings most litigation into the bankruptcy court, which streamlines and reduces litigation time and cost. Fifth, contracts can be revised, like reducing a higher-than-market lease rate. There are additional less-common benefits as well. It’s not all good, though. There are plenty of negatives to operating a business under either Chapter 11 or 13. Most of these negatives have to do with loss of flexibility to make major business decisions. Fortunately, normal day-to-day decisions are made by the owner.
Contact us for help
Business Bankruptcy Solutions helps Coloradoans lower their debts, renegotiate contracts and save their businesses. Call (720) 674-7311 or email now to schedule a free consultation. We will discuss the problems facing both your business and personal finances and the tools we can use to achieve your goals. We draw upon decades of legal and business experience to provide you with actionable solutions. With BBS on board, we’ll help you weather this storm.