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Archive for the ‘Business Bankruptcy’ Category

Avoiding Paying Prior Employee Debt

March 9th, 2020 at 7:00 am

If you prefer NOT to pay back wages to a present or prior employee, bankruptcy can help you use the law to prevent it being a priority debt.


Imagine that in the near future you’re closing down a business and filing bankruptcy.  You owe an employee or independent contractor back wages or commissions. But you’d rather not pay that debt because you believe that employee had a major role in the business failing. You’d much rather have your scarce money go towards, for example, paying your income taxes. How do you use the law to your advantage to accomplish this?

Our last blog post showed how to use the law to pay a favored prior employee or independent contractor. Today we show how to avoid doing so.

It’s All about the Timing

We fully laid out the rules about “priority” wage/commission debts in our blog posts of 3 and 4 weeks ago. Briefly, a wage or commission is a priority debt if it meets two conditions. One’s a timing condition and the other a dollar-amount one. The wage/commission money owed:

  1. must have been “earned within 180 days before the date of the filing of the [bankruptcy] petition or the date of the cessation of the debtor’s business, whichever occurs first …” Section 507(a)(4) of the Bankruptcy Code;  and
  2. the amount earned can be no more than $13,650. Section 507(a)(4) of the Bankruptcy Code, with a cost-of-living adjustment of the $10,000 stated there.

Assume that the amount you owe your prior employee or independent contractor is less than $13,650, thus meeting that condition. So the other, timing condition is what we’re focusing on.

A wage/commission is a priority debt if it was earned within the indicated 180-day period. If it wasn’t earned within that period, the wage/commission is instead a “general unsecured” debt. As we’ll show in our two examples below, general unsecured debts are much less likely to get paid in bankruptcy.

Some Facts for Our Example

Imagine the following basic facts.

You owe your prior employee $7,500 for wages and benefits. He earned these wages and benefits over a period of four months, from 180 to 60 days ago. That’s when you laid him off, suspecting embezzlement or other inappropriate behavior.

Your sole proprietorship business is still operating, but you intend to close it and file personal and business bankruptcy soon.

You owe $10,000 in last year’s personal income taxes. In addition you owe $150,000 more on all of the rest of your debts. These consist of unsecured trade debt, business and personal unsecured credit cards, and medical bills. These are all considered “general unsecured” debts.

Not Paying Employee in Asset Chapter 7

An asset Chapter 7 case is one in which you have some assets which are not protected. They are not protected from a Chapter 7 trustee taking and liquidating them to pay your creditors. The crucial fact is that the trustee pays any priority debts in full before paying a dime of general unsecured debts. Often there’s only enough money to pay priority debts—in full or pro rata—with nothing or very little left for the general unsecured debts.

In our example assume that your bankruptcy lawyer has advised you that your business equipment is not protected. It’s not “exempt.” It has a liquidation value of $10,000. If you file a Chapter 7 case it’s the asset that your bankruptcy trustee would use to pay your creditors.

This equipment has a liquidation value of about $10,000. You won’t need the equipment after closing the business. But you do want to put its value to the best use possible.

The point is to use the above timing condition to turn this prior employee debt into a general unsecured one. You do that by either closing your business or filing the Chapter 7 case so that the $7,500 wage debt was not earned during the 180 days before either of those two events. Under our facts the wages were most recently earned 60 days ago. So wait 120 more days to either close down the business or file the Chapter 7 case. That way none of the wages would have been earned within the 180-day period  (It’s the earlier of those two events that counts so you can’t do either for 120 days. But once you do one—such as close down the business—you can file the bankruptcy case at any point later.)

The Result in the Asset Chapter 7 Example

Under our facts the trustee would do the following with the $10,000 from sale of the business equipment. After paying his or her legally-allow fee, all the rest would go to your income tax debt. None would go to your disfavored prior employee.

The trustee’s fee would likely be no more than $1,750. It’s calculated at a maximum of 25% of the first $5,000 liquidated amount and then 10% on the second $5,000. Section 326(a) of the Bankruptcy Code. $10,000 minus $1,750 leaves $8,250. That remaining $8,250 would go to pay priority debts first, before paying anything to the general unsecured debts. In our example the wage debt is all general unsecured debt, not priority debt. So all of the remaining $8,250 would all go to your last year’s income tax debt of $10,000. You’d owe the rest—about $1,750. But you would have used most of your equipment value towards a debt you would have otherwise had to pay anyway, leaving a relatively low balance. And again, you met your goal of having none of your equipment value go to your prior employee.

Not Paying Employee in Chapter 13

In a Chapter 13 case you must pay all priority debts in full during the 3-to-5-year court-approved payment plan. Usually you must pay general unsecured creditors only as much as you can afford to pay them. This is AFTER paying priority debts in full, and often after paying secured debts as well. General unsecured debts often receive little, sometimes nothing at all. So whether a debt is a priority debt usually has a huge impact on whether and how much you must pay it.

In our example, if you were to close down the business or file bankruptcy right away, the $7,500 prior employee wage would be a priority debt. During the course of the payment plan you’d have to pay it in full. That’s in addition to paying the $10,000 income tax priority debt in full.  What happens if your budget would not allow you to do that in 3 years? The payments could be extended as long as 5 years to accomplish that. That is, you could be in your case years longer if your employee debt was a priority one.

However, if you waited the 120 day mentioned in the Chapter 7 example above to close down your business and file the Chapter 13 case, the $7,500 wage debt would likely receive much less. It may receive nothing. It would be a general unsecured debt, mixed in with the other $150,000 of general unsecured debts. This pool of $157,500 of general unsecured debts would only get paid to the extent your budget allowed. It would receive something only after you paid the $10,000 priority income tax debt in full. Plus your bankruptcy lawyer fees and Chapter 13 trustee fees receive payment usually before the general unsecured debts receive anything.

The Result in the Chapter 13 Example

So, if you’d close the business or file the Chapter 13 case right away, you’d have to pay your prior employee’s prior wage debt in full. If you couldn’t do so (and pay the income tax debt, etc.) within 3 years, you’d have to pay as much as 2 years longer.

If instead you’d wait until the wage debt turned into a general unsecured debt, you’d likely pay it very little. There’s a decent chance (depending on your budget) that you’d pay nothing on it at all.

 

Paying Employee Debt in Chapter 13

March 2nd, 2020 at 8:00 am

If you prefer to pay back wages to a present or prior employee, you can do so in Chapter 13 especially well if that debt is a priority one.

 

Our last three blog posts have been about debts you owe to your employees or independent contractors. Specifically, we discussed the conditions under which past wages, commissions, or benefits qualify as a“priority” debt. These posts covered:

  • the conditions that apply to both employees and independent contractors (3 weeks ago)
  • the special additional condition applicable only to independent contractors (2 weeks ago)
  • an example of paying an employee’s wages as a priority debt in an “asset” Chapter 7 case (last week)

Today, we’ll show how you could pay an employee/independent contractor in full in a Chapter 13 “adjustment of debts” case.

Why Priority Matters under Chapter 13

Assume you’d really like your former (or ongoing) employee/independent contractor to receive payment on what you owe. Whether that debt qualifies for priority status often determines whether you’ll pay that debt or not. Or it may determine whether it’s paid in full, in large part, very little, or nothing at all.

Focusing on Chapter 13, whether or not a debt qualifies as a priority one is usually crucial. That’s because you are legally obligated to pay all priority debts in full. Debts that don’t qualify as priority usually receive much less, and sometime receive nothing.

Your Chapter 13 payment plan must show how you will pay all priority debts. The bankruptcy judge will otherwise not approve the payment plan. The U.S. Bankruptcy Code is straightforward:

(a) The plan—

(2) shall provide for the full payment, in deferred cash payments, of all claims entitled to priority under section 507

Section 1322 of the Bankruptcy Code.

(There’s an exception if the employee/independent contractor agreed not to receive “full payment.” But assume here that—as is almost always true—he or she does want to get fully paid and won’t agree not to be.)

So what happens under Chapter 13 if that wage/commission debt does not meet the conditions to be priority debt? That wage/commission is lumped in with all the other ordinary “general unsecured” debts. Very seldom do Chapter 13 plans pay general unsecured debts in full. (A so-called 100% plan.) Most often they receive significantly less than 100%. (Say, a 30% or 40% plan.) Quite often they receive payment of only pennies on the dollar. (For example, a 3% plan.) Finally, it’s not unusual that general unsecured debts—including a non-priority wage/commission debt—would receive absolutely nothing. (A so-called 0% plan.)

In summary, your plan must pay a priority debt in full. But the plan will very likely pay your general unsecured debts a fraction, or possibly even nothing.

Our Chapter 13 Case Example

Assume you owe a prior employee $5,000 for wages earned over a period of four months. This period was from 150 to 30 days ago, at which point you had to lay him off.

Your sole proprietorship business is still operating. You intend to close it and file a Chapter 13 bankruptcy soon. You have a decent job waiting for you as soon as you do, and have some flexibility when to start.

You owe $125,000 on all of the rest of your debts, which are all general unsecured. None are priority debts except potentially the $5.000 you owe to your prior employee.

Reminder about the Priority Conditions

As discussed in our last 3 blog posts, a wage is a priority debt if it meets two conditions:

  1. it was “earned within 180 days before the date of the filing of the [bankruptcy] petition or the date of the cessation of the debtor’s business, whichever occurs first …”. Section 507(a)(4) of the Bankruptcy Code.
  2. the amount is no more than $13,650. Section 507(a)(4) of the Bankruptcy Code, plus a cost-of-living adjustment of the $10,000 stated there.

With the amount of the wage owed in our example being $5,000, this debt meets the second, dollar-limit condition. So we focus the rest of this blog post on the first, timing condition.

Timing the Filing of Your Chapter 13 Case

As you can see from the timing language in the statute above, a wage’s priority status turns on when the employee earned it.  The wage (or commission or benefits) must have been earned within a 180-day period. That period must be immediately before either the closing of your business or your filing Chapter 13, whichever of those happens first.

Back to the Example

To pay the $5,000 wage debt in full, you need to have it meet the conditions of priority status. Your business is still operating at the moment. You have control over when to cease operating, and when to file the Chapter 13 case.

In the real world you actually likely have limited control over these two events. You likely have various constraints on both. Timing when to shut down even a small business usually involves a variety of practical, and sometime tough, choices. Timing a Chapter 13 filing likely turns on the creditor collection pressures and there are often other legal timing considerations.

But let’s assume you have at least some flexibility. Under our facts, if you want this employee’s wage debt to be a priority debt you need to do one of two things within the next 30 days. You need to either close down your business or file your Chapter 13 case within that time.  After that some of this employee’s wages will start turning into general unsecured debt. (Recall it was all earned 150 to 30 days ago.) So after 30 days the oldest of the wages will be start being more than 180 days old. Then 210 days from now the last of the wages would turn into general unsecured debt.

If you can’t file your Chapter 13 within 30 days for practical or legal reasons, it’s enough to just shut down your business. As you see from the statute’s language, that triggers the 180-day period, even if you don’t file the Chapter 13 case until later.

What Happens in the Chapter 13 Case

Assume you either shut down your business or file your Chapter 13 case within the next 30 days. Then the $5,000 wage debt would be a priority debt. Simply put, Chapter 13 law requires the payment plan you and your bankruptcy lawyer put together to include enough money to pay that $5,000. The bankruptcy court would otherwise not approve the plan. Furthermore, you could not complete the case without actually paying off that $5,000.

Now assume instead that you don’t shut down your business and don’t file Chapter 13 until after 210 days from now. Then, as just discussed, none of the wage debt would qualify as priority. It would all be general unsecured debt. Assume that in the next 3 years you would afford to pay $200 per month on all of your debts. That’s a total of $7,200. Assume that you paid all your attorney fees when you filed your case (leaving none to pay in the plan). In your jurisdiction assume the Chapter 13 trustee gets 5% of everything that flows through the plan—$360. That leaves the rest—$6,840—to go to all of the creditors. The general unsecured debts total $130,000—$125,000 plus the $5,000 wage debt. The $6,840 would be divided among this $130,000, meaning that these debts would receive about 5% of the amounts owed. Your former employee would receive only about $250 on the $5,000 wage debt.

So, if the $5,000 wage debt would qualify as priority, your former employer would receive payment in full. If none of it would so qualify, your employee would receive only about $250

.

Paying Employee Debt in Bankruptcy

February 24th, 2020 at 8:00 am

If you prefer to pay back wages to a present or prior employee, bankruptcy can help you do so if you use the law in that employee’s favor.  

 

Our last two blog posts were about debts owed to your employees or independent contractors. Specifically we discussed the conditions in which past wages, commissions, or benefits qualify as “priority” debt. Two weeks ago we got into the conditions that apply to both employees and independent contractors. Last week the focus was on a special additional condition that only independent contractors must meet.

Whether a debt qualifies for priority status is often crucial. That’s because this can determine whether or not you pay that debt in the bankruptcy case.   In a no-asset Chapter 7 case none of the debts receive any payment within the case. So whether an unpaid wage or commission qualifies as priority or not doesn’t matter in this situation. But in an asset Chapter 7 case it makes all the difference. It’s common that priority debts receive payment in part or in full, while the rest of the debts receive little or nothing. There’s a similar result in a Chapter 11 business reorganization or 13 adjustment of debts case. Priority debts generally receive payment in full while other debts receive little or nothing.

Assume that you’d prefer that your past or present employee/independent contractor receive payment for what you owe him or her at the time of your bankruptcy filing. If so, you need to know the conditions for making that debt a priority debt, and how to apply them. Today we’ll review the conditions and then apply them an asset Chapter 7 example. Next week blog post will demonstrate an example in a Chapter 13 case.

The Conditions

We covered the conditions that an unpaid wage or commission is a priority debt the last two blog posts. We’ll review them very briefly here.

For a debt you owe either an employee or independent contractor:

If you owe the debt to an independent contractor, he or she needs to meet an additional condition. The debt is a priority debt ONLY if

during the 12 months preceding that date [of bankruptcy filing or cessation of business], at least 75 percent of the amount that the individual or corporation earned by acting as an independent contractor in the sale of goods or services was earned from the debtor.

Section 507(a)(4)(B) of the Bankruptcy Code (bold added).

Our Chapter 7 Asset Case Example

Assume you owe a prior employee $7,500 for wages and benefits. Your employee earned these wages and benefits over a period of four months, from 150 to 30 days ago, when you had to lay her off.

Your sole proprietorship business is still operating. You intend to close it and file a Chapter 7 bankruptcy soon.

Your bankruptcy lawyer has advised you that your business equipment is not exempt. This mean it’s not protected from collection and liquidation by the Chapter 7 bankruptcy trustee. He or she will take it from you, sell it, and use the proceeds to pay your creditors.

This equipment has a liquidation value of about $10,000. You don’t need the equipment after closing the business because you don’t intend to be in this kind of business ever again. But you do wish you could put it’s value to some good use.

You owe $150,000 on all of the rest of your debts. These consist of unsecured trade debt, business and personal unsecured credit cards, and medical bills. These are all considered “general unsecured” debts. None are priority debts except potentially the $7,500 you owe to your prior employee. You have a home mortgage but you’ve managed to keep current on it. Your home has a bit of equity but it’s protected by the homestead exemption.

Timing the Filing of Your Chapter 7 Case

You may have reasons to delay filing your case. You may have new employment lined up but it doesn’t start for several months. You may have business customer paying you soon and you’ll need the money for your home mortgage in the meantime. There can be countless legal and/or practical reasons for filing your case later.

However, your prior employee would likely really benefit from you filing your case within about a month. Then, because of the 180-day condition cited above, there’s a good chance she’d receive all or most of her $7,500.

How? The Chapter 7 trustee would liquidate your business equipment. The trustee would receive a fee—likely about $1,750. (By law, no more than 25% of the first $5,000 liquidated and 10% on the second $5,000. Section 326(a) of the Bankruptcy Code.) $10,000 minus $1,750 leaves $8,250. (25% for the first $5,000 is $1,250, plus 10% for the second $5,000 is $500, totaling the trustee’s $1,750 fee.) The remaining $8,250 would go to pay priority debts first, before paying anything to the general unsecured debts.

The $7,500 debt to your prior employee would all be priority debt. That’s because in our scenario it was all earned within the 180-day period before your simultaneous business closure and bankruptcy filing. Plus the $7,500 amount is less than the $13,650 limit referenced above.

So in this example your prior employee would receive her $7,500 in full.

Of course if the business equipment sold for less, your employee would receive only partial payment. Assume it sold not for $10,000 but rather only $7,000. $7,000 minus the trustee’s $1,450 would leave $5,550 for the trustee to distribute. Likely all of this would go to your employee. So she’d receive at least a significant portion of her debt.

If You Delayed Filing Bankruptcy

Assume instead that you closed your business and filed your Chapter 7 case five months from now. At that point all of her wages and benefits would have been earned more than 180 days earlier. So, none of the $7,500 would qualify as priority. The debt would be a general unsecured one, lumped in with other $150,000 of such debt.

Then, your employee would receive very little. Assume again that the bankruptcy trustee sells your business equipment for $10,000, leaving $8,250 for payment of the debts. This would be distributed pro rata to the $157,500 in general unsecured debt (her $7,500 plus the other $150,000). $8,250 divided by $157,500 amounts to all debts receiving only about 5 cents on the dollar. So your prior employee would receive only about $375 on her $7,500 debt.

Conclusion

There are many factors that come into play for determining what day you file your bankruptcy case. Some of those factors may well be much more important than helping your employee/independent contractor receive payment. But sometimes a business owner has some flexibility on timing. And getting an employee/independent contractor some money may be a high priority for various personal or business reasons. This would be especially true if that money would otherwise go to a debt you don’t care about getting paid. In such situations you and your bankruptcy lawyer may well be able to put these priority laws to good use, as we showed in today’s blog post.

 

Commissions Owed to Independent Contractor

February 17th, 2020 at 8:00 am

If you owe sales commissions to an independent contractor when you file bankruptcy, it may be a priority debt. Here’s what determines this

 

Our last blog post was about conditions in which wages, commissions, or benefits owed to an employee are “priority” debt.

But what if your debt was not to an employee but an independent contractor? Especially in today’s “gig economy,” small businesses (and large ones, too) often have independent contractors instead of employees.

Why “Priority” Matters

As discussed last week, whether a debt qualifies as a priority debt can make a huge difference.

This most often matters in a Chapter 13 “adjustment of debts” case. You have to pay all priority debts in full during the 3-to-5-year court-approved payment plan. In huge contrast, usually you only pay the non-priority “general unsecured” debts to the extent you can afford to pay. The common result is that you pay priority debts 100%, while those that don’t qualify as priority little or nothing.

The distinction between priority and general unsecured also matters in an “asset” Chapter 7 case. That’s the relatively uncommon situation in which a debtor needs to surrender an unprotected asset to the Chapter 7 trustee. In that situation the trustee liquidates the asset and pays priority debts in full before paying any general unsecured debts. The result: priority debts often get paid in full or in part, while there’s nothing for any general unsecured debts.

The distinction between priority and general unsecured does not directly matter in a simple, “no-asset” Chapter 7 “straight bankruptcy” case. That’s the common situation when everything you own is “exempt”—protected from the Chapter 7 trustee. Many Chapter 7 cases are “no-asset” ones. (However, note that most priority debts can’t be discharged in a Chapter 7 bankruptcy. So while such debts won’t receive anything from the trustee, you’ll likely still have to pay the debt afterwards yourself.)

The Basic Amount/Timing Rule

Whether you owe an employee or an independent contractor, some of the conditions to make the debt priority are the same.

First is the maximum dollar amount. The maximum amount of a debt that would qualify as priority is $13,650. See the discussion in our last blog post about this amount. (Also see the original statute’s $10,000 amount in Section 507(a)(4) of the U.S. Bankruptcy Code, the cost-of-living provision in Section 104 of the Bankruptcy Code, and the current $13,650 amount since April 1, 2019 in this notice in the Federal Register.)

The second condition is the timing. The debt owed must be

earned within 180 days before the date of the filing of the [bankruptcy] petition or the date of the cessation of the debtor’s business, whichever occurs first

Section 507(a)(4) of the Bankruptcy Code.

So, any amount owed to an employee/contractor beyond $13,650 would be a general unsecured debt, not a priority one. Same with any amounts earned outside the specified 180-day period.

The Special Independent Contractor Rule

Beyond the above amount/timing conditions, there’s another significant condition especially for independent contractors. The debt is a priority debt ONLY if

during the 12 months preceding that date [of bankruptcy filing or cessation of business], at least 75 percent of the amount that the individual or corporation earned by acting as an independent contractor in the sale of goods or services was earned from the debtor.

Section 507(a)(4)(B) of the Bankruptcy Code.

So if your independent contractor earned less than 75% of its overall income during that one-year period from you, then none of what you owe it is priority.

Presumably the purpose of this condition is so that it applies only to independent contractors who are more like employees. It includes only those independent contractors who work mostly for you. It is not meant to apply to debts owed to suppliers of goods and services that serve many customers. Those are more like conventional payables, which are general unsecured debts, not entitled to priority.

 

Wages Owed to an Employee

February 10th, 2020 at 8:00 am

If you owe wages to an employee when you file bankruptcy, that may or not be a priority debt. Here’s what determines this and why it matters.  

 

Our last dozen blog posts have been about “priority” debts. These are special unsecured debts that bankruptcy law treats better than the rest, called “general unsecured” debts.

(Secured debts are a third main category of debts, distinctive because they are attached to your assets as security. We’ve covered those before and will again later. But now we’re addressing priority debts, which are not secured by any of your assets.)

The most common priority debts in consumer bankruptcy cases are income taxes and child/spousal support. So our recent blog posts have focused on these two. But if you have been operating a business with employees or independent contractors there are other important potential priority debts. These involve unpaid wages, salaries, commissions and benefits owed at the time of bankruptcy filing. Our next few blog posts will focus on these.

The Conditions of Priority

If you owe a wage, salary, commission, or employee benefit when filing bankruptcy, that may or not be a priority debt. It depends on timing and the amount owed. The pertinent statute says that priority debts include those:

only to the extent of $13,650 for each individual or corporation, as the case may be, earned within 180 days before the date of the filing of the petition or the date of the cessation of the debtor’s business, whichever occurs first, for… wages, salaries, or commissions, including vacation, severance, and sick leave pay earned by an individual

Section 507(a)(4) of the U.S. Bankruptcy Code.

The $13,650 Dollar Limit

This dollar limit is mostly self-explanatory. Any amount owed to an employee up to $13,650 is a priority debt. Any amount beyond that is just a general unsecured debt.

This amount may seem odd. That’s because it’s been adjusted for inflation every 3 years as mandated by law. Section 104 of the Bankruptcy Code. It was originally $10,000. It’s been $13,650 for bankruptcy cases filed since April 1, 2019 (and will likely increase on April 1, 2022). See this notice in the Federal Register of February 12, 2019.

Timing

The wage, commission, etc. must have been earned within a very strict time period of 180 days. This is 180 days before your bankruptcy filing date or before you stopped operating your business, whichever happens first. So for example if you stop operating your business on January 1 and then file bankruptcy on the following March 1, the pertinent period would be the 180 day period before January 1. Wages, etc. earned during that period would count as priority. Earnings outside that period would be general unsecured debt.

Why Priority Matters

Whether a debt is a priority or general unsecured one sometimes doesn’t matter. But often it matters a lot.

This distinction of itself does not matter in a simple, “no-asset” Chapter 7 “straight bankruptcy” case. That’s one in which everything you own is “exempt”—protected from collection by the Chapter 7 trustee. Most straightforward consumer Chapter 7 cases are “no-asset.” If you operated a business you may also have a “no-asset” Chapter 7 case although that’s less likely.

The priority-general unsecured distinction matters a lot in an “asset” Chapter 7 case. That’s because the trustee pays debts out of the collected and liquidated non-exempt assets. The trustee pays priority debts in full before paying anything to general unsecured debts. Often that means that priority debts are the only ones that receive any funds from the trustee. Or priority debts may be paid in full while general unsecured debts only receive a few pennies on the dollar.

The priority-general unsecured distinction also matters a lot in all Chapter 13 “adjustment of debts” cases. A 3-to-5-year court-approved Chapter 13 payment plan must pay all priority debts in full. In contrast, the plan usually pays general unsecured debts only if and only to the extent there’s any money left over after paying all priority (and often secured) debts first. The result is that priority debts stand a much better chance of getting paid. In contrast, general unsecured debts often receive only a small portion of the amount owed, and sometimes absolutely nothing. (This also largely applies to Chapter 11 business reorganizations and Chapter 12 farm reorganizations.)

So under “asset” Chapter 7s and all Chapter 13s, whether a wage, etc. meets the priority conditions or not usually makes a tremendous difference about whether and the extent to which it is paid.

Order of Priority

There’s one more important consideration in whether a wage, etc. gets paid and to what extent. The law doesn’t just make a distinction between priority and general unsecured debts. Some priority debts have higher priority than others. The higher priority debts receive payment in full before the lower priority ones receive anything.

This doesn’t matter so much under Chapter 13 in which you must pay all priority debts in full. Nor does it matter in an asset Chapter 7 case in which there’s plenty of money to pay all priority debts. But it does matter in an asset Chapter 7 case in which there are more than one type of priority debts and there’s only enough money to pay some of them.

The order of priority for wages and such is fourth out of the ten listed priority debts. Some of these ten are obscure ones that seldom apply. Focusing on the most common ones, the wage priority is lower than child and spousal support debts but higher than income taxes.

 

Small Business Bankruptcy in Texas

July 16th, 2018 at 11:52 am

bankruptcyThe modern business world is tough, especially for smaller firms. If your small business has run into serious financial distress, you are far from alone. Right now, it may be time for your company to review its available options, to work towards shedding or restructuring some of that overly burdensome debt. Bankruptcy is one option that is on the table for your company. However, it is certainly not the only option and it is not always the best option. Here, our experienced San Antonio business bankruptcy attorneys offer tips for weighing whether or not it is time for your small business to file for bankruptcy protection.

Know Your Situation, Know Your Finances

When your business is facing financial distress, it is time to take a very hard look at the books. You need to know your finances, your assets, your debts and your projected future revenue like the back of your hand. Indeed, the key to making the best possible decision is knowing the true financial standing of your company. It is imperative that you enter the debt restructuring process with full knowledge and a clear head.

Always Consider Non-Bankruptcy Options First

Filing for business bankruptcy is a big step. It is neither right nor necessary for every financially distressed Texas small business. Our firm focuses on helping businesses find the best available solution for their individual needs. We always carefully consider all available non-bankruptcy options first. Your company may be able to get back on firm, stable financial footing with a less disruptive method, such as debt consolidation or voluntary debt restructuring. If you go down this road, our attorneys can help you negotiate the terms of these agreements.

Make an Honest Assessment

Finally, small business owners will need to make an honest assessment of the state of their business. While bankruptcy is not the appropriate legal tool for every financially distressed company, it is necessary in many cases. Further, waiting too long to file for bankruptcy may result in your business falling into an even bigger financial hole, making it very difficult to restructure and dig yourself out. The bottom line: If your small business is facing serious financial troubles, you need to take action now. The sooner you address the problem, the better off your company will be.

Request Your Free Business Bankruptcy Consultation

At the Law Offices of Chance M. McGhee, our passionate San Antonio business bankruptcy attorneys have extensive experience serving the unique needs of small businesses. If your small business is facing significant financial distress, we can help. Please do not hesitate to contact us today to set up a free review of your case.

 

Source:

https://www.thebalance.com/what-is-business-bankruptcy-393017

When a Business Lease is Not a True Lease

March 1st, 2017 at 8:00 am

Here are the factors for determining whether a business lease is treated as a true lease in bankruptcy or rather as a secured purchase.  


A couple days ago we ended our blog post saying that we would next “get into the special business-oriented factors the bankruptcy courts use to determine whether a lease is a true lease.” We described the benefits that a true lease gives to the lessor. And we showed the ways that recharacterizing a lease as a secured purchase can greatly benefit the business debtor.  

When a Business Lease is Not a True Lease

Some initial principles:

  • Federal bankruptcy law often works closely with state laws. This includes state laws determining whether a lease is a true lease. Bankruptcy law does not define a lease, and yet makes significant consequences arise from labeling a transaction a lease. So we look to state laws for making this determination.
  • Especially in the context of business asset leases, in interpreting state lease law bankruptcy courts look to the substance of the transaction not at the name given to it. Look to the economic substance of a transaction instead of whether or not it’s called a lease.
  • The courts do not put weight on the subjective intent of the parties—whether they think it’s a lease or not. Instead they look to the objective factors found within the lease agreement and in the parties’ economic relationship.

Factors Relevant to Business Leases

Consider the following questions, in the context of an equipment lease, to get at the substance of a lease vs. secured purchase:

  • What is the total amount of the lease payments compared to the value of the equipment? Do the “lease” payments compensate the lessor for the lessee’s ongoing use of the lessor’s property? Or do they pencil out more like payments of principal and interest?
  • Did the lessor manufacture or purchase the equipment specifically for the lessee’s use? Was it specifically designed for the lessee, so that its continued business operations depend on its use of the equipment?
  • Did the lessee assume the typical risks and obligations of ownership instead of the lessor? Which one is contractually responsibility for paying insurance, taxes, maintenance and upkeep?
  • How does the term of the lease compare to the useful economic life of the goods? Is the lessee required to renew the lease for the equipment’s full economic life?
  • What happens to the equipment at the end of the lease term? Is the lessee allowed or required to buy the equipment at the end of the lease at a modest payoff? Is the lessee required to purchase it under certain conditions?

Overall, if the equipment has little or no value at the end of the lease, the transaction is more likely a purchase. If the lessee is able to buy the equipment cheaply, the economic substance of the deal is less likely a true lease than a purchase.

Conclusion

Whether an agreement is a true lease or a disguised secured financing arrangement can be hugely important when you, the lessee, file bankruptcy.  Be aware that economic substance—not the agreement’s title or your subjective understandings—is the determinative factor.

 

Business Leases Recharacterized

February 27th, 2017 at 8:00 am

A business leases may not be a true lease but rather recharacterized as a secured purchase, giving you significant power over the creditor.  


Our blog post a week ago was titled “Leases that Are Actually Secured Purchases.” Sometimes a transaction labeled a lease is legally not truly a lease but is really a disguised purchase. Leases give the lessor/creditor a lot of leverage over you, the lessee/debtor. If you can persuade your bankruptcy court to recharacterize the “lease” as a secured purchase, you are usually in a much better position.

Last week’s post reviewed this from a consumer perspective. Today’s focus is on business leases, using an equipment lease as an example.

Disadvantages of True Leases in Bankruptcy

As a lessee, such as on a business equipment lease, very soon after filing bankruptcy you must choose between “assuming” or “rejecting” the lease. You “reject” the lease if you are not keeping the leased equipment. If you want to keep the equipment, you “assume” the lease.

That comes with the following disadvantages.

  • If the lease has below-market payments, the bankruptcy trustee may “assume” the lease ahead of you. The trustee does this to sell the lease rights to another party and then pay the proceeds to your creditors. So you could lose equipment you need to operate your business.
  • If you were behind on your lease payments when filing the bankruptcy case, you must cure any missed payments quickly.  
  • If you fell behind after filing bankruptcy while deciding whether to assume the lease, you have to catch up on those as well.
  • You have to make the full regular lease payments going forward, with no break in price.
  • At the end of the lease you return the leased equipment. That’s true unless the agreement allows you to renew the lease or to purchase the equipment. You’re stuck with whatever the lease provides.

After Recharacterization

In contrast, if the equipment lease is recharacterized as a disguised purchase:

  • A trustee may under limited circumstances have some say about keeping the equipment. But generally, if your business needs the equipment and you meet some basic requirement, the trustee can’t take it away from you.
  • If you qualify for “cramdown,” you don’t have to pay any missed payments. As long as you entered into the transaction more than a year ago, and the equipment is now worth less than the remaining balance, you qualify for “cramdown.”
  • With “cramdown,” your monthly payment is reduced, as well as the total you pay for the equipment. The balance owed is divided between secured and unsecured portions. The secured portion matches the amount of the value of the equipment. The unsecured portion is the rest, the portion not covered by the equipment’s value. The monthly payments are reduced because they are based on only the secured portion. They are also often stretched over a longer period, possibly at a lower interest rate.  You pay the unsecured portion only to the extent that you have available funds to do so.
  • At the end of the payment period, you own the equipment free and clear.

 

Our next blog post will get into the special business-oriented factors the bankruptcy courts use to determine whether a lease is a true lease and so deserves the benefits that gives to the lessor.

 

Business Leases of Personal Property

February 24th, 2017 at 8:00 am

With business leases you have the same options in bankruptcy as with consumer leases: to “assume” or “reject” the lease. 


Our last three blog posts have been about leases of personal property in bankruptcy. We’ve been focusing mostly on consumer leases. Now let’s see how it works in the business context.

“Personal Property” in a Business

Let’s first clear up one thing. Personal property does not mean consumer or non-business property. It simply means property that isn’t real property. (Real property is real estate—“any property attached directly to land as well as the land itself.”)

Personal property for a business would include equipment, office furniture and equipment, computers and other electronic hardware, and vehicles used by the business.

Business Leasing

It’s possible to lease just about anything needed in business. Leasing gives you the use of necessary business assets without paying up front for it or tying up your credit. The main downside is that you almost always pay more in the long run. And you commit yourself to keep the business asset for a set period of time.

Bankruptcy Options with Unexpired Leases

In general, regardless which bankruptcy Chapter you or your business files under, you have two basic options with leases.  You can retain the use of the property by “assuming” the lease. If so, you are required to “assume” ALL of the obligations under the lease agreement. Or you can “reject” the lease. Then you return the leased asset. And, if you are in a bankruptcy Chapter that provides for this, any remaining liability is “discharged”—legally written off.

There’s a lot to this, depending on your type of business entity, the terms of the lease, and your continued need for the leased property, among many considerations.

Individual vs. Business Liability

Who is the lessee on the lease agreement? Is it in the business’ name or in your name as an individual? Is it in the business’ name but with you as a co-signor or guarantor?

If you have a small business, usually you will be on the hook for all liabilities on the lease. You may well have directly signed the lease, or signed a guaranty. Or if you own the business as a sole proprietorship, you are individually liable for all obligations of the business.

Sole Proprietorship vs. Corporation

A sole proprietorship is not a separate legal entity from you, unlike a corporation or a limited liability company. Corporations and such can own property and owe debts on their own. Sole proprietorships cannot. So if you operate a sole proprietorship, you are liable on the business’ lease agreements. That’s true even if you operate it through a state- or city-registered assumed business name, and only that name is on the lease agreement.

To be practical, most of the time a lessor will require all small business owners to be individually liable. That’s again done either by requiring you to sign the lease agreement or an accompanying personal guaranty. This is usually true regardless whether you have a sole proprietorship or a corporation or whatever. The liability-avoiding purpose of having a corporation or LLC are often defeated this way in practical reality.

So, most of the time you are personally liable on the lease, and often on all of the business’ other obligations.

Filing Individual Bankruptcy

Assuming you are personally liable on your lease, and on all or most of the debts, you will need to file an individual bankruptcy case. If you have a sole proprietorship, it cannot file and does not need its own bankruptcy. (Whether your corporation or other business entity should do file one is beyond this discussion.)

You will likely have the option to “assume” or “reject” your business lease regardless which bankruptcy Chapter you file. Here is a very broad summary of how this works in Chapter 7, 11, and 13.

Chapter 7, 11, and 13

Under a Chapter 7 liquidation, if you assume the lease and are behind on the lease payments or are in breach of any other terms, you must get current and/or cure the breach within a month or two.  If you reject the lease, you surrender the property and your liability is usually discharged within about 4 months.

Under a Chapter 11 reorganization, you usually have more time to cure any breach. But Chapter 11 is a relatively expensive and time-consuming procedure that is seldom appropriate for a very small business.

Under a Chapter 13 adjustment of debts, you also have more time to cure a breach of the lease. It is a much less expensive procedure—it can easily cost one-tenth as much than Chapter 11. Only individuals can file under Chapter 13; corporations and other business entities cannot. But usually, even on a business lease, there is only personal liability. Or the personal liability is the only one that matters. If you assume the lease, you must still accept all the lease obligations. And if you reject the lease, any obligations arising from it are included with the rest of your “general unsecured” debts. You may have to pay some portion of that. But usually you are only paying a set, limited amount to all those “general unsecured” debts, so adding in the lease obligations does not increase the amount you would pay overall.

 

“Priority” Wages and Benefits Owed to Employees

September 14th, 2016 at 7:00 am

If you owe an employee wages or benefits, it’s likely a priority debt. Same if you are owed wages or benefits.  More likely to be paid.

 

We’ve been writing in recent blog posts about “priority” debts, such as child/spousal support and income taxes.

In a Chapter 7 case the bankruptcy trustee pays these in full ahead of paying anything whatsoever on other debts. See Section 726(a)(1) of the U.S. Bankruptcy Code. (That’s only if the trustee has any of your assets to liquidate, which is usually not the case.)

In a Chapter 13 case you have to pay priority debts in full during the life of the case. See Section 1322(a)(2).

Employee Wages and Benefits

There’s a type of priority debt that doesn’t come up nearly as often as child/spousal support or income taxes. But when it does it could be very important.

Under certain conditions a debt for unpaid employee wages, salaries, commissions, or benefits is a priority debt. If you’ve operated a business and owe this type of debt, it’s important to know how it’ll be treated.

Why It’s Important

Whether or not a debt for unpaid wages and benefits meets the conditions for being a priority debt especially matters if:

  • You are filing a Chapter 7 case in which the trustee is paying creditors, and you prefer that your employee(s) get paid ahead of other creditors. Then you want the wage/benefits debt to be a priority debt. That way it’s more likely your employee debt(s) will get paid.
  • You are filing a Chapter 13 case and you have very limited amount of money to pay your debts. Then you prefer the wage/benefits debt not to be a priority debt. That way you are not required to pay that debt in full. That makes your Chapter 13 plan less expensive to fund, perhaps turning an impossible situation into a feasible one.

The Conditions that Make a Debt to an Employee a Priority Debt

The basic rule:

  1. a debt for wages, salaries, or commissions (including vacation, severance, and sick leave pay)
  2. earned by an individual within 180 days of the bankruptcy filing or the closing of the business, whichever comes first
  3. up to $12,850

is a priority debt.

Chapter 7 Example

Let’s use two examples reflecting the scenarios mentioned above.

First, imagine you operated a business in your name that you closed the same day you filed a Chapter 7 case. You didn’t have the money to pay your single employee $3,000 for her final month of wages. You really want her to get paid. You also owe $100,000 in other personal and business debts.

You’re pleased to hear that $3,000 is a priority debt because it meets the 3 conditions listed above.

As your bankruptcy lawyer told you to expect, your Chapter 7 trustee asks you to turn over the last of your business equipment. The trustee liquidates the equipment, receiving $4,000. Out of that the trustee pays himself a fee of 25%, $1,000. (See Section 326(a).) The trustee pays your former employee the remaining $3,000, paying her off in full, because it’s a priority debt. Your other debts receive nothing, and are discharged (permanently written off).

Chapter 13 Example

Second, imagine you operated a business in your name that you just closed. Your single employer had quit 6 months ago. You suspect that one of the reasons your business failed is because that employee had been referring customers to a competitor, and getting paid a kickback fee. He started working for that competitor as soon as he stopped working for you. You have some evidence backing up your suspicions, but a lawyer has told you your legal case is weak against both your former employee and your competitor and simply not worth pursuing.

This employee’s regular salary was $4,000 per month. Because money was so tight during the final 6 months of working for you he agreed to let you hold back $1,500 of that salary monthly until you could afford to pay it back. The amount of back pay totaled $9,000. You feel like he owes you many times that amount of money for cheating you. And you certainly don’t want to pay him that $9,000 as a priority debt in the Chapter 13 case you’re filing.

So you’re happy to learn that this $9,000 debt is not a priority debt. It meets two of the 3 conditions listed above, but not the third one. Your former employee did not earn any of that $9,000 within 180 days of the close of the business or of the filing of your Chapter 13 case. So that debt is just a “general unsecured” debt. You pay it only to the extent you have enough disposable income to pay it, after living expenses and other more important debt. In many Chapter 13 cases the “general unsecured” debts are paid only pennies on the dollar. Sometimes they’re paid nothing.

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