In Michigan and elsewhere, a corporation, LLC, S-Corp, or other entity is a separate legal person. These entities are able to incur their own debt and own property. One main reason that people form these business entities is to shield their owners from the liabilities of the business. Most lenders nevertheless require the owners of small corporations to pledge their personal guarantees before advancing any loans or lines of credit to the business, making them personally liable for the business debt.
Thus, when a business is failing, it has the option to file for bankruptcy just as an individual human being does.
An individual (human being) with the need to escape overwhelming debt has the option to file bankruptcy under Chapter 7, Chapter 13, and, in rare cases, under Chapter 11 of the US Bankruptcy Code. A “legal person” (corporate entity), on the other hand, has the option to file only a “business” Chapter 7 bankruptcy or a Chapter 11 bankruptcy. In some circumstances, it is possible to Discharge your business debt in a personal bankruptcy case.
Chapter 11 is a business reorganization available to large and small businesses. Attorney fees are usually quite high as this type of bankruptcy is complicated and is usually reserved for large businesses who are likely able to stay in business and are likely to become profitable after a Chapter 11 restructuring. General Motors is a good example of a successful Chapter 11.
This is fairly clear-cut, but it can become complicated quickly.
If you are a sole-member LLC or the sole officer (and shareholder) of a corporation, do you file bankruptcy or does the business file bankruptcy when the enterprise fails? Do both file?
If the business alone is the “person” carrying the overwhelming debt, can it file with you?
What if the business has multiple members or officers? What if one of those officers or members is your spouse, or another family-member?
This article will attempt to briefly answer a few of these questions.
Chapter 7 Business Bankruptcy in Michigan
Chapter 7 bankruptcy is commonly known as a “liquidation” bankruptcy. That is, in exchange for a complete discharge of your debt (other than certain debts that cannot be discharged), your assets are subject to seizure, liquidation, and sale by someone called the Chapter 7 Trustee.
It is the job of the Chapter 7 Trustee to reduce your assets—where unprotected—to a pool of cash which is then distributed to your creditors.
For individual (human) Chapter 7 debtors, the majority of cases do not involve any actual loss of property.
This is because the US Bankruptcy Code and Michigan state law allow a debtor in Chapter 7 to remove from the “bankruptcy estate” created with the filing of the bankruptcy petition certain types of assets up to certain dollar value limits. These are the so-called “exemptions” used to protect your property from the Chapter 7 Trustee’s liquidation power.
For example, if you file for Chapter 7 bankruptcy and own a car free and clear that is worth $2,000, it can be totally protected. The US Bankruptcy Code provides an “exemption” amount with a cap of approximately $4,000 for a single vehicle. That car can be fully exempted—and it is then fully removed from the bankruptcy estate.
For individuals, most of the time, the various exemptions for household goods, jewelry, automobiles, retirement accounts, and so on are more than adequate to protect all of what an individual living a “normal” lifestyle tends to own.
The individual in this situation is able to discharge and walk away from 100% of the debt owed while losing no property.
Chapter 7 bankruptcy is a win-win, in these sorts of cases. The individual is able to obtain the “fresh start” promised by the Bankruptcy Code and move on with life.
For a business that files Chapter 7 bankruptcy, the calculation is different. A business enters that enters Chapter 7 bankruptcy is doing so because there is no further hope for “life.”
A business Chapter 7 is, essentially, a business liquidation which allows the business owner or principals to sit back and let the Chapter 7 Trustee do all of the work. It basically allows an independent third party, the Trustee, to conduct a formal liquidation of the businesses assets, all within the oversight of the United States Bankruptcy Court.
The process settles the business’ remaining legal questions concerning assets, debts, and other legal liabilities. The business cannot claim exemptions in property as is the case with individuals, nor can it receive a discharge of it’s debts. The Chapter 7 basically gives the failing business a proper burial. The debts remain, but their is nothing left of the business for creditors to collect from and the business ceases to exist.
If you hope to continue operating the business, Chapter 7 bankruptcy is not the appropriate path to take. A Chapter 11 bankruptcy is a business reorganization that will allow, in theory, the business to continue operating during and after the bankruptcy process.
Further, a business Chapter 7 bankruptcy carries some serious possible drawbacks.
When Chapter 7 Business Bankruptcy Should Be Avoided
There are great many bankruptcy lawyers in Metro Detroit and elsewhere who maintain the firm opinion that a business should never file for Chapter 7 bankruptcy.
Why would so many take this position?
The short answer is that a business Chapter 7 bankruptcy is a potential minefield not only for your business but, potentially, for you, the owner, personally, and potentially also for your family, friends, and anyone else in your orbit, depending on a variety of circumstances.
Did you commingle your personal funds with those in the business’ bank accounts? Did you use the business checking account as your own personal checking account? (This is very common for single member LLC operators in Michigan.) Did you write a check to your mother from that business bank account for her new water heater? Your spouse? Your children?
You get the idea.
When considering filing for Chapter 7 bankruptcy generally and especially a business Chapter 7 bankruptcy, it’s important to remember that the Chapter 7 Trustee doesn’t just have the power to liquidate the present assets of the debtor.
The Chapter 7 Trustee also has the power to avoid (unwind) transfers of cash and assets made prior to the filing of the bankruptcy, to collect the business’ debts and receivables, to recover what are called “preference payments” made by the business to creditors prior to filing, and to stand in the shoes of the debtor to write corporate resolutions, dissolve the business, and, to some extent, even operate the business for the benefit of the creditors.
In other words, the Chapter 7 Trustee is empowered to chase down every dime transferred or loaned out by the business and empowered to recover all assets of the business.
When the business was failing, did you title the company car over to your son-in-law? Or sell it to your cousin for $1?
You, yourself, will be exposed to liability to the business when the Chapter 7 Trustee. Worse, anyone else who walked away from the ashes of your enterprise may be, too.
When Chapter 7 Business Bankruptcy Is Advisable
Chapter 7 business bankruptcy may, however, result in a good outcome for your business when:
- There has been no commingling of funds;
- There have been no non-arm’s length transfers of cash or property;
- When the business has generally been run in a professional manner in accordance with GAAP (generally accepted accounting principles);
- When the business’ creditors are threatening or have filed lawsuits and there are sufficient business assets to provide a “target” for such legal action.
If the business has been operated “cleanly” leaving no personal exposure for you or your loved ones to worry about and the alternative is a prolonged period of settling matters with creditors (including through defending collection and contractual breach lawsuits), a business Chapter 7 bankruptcy could be worth considering.
It is highly inadvisable to attempt a business Chapter 7 on your own. Any bankruptcy involving a business should be filed with the assistance of an experienced Michigan bankruptcy attorney.
Alternatives to Chapter 7 Business Bankruptcy: Wind-Down & Dissolution
What if everything written above worries you?
The primary reason that many bankruptcy lawyers advise against a business Chapter 7 bankruptcy is that, often, it isn’t less harmful to you than are easily available non-bankruptcy options.
With the help of a good lawyer and accountant, a business can simply be wound down and dissolved without the need for bankruptcy.
Once the assets have been (properly) liquidated and creditors paid to the extent possible from those liquidation funds and a certificate of dissolution filed with the Michigan Secretary of State, a business creditor’s collection lawsuit won’t be worth the paper it’s written on.
This can all be accomplished without handing a highly aggressive Chapter 7 Trustee the keys to years’ worth of your business and personal accounting.
If you’re not sure which option is best for your business, you need to consult an experienced bankruptcy and/or business attorney.
Chapter 11 Business Bankruptcy
As noted above, if your goal is to continue to operate your business but need to deal with the debt of the business to do so, a Chapter 11 corporate reorganization may be appropriate for your enterprise.
A Chapter 11 bankruptcy process is enormously complicated and can take years to resolve. For a small business, it is often a burdensome—and expensive—prospect.
However, new reforms to US bankruptcy law have been implemented with the aim of improving the process for small businesses.
If you are considering Chapter 11 bankruptcy for your Michigan business, contact an experienced bankruptcy lawyer.
Business Bankruptcy in Michigan: The Bottom Line
The bottom line with regard to business bankruptcy is that it is not for the faint of heart. It is also not for the lightly experienced attorney—and definitely not for the non-attorneys among us.
Detroit Bankruptcy Lawyer Walter Metzen is a Board Certified Bankruptcy Expert who has successfully represented thousands of bankruptcy clients for over 30 years.
If your business is failing, contact us to discuss legal options for your enterprise.