Kentucky Bankruptcy Law

Counsel with Care

Saving Your House: Mortgage Business Loans

I speak with many small business owners who have weathered tough financial struggles in their businesses and need some sort of relief. Inevitably, at least one business loan has insisted on a second mortgage against their house. This becomes problematic if the business person is forced into bankruptcy as a last resort and also wants to keep his or her residence. There are two possible sources of relief, only one of which do I address in this post and I am not going to touch on a Chapter 11 at all because that is nearly always to expensive for a small business.

11 USC Section 1322 provides for what one can and cannot do in a Chapter 13 plan. Section 1322(b)(2) basically says that you cannot modify a debt secured against one’s personal residence. However, that debt can ONLY be secured against one’s home to have this protection. In most cases, a business loans secured against the debtor’s personal residence is also secured against some other property, such as a building owned by the business or the assets and inventory of the business. These loans can be modified.

So, a business owner who wants to save their house can go into a Chapter 13 and “cram down” the principal of that business loan to the value of available equity in that home. The rest of the loan becomes unsecured and subject to discharge at the completion of the Chapter 13. If there is no equity, then the loan becomes wholly unsecured.

My usual caveat here: each particular debtors circumstance can impact whether or not the approach I am referencing would work. One should consult with a knowledgeable bankrutpcy attorney to determine whether all the details line up becuase navigating the bankruptcy code can be rather complex.

June 29, 2017 Posted by | Bankruptcy, Business & small business, Chapter 13, Foreclosure, Plan, Planning, Pre-filing planning, Security interests, Uncategorized | , , , , , , , , , | 1 Comment

Tips for Tough Times #3

One of my repeated themes is to seek legal counsel early. This is a variation on the theme of seeking counsel when trouble first rears it head so that you can plan for the worst case eventuality. This post is geared towards those entrepreneurial spirits out there who are forging ahead with starting their own businesses. It takes an extra measure of courage to do this in this post-recession recovery period (I am not entirely convinced that we are post-recession, but let’s go with it). And, along with that extra measure of courage I recommend an extra measure of counsel.

For by wise guidance you will wage war, And in abundance of counselors there is victory. Proverbs 24:6 (NASB)

And, while starting a business is not as bloody as waging war, it is indeed a financial battle. So, I recommend getting counsel from a lawyer all the way from setting up the proper corporate entity to tips on financing that can save you down the road. While talking to a lawyer about your business idea may not be the most inspiring and motivating conversation, it can be a lifesaver for you finances. This is because lawyers are trained to think about and plan for worst case scenarios – those eventualities you do not want to contemplate. The conversation, then, may feel like it is taking wind from your sails. However, making sure the right documents are in place from the inception of your business all the way to how to sign on promissory notes can make a huge difference when times are tough.

March 15, 2013 Posted by | Bankruptcy, Business & small business, Financing, Planning, Pre-filing planning, Solo & Small Firm | , , , , , , , | Leave a comment

Small businesses and the bankruptcy estate

I wrote a while back about strategies for dealing with debt for the small business owner. I will get more focused here about a key issue involved in a business related individual bankruptcy. As I explained in that previous post, most small business owners who become insolvent are forced into a personal bankruptcy even though most of the debt belongs to their business because of the owner’s personal guarantee. I refer to these as business related bankruptcies even though it is actually the individual person who files.

For an oversimplification, when someone files a bankruptcy, everything they own (with some exceptions) goes into an estate under the control of the trustee. The individual then uses exemptions to reach into the estate and keep certain property. Now, the issue in focus is what happens to the business when the owner files. Although the business itself is not in bankruptcy, the owner’s interest in that business goes into the bankruptcy estate the moment the bankruptcy is filed. And, there is only a small exemption for business equipment and tools of the trade so most exemption must come from the “wild card” exemption of 11 USC Sect. 522(d)(5). So, if the company has many assets, accounts receivables, ongoing contracts for work, inventory, or transferable goodwill, the owner may not be able to exempt it all. That creates a real problem and a potential battle over the real value of the owner’s interest or the forced sale of the interest.

Ordinarily, the owner’s interest is actually very small or zero due to debt load or because most of the company’s value is tied to the owner’s personal efforts. However, there is little reason to tempt such complications when there is another option. The best practice in such situations is to wind down the business and dissolve it administratively just prior to filing the bankruptcy. Then, immediately after filing the bankruptcy, create a new Limited Liability Company or S-Corp and begin doing business as a new entity. While the trustee could attack the new company as an alter-ego of the first, there is a strong disincentive because now the trustee has to first win through on an alter-ego theory and then still argue over the value.

There are many details involved in the winding down of the old and the starting up of the new business including how bank accounts, accounts receivables, contracts and employees are all handled. So, it is best to get in with a bankruptcy attorney that is versed in these types of business related bankruptcies early on to give adequate time to plan and prepare.

February 6, 2012 Posted by | Bankruptcy, Chapter 7, Exemptions, Planning, Pre-filing planning | , , , , , , , , | Leave a comment

What options do small businesses have to deal with debt?

This economy has been tough on the small business owner. Many of the people I talk with are sole owners of a Limited Liability Company, S Corporation, or sole proprietorship. Invariably, the owner has invested a great deal of his or her own resources into the business to fuel their dream. Because small business ventures, especially start-ups, lack assets and reliable revenue streams, banks always insist that the company and the owner individually AND the owner’s spouse all co-sign any loans. They typically also insist on a lien against personal property, such as the family residence.

So, when a small business start-up becomes insolvent (which statistically accounts for the majority of new businesses) there is far more at stake than just the business assets. The home and other personal property are at stake as well. Because of what is at stake, many folks understandably push on past the point of wise investing and empty out retirement accounts and cash in other exempt assets to keep the business going just a little longer.

When the economy first began faltering, this strategy had some wisdom to it because everyone expected a rebound in a few months. Now, though, the new reality of our economy is setting in and fewer people are expecting a big turn around. Because of this, the small business owner is compelled to a new level of shrewd thinking.

However, what happens when one’s best laid plans simply are no match for sluggish sales? It basically boils down to two possibilities: 1) an out of court work-out, or 2) bankruptcy. The way to determine which route to go involves an analysis of debt, income and assets. One business owner I consulted with was being pressed very hard by creditors and wanted to do a bankruptcy, but when I reviewed the assets he had that were not encumbered (were not collateral on a debt) he realized how much he stood to lose in a bankruptcy. The analysis allowed him to explore an out of court restructuring of debt because he had a dollar number where it made sense to incur additional debt and a cut off point. In other words, the analysis gave him a make it or break it line. I’m happy to say he avoided bankruptcy and his business is still going.

Out of court work-outs are generally a good thing to attempt, but you have to be careful. I’ll visit that more in-depth soon. The other option is bankruptcy. If most of your total debt is from business debt (your home loan debt is non-business in nearly every instance, so that is often a stumbling point for this) then you can file a personal Chapter 7 bankruptcy without having to pass the means test (the test that sets a threshold of income for taking Chapter 7 bankruptcy). I say a personal bankruptcy because a business cannot receive a discharge from debt; only an individual, and as I said earlier, small business owners are on the hook individually 99 and 44/100s percent of the time. Whether or not the business also takes bankruptcy is a case by case analysis. Often, the company can be dissolved prior to filing bankruptcy and then a new business can be created afterwards. Sometimes the value of the business is so low that one can exempt their ownership interest.

Many small business owners have heard about Chapter 11 bankruptcy. This is an option to consider if you have too much at stake in terms of non-exempt assets (assets you stand to lose in a bankruptcy) to file a Chapter 7 but your creditors are unwilling to cooperate in a work-out. However, Chapter 11s are not a viable option for the overwhelming majority of small businesses because they are incredibly expensive. And, if any secured creditor has a perfected security interest against your cash collateral (including revenue coming in), then you are going to have to have a new source of funding on-line whether that is a new creditor who gets a super-priority position for the new value they bring or if it is an investor who will inject unencumbered cash.

January 3, 2012 Posted by | Bankruptcy, Planning, Pre-filing planning, Property (exempt | , , , , , , , , , , , , , , , , | 2 Comments