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In a business liquidation, an entity files a Chapter 7 Bankruptcy Petition and turns over the control of their company to a Trustee who is a fiduciary for creditors. The Trustee then assists with every aspect of sale of any assets and pursuit of litigation to fund a distribution to the creditors through the Chapter 7 process. A business liquidation is known as a “walk away” while the business owners have a responsibility to and assist and cooperate with the trustee to provide needed support and financial information about the company’s affairs.

A reorganization under Chapter 11 involves an entity that is a debtor in possession of their assets and operation of the company. Essentially, a debtor in possession has rights and obligations and can operate in the ordinary course of business. One administrative requirement is that a Debtor must file monthly operating reports with the United States Trustee Office. In these reports, all receipts and disbursements of funds must be accounted for, tracked, and organized in a strict format. The debtor in possession must also pay quarterly fees, and formulate a plan of reorganization that creditors and the United States Trustee Office could oppose if not in compliance with the Bankruptcy Code.

What Type Of Debt Qualifies As Business Debt?

Business debt can be defined as debt incurred for reasons unrelated to personal, family, or household purposes. The characterization of debt as business vs personal is related to the issues in the “means test” applicable to Chapter 7 and Chapter 13 bankruptcies. An individual that has in excess of 50 percent business debt is not subject to the means test for family median income. Under such circumstances, a determination must be made as to whether the debt is truly business debt. Each individual debt has to be analyzed. The reality is that if the debt was incurred for the purpose of assisting a business, then it will likely qualify as a business debt.

Who Can Authorize A Bankruptcy Filing?

The question of authority to file a business bankruptcy case derives from the Articles of Incorporation or the Operating Agreement governing a limited liability company. A small corporation may not have a board of directors as a larger corporation does. A shareholder agreement may require a meeting and a majority or a higher percentage to favor authorizing a bankruptcy case It may be that a 2/3 vote is required by the members in an LLC. Some operating agreements do not require the managing member to be in support. In real estate bankruptcies involving entities that own one particular or several pieces of property, the documents may require unanimous consent of all general and limited partners, or else require that more than 50 percent of the stockholders vote in favor of the bankruptcy. Ultimately, authority to file bankruptcy will depend on the circumstances and the documents that were created when the business was formed. The issue of authority in this context must be analyzed carefully, because cases can be dismissed if bankruptcy filings are unauthorized or the organizational documents of the company and the bylaws are not properly followed.

Can A Creditor Force A Business Into Bankruptcy?

According to section 303 of the bankruptcy code, if a debtor has fewer than 12 creditors, then a single creditor can file an involuntary bankruptcy petition. Three or more creditors who have claims not contingent as to liability and amount or that are the subject of a good faith dispute can also file an involuntary bankruptcy petition. In both instances, however, the creditors must prove that a debtor is not generally paying debts as the debts become due.

A Word of caution to any creditor that is considering filing an involuntary bankruptcy petition. If it is determined that the petition was filed in bad faith or as a means to collect the money benefiting the sole interest of the petitioning creditor , and if the petition is contested by the debtor and ultimately dismissed for this reason, then the creditor may be held liable for damages, punitive damages, counsel fees.

Filing an involuntary bankruptcy against an individual or a company is a very risky maneuver. However, it can have some benefit where an entity has actually shut down and ceased operation. At that point, the entity can’t be said to be generally paying its debts since it has terminated operations. Involuntary bankruptcy is a possibility in unique circumstances, but it has also been the subject of many reported decisions that sanctioned attorneys and their clients for not filing in good faith.

What Happens To My Business If I File For Personal Bankruptcy?

If someone files a personal bankruptcy, such as a Chapter 7 bankruptcy, then their legal interest in their business is considered an asset in the case. The exemptions in bankruptcy are not unlimited. It is often very difficult to value the percentage of interest in a small corporation or LLC. A Chapter 7 trustee essentially becomes an equity owner of that company and assumes the rights of the individual stockholder or equity holder. Frequently, the trustee will ask for the business’s records and tax returns in order to evaluate whether the value of business interest exceeds the exemption the debtor has claimed in the case. If a debtor does not use the $25,000 real estate exemption, then an exemption of $12,500 can be applied to any property.

A debtor might list the value of their stock interest at a fraction of the value of the company and use whatever available exemption they have to retain their legal interest. Very frequently, trustees conclude the value an individual’s interest in an entity is not. The reality is that it’s risky for someone who has a substantial amount of ownership in an entity. Some trustees will have to utilize their business judgment in reaching a decision as to whether a debtor should have to repurchase their stock or equity interest in the entity because it exceeds the exemption under the bankruptcy code.

Get Information on Business Liquidation Vs. Reorganization, or call the Michael McLaughlin, LLC, for an initial consultation at (908) 373-8500 and get the legal answers you are seeking.

Michael McLaughlin, Esq.

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(908) 373-8500

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