By Tsu-Li Liew
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Business owners have multiple choices for filing for bankruptcy. Last week, we explored how a Chapter 7 bankruptcy can discharge most debt at the steep price of closing down the business and selling the owner’s assets. This week, we will look at how Chapter 13 bankruptcy is beneficial to a small business owner who has a lot of debt but wants to keep running their business. During the economic crisis due to the COVID-19 pandemic, many small businesses are facing new challenges that they may be unprepared for. As many businesses were forced to close and continue to be closed during stay-at-home orders, owners may find their incomes decreasing. This can cause them to find it difficult to pay back any debts or loans that they have and fall behind on their payments.
Owners will have to figure out how to reduce their risk and consider filing for bankruptcy. By filing for Chapter 13 bankruptcy, business owners will need to create a judge-approved plan to pay off their debt in installments over three to five years, depending on their monthly income. This means that instead of selling off their property to raise money, the trustee appointed to the case will collect payments from the business owner to pay off their creditors.
The Process
Any individual can file for a Chapter 13 bankruptcy, as long as the debts are below a certain amount. Individuals who are unable to pass a Chapter 7 means test will usually have to apply for a Chapter 13 bankruptcy. It is important to note that only individuals can file for Chapter 13 bankruptcy. Therefore, it is limited to businesses owned by sole proprietors, and excludes businesses that are formed as a partnership or a corporation.
However, there are other requirements and restrictions that may prevent a business owner from filing for a Chapter 13 bankruptcy. Prior to filing, a business owner will have to receive credit counseling from an approved counseling agency within the preceding six months. There are two exceptions: 1) an emergency situation or 2) insufficient approved agencies in the area to provide the counseling. A business owner would also be barred from filing if they had previously filed for any bankruptcy petition in the past six months but caused a dismissal of the petition by failing to appear in court or comply with court orders. This restriction also applies if the owner voluntarily dismisses the petition.
Once a business owner can meet all the requirements and is not barred by any restrictions, they can file a petition with the bankruptcy court, where they live. Along with the petition, they have to file these documents: 1) schedules of assets and liabilities, 2) schedules of current income and expenditures, 3) a schedule of executory contracts and unexpired leases, and 4) a statement of financial affairs. An owner will also need to file a certificate of credit counseling, and a copy of a debt repayment plan developed through credit counseling if there are any. To complete the forms, the owner will need to know the following information: 1) a list of all creditors and amounts of their claims, 2) the source of their income, 3) a list of all property, and 4) a list of monthly living expenses. Seth L. Hanson provides a list of information related to the business that owners might need to provide for a Chapter 13 filing as well.
There will be an administrative and filing fee that an owner will need to pay upfront. However, the court can grant permission to the owner to pay the fee in four installments instead. These installments need to be paid within four months after the date of filing, but an owner can ask for an additional two-month extension with good reason. If the fees are not paid within a timely manner, the court may dismiss the case.
Once the bankruptcy petition has been filed, an impartial trustee will be assigned to the case. This trustee will work with the owner to collect the payments and redistribute them to the creditors. The trustee will also hold a meeting of creditors between 21 and 50 days of the date of filing, where the owner will have to answer questions from the trustee and the creditors under oath regarding their financial affairs and repayment plan. Unsecured creditors will have 90 days from the meeting to file a claim with the bankruptcy court in order to receive payments.
Filing for a Chapter 13 bankruptcy will automatically prevent most creditors from collecting payments from the business owner. This is known as an “automatic stay.” This means that those creditors cannot start or continue with any lawsuit to collect money from the owner. Any foreclosure proceeding on the owner’s property will automatically stop, which may help the owner from losing their property. However, if the foreclosure proceedings ended before the owner files the bankruptcy petition, it would be too late for the owner to save their property. Unless the bankruptcy court grants permission, creditors will also be unable to collect from other individuals who are liable for the same debt as the owner.
If the business owner did not file the repayment plan along with the petition, they have 14 days to file it with the court or can to ask for an extension. The court will have 45 days to approve the plan during a hearing, which the owner and trustee must attend. Any creditor can choose to attend the hearing and object to the approval. Once the court approves the plan, the business owner will usually make either monthly or bi-monthly payments to the trustee, who will redistribute the money to the creditors. If a court rejects the plan, the owner will have to file a modified plan.
There are three types of debts: 1) priority, 2) secured and 3) unsecured. Priority debts include taxes and the cost of proceedings. These debts have to be paid in full, unless the creditor agrees to a different outcome. Secured debts are those that are tied to a collateral, such as an owner’s property or car, which grants creditors the right to take the collateral away. If an owner wants to keep the collateral, then the repayment plan must provide these creditors with at least the value of the collateral. However, depending on when or how the debt was incurred will influence whether the creditor will receive the full amount back.
Creditors of unsecured debt, on the other hand, do not have any right to take away property from the owner. An owner does not have to pay unsecured debts back fully, if the owner uses all projected disposable income during the applicable commitment period and these creditors will receive the amount that they would have gotten in a Chapter 7 asset liquidation. An owner’s disposable income is the amount that they earn minus their living expenses, charitable contribution and the overhead costs of running a business. The length of the plan will depend on the owner’s monthly income as well. If they make less than the state average of a same-sized family, the commitment period is three years. On the other hand, the plan is five years if the owner’s monthly income is greater than the state average of a same-sized family.
As long as the business owner sticks to the repayment plan, the court may discharge some debts at the end of the commitment period. This means that creditors who got their payments in full or in part will not be able to sue the owner for any remaining debt. However, certain debts, such as home mortgages, student loans and others, cannot be discharged. During the commitment period, a business owner will not be able to take on additional debts as well. For more general information, the U.S. Courts and the Balance have guides on Chapter 13 bankruptcy.
Advantages and Disadvantages
There are many advantages to filing for a Chapter 13 bankruptcy, in comparison to other bankruptcy chapters. It is more accessible to most business owners, as they will not have to pass a means test to determine their eligibility, in comparison to a Chapter 7 filing. Another advantage is that it gives a business owner more time to pay off their debts. As Simon Resnik Hayes LLP points out, if a business owner was behind in paying off their debts, they will be able to use a Chapter 13 repayment plan to pay off the late payments without worry of getting sued by creditors or losing a collateral. At the end of the commitment period, some of the owner’s debt might be discharged, if they kept up with the repayment plan. The biggest advantage of a Chapter 13 bankruptcy filing is that an owner can keep their business. An owner is encouraged to keep their business open as they will need to generate income to give to the trustee for redistribution.
No matter the advantages, there are some downsides to choosing Chapter 13 bankruptcy. Firstly, it does not apply to all business owners; it only applies to those who are sole proprietors. This means that individuals who are in partnerships or other forms of incorporation cannot file for Chapter 13. Depending on the owner’s income, the entire process will take a few years at least. An owner has to be diligent and hardworking to keep making the payment during that time. The Balance lists a few reasons why a Chapter 13 case might fail. In comparison, a Chapter 7 filing might resolve within six months. Chapter 13 bankruptcy might make it hard for an owner to make any major changes to their business. An owner will not be allowed to take on new debt during this time and will have to give the trustee their disposable income to pay off the debts. If an owner is unable to keep up with payments as well, a court might dismiss the case or change it to a Chapter 7 bankruptcy instead.
Despite the long commitment period of a few years, filing for a Chapter 13 bankruptcy gives a business owner a second chance at running their business. Even if they had fallen behind on some payments, this will allow them to get back on their feet and catch up on their payments. Depending on the situation, some unsecured debts will be discharged at the end of the commitment period as well. Since the business owner is allowed to keep their property, Chapter 13 lets them continue generating an income through their business, and hopefully use that income to give money to the trustee for redistribution.
Concluding Thoughts
While bankruptcy is often associated with running out of money, it can be a useful tool for owners. A petition for Chapter 13 bankruptcy might seem daunting. After all, business owners who filed for it will need to generate income to pay off their creditors, instead of earning money for themselves. However, in unprecedented times brought about by the COVID-19 pandemic, a Chapter 13 bankruptcy filing could give business owners a little peace of mind. According to the National Law Review, the commitment period for all pending cases and cases filed within a year of the CARES Act can be extended to seven years at most. It gives them more time to pay off their debts, and they do not need to worry about losing their property or the business to their creditors. Basically, Chapter 13 gives owners another shot at running their business.
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