Bankruptcy Article #15

Closely held corporations, in which there are only one or two shareholders can not file the corporation into bankruptcy unless the corporation files a Chapter 11 case. Chapter 11 bankruptcy cases are expensive. The filing fee for a Chapter 11 is $1,000 (compared to a $274 filing fee for a Chapter 13 case) and the attorneys' fees in a Chapter 11 can easily be over $20,000 before the case is over. It is not unusual for an attorney filing a Chapter 11 case to require a retainer from the debtor of $10,000 or more.

Consequently, it can be advantageous for a small business to use a Chapter 13 to reorganize, if possible. A technique to take advantage of Chapter 13 for a small corporation is known as "disincorporation". Although this is not a word in the dictionary, it accurately describes the practice of transforming a corporation into a sole proprietorship. In essence, a disincorporation is accomplished by transferring all of the corporate assets and the corporate debts to the sole shareholder (or one of the two shareholders) of the closely held corporation. The new sole proprietor then immediately files a Chapter 13 bankruptcy petition.

The advantages to disincorporation is that it can enable the business enterprise to survive and even flourish through a reorganization bankruptcy at a lower cost, enable the owner of the business to obtain a broader bankruptcy discharge than is available in any other bankruptcy chapter, and address not only business debt, but personal debt which may also be creating significant financial pressure on the business owner.

The costs associated with filing a Chapter 13 case are the $274 filing fee and a retainer for bankruptcy counsel of $2,000 in the usual case. An additional $1,000 - $5,000 in fees are usually included in the case as well and paid for through the Chapter 13 payment plan. In other words, the remaining fees are paid by the Chapter 13 Trustee from the funds the debtor pays into the plan over a three to five year time period. These costs are about 25% of the costs associated with trying to succeed in a Chapter 11 bankruptcy case.

In Chapter 13, a debtor who successfully completes the case receives a discharge from the Court which can eliminate more types of debts than is possible in a Chapter 7, 11, or 12 case. Debts incurred by fraud, various tax debts, and divorce property settlement debt can easily be discharged in Chapter 13. For business owners who have a variety of problem debts (and many do), the discharge advantages of a 13 must be taken into consideration.

In Chapter 13, not only can business debts be addressed and repaid through the bankruptcy case, but also personal debts can be included in the repayment plan. Many small business owners enter into bankruptcy with past due mortgage payments on their home, cars about to be repossessed, student loan obligations, past due child support and /or alimony payments, and recently incurred credit card debt. Chapter 13 can provide relief for a business owner for many of these types of problems in addition to reorganizing the business.

The disadvantages to disincorporation are several. First, if the corporation is a C-Corp, instead of an S-Corp, the new sole proprietor may encounter tax problems as a result of the transfer of the corporate assets and debts to the individual. It is critical for the prospective Chapter 13 filer to consider this issue in depth with his or her accountant. Second, if the individual has significant personal assets, but few business assets, the disincorporation permits the business creditors to look to personal assets for recovery. It is critical for debtor's counsel to consider the effect on a business owner's personal assets, particularly if the Chapter 13 turns out to be unsuccessful. While a successful 13 can free the business owner of a myriad of debt problems, an unsuccessful 13 (due to dismissal or conversion of the case) can cause the business owner's debt problems to be greater that they were before the disincorpation was initiated.