The Truth About Bankruptcy: Debunking Five Common Myths, by Ethan D. Ganc, Esq.

Myth # 1: A company that files for bankruptcy is going out of business.

The fact that a company has filed for bankruptcy protection does not mean it is necessarily going out of business or ceasing operations. In fact, companies that just need some breathing space but have the prospect of rehabilitation can file for protection under Chapter 11, which is a reorganization proceeding. In very broad terms, Chapter 11 enables companies to continue their operations, address their outstanding debt, shed burdensome leases and other contracts, and reemerge at the end of the bankruptcy process. Alternatively, some companies use the Chapter 11 process to sell their assets as a going concern, which enables the buyer to continue to operate the same business under new ownership.  

 

Myth # 2: The best way to deal with a failed business is to file for Chapter 7.

In contrast to Chapter 11, Chapter 7 is a liquidation proceeding where the company that files for bankruptcy protection ceases operations. Chapter 7 may be an appropriate option for a business that has significant assets available for liquidation; however, Chapter 7 is rarely a good choice for a failed business that has few or no assets of value. Unlike an individual, a business that files for Chapter 7 does not receive a discharge (forgiveness) of its debts. More importantly, particularly for a closely held business, filing for Chapter 7 may result in unwanted scrutiny by the bankruptcy trustee (a third party appointed to marshal and liquidate assets) of the business owners’ compensation and other financial transactions with the company, which could result in an attempt by the trustee to recover payments made by the company to the business owners prior to the bankruptcy filing.

 

Myth # 3: A business or individual must be insolvent (i.e., its debts must exceed its liabilities) in order to be eligible to file for bankruptcy.

There is no requirement in any section of the Bankruptcy Code that a debtor (the company or individual that files for bankruptcy) be insolvent. In fact, it is not infrequently the case that debtors, both corporate and individual, have assets that exceed their liabilities. Businesses may have assets that exceed liabilities but may still benefit from filing for bankruptcy because it allows them to restructure certain debts and shed burdensome lease obligations and other contracts while continuing to operate as a going concern. As explained in the next section, because individuals who file for bankruptcy can exempt certain property from the reach of creditors, those individuals may have assets that exceed their liabilities but still be able to discharge certain debts by means of a bankruptcy filing.

 

Myth # 4: An individual who files for bankruptcy will lose all of his/her assets.

Both state and federal laws protect certain assets from the reach of creditors. These assets are called exempt assets. A few limited examples of exempt assets include federally qualified retirement accounts like 401(k)s, most ordinary household goods and furniture, some amount of equity in a home (this varies from state to state and under federal law), and some amount of equity in a car (this also varies). Exemptions allow a person to file for bankruptcy protection and still discharge his/her debts while keeping the exempt property.

 

Myth # 5: Personal income taxes are never dischargeable by an individual debtor in bankruptcy.

While personal income taxes of newer vintage are not discharged (forgiven) in bankruptcy, some income taxes that are older may be dischargeable. Generally speaking, if a specific tax return was last due more than three years before the bankruptcy filing, the return was filed more than two years before the filing, and there are no additional assessments relating to that tax year that occurred less than 240 days before the filing, the taxes for that year may be dischargeable.

 

If you have any questions about these or any other legal matters, please do not hesitate to contact TLA past-president, Ethan Ganc, Esq.

Ethan Ganc maintains a practice in New York City, where he serves clients in the areas of bankruptcy/creditors rights, business law, and commercial litigation, among others. Ethan was president of the TLA from 2014 to 2018, vice president from 2012 to 2014, and served on its board of directors from 2010 to 2017.