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.
