Short explanation of bankruptcy alternatives

This is an email I sent to a prospective client a few months ago.  A succinct explanation of bankruptcy alternatives.

Dear Joe,

Your choices for bankruptcy are chapter 7 and chapter 11.  Neither you nor any of the corps qualify for chapter 13.  

Chapter 7 is a liquidation.  A trustee is appointed.  He/she sells everything you own that has equity and is not exempt.  You have no choice in it.  The trustee owns everything you own instantaneously and sells it – if of course he can find a buyer.  If he can’t find a buyer or there is no equity or it is exempt, he will “abandon” it back to you.  

In a personal case, i.e., you as an individual, “everything you own” includes all community property.  The trustee will sell it irrespective of your wife’s interests.  The trustee cannot sell your wife’s separate property.  

In chapter 7, all your debts are discharged – wiped out – with a few exceptions like child and spousal support, most taxes, fraud.  Your wife’s debts will not be wiped out in your bankruptcy but that does not mean she is liable for your debts.  She is only liable for debts she promised the creditor she would pay.  For example, I saw that she signed for some the [bank debt].  Her obligation to pay that would not go away in your bankruptcy (unless you stay married and then it sort of goes away).  Likewise any deal you make with your wife in family court to pay the debts she owes is not binding on the creditor.  

So in chapter 7, the trustee would sell your home – and give you the $600,000 exemption.  He would sell your interest in [your corp].     

corporate chapter 7 works the same way with one big exception – the corporation/LLC does not get a discharge.  When the case is over, the corp still owes whatever it owed when the case started.  Corps don’t file chapter 7 very often.  There may be other reasons to file – other than getting a discharge. 

If [your corp] files chapter 7, the trustee would control the litigation against [the bank].  The trustee might actually litigate it, i.e., hire a lawyer on a contingency – even your lawyer if he will do it on a contingency.  It is more likely though that the trustee will try to settle it with [the bank].  The trustee might think it’s too much hassle and just close the chapter 7 case which would mean it is your asset again to proceed with.  That would only happen if [the bank] refused to pay even $10-15-20,000 to settle.   

Chapter 11 is a reorganization.  There is no trustee.  You personally function as the trustee.  You keep all of your property, you continue to operate your business with bankruptcy court oversight.  

You file a plan of reorganization.  The creditors get to vote on the plan, i.e., accept or reject it.  The court can approve the plan, even if almost everyone rejects it.  That is called the cram down powers of the court.  

The most fundamental part of the plan is that you have to pay your creditors at least as much as they would get in a liquidation.  So you would have to value [your corp] at some amount, and the litigation against [xyz] and the equity in your home after the homestead exemption, and then pay that amount to your creditors over five years – up to 100% of the total debts.    

A corporate chapter 11 works basically the same way.  You propose a plan to pay creditors what they would get in a liquidation.  If [your corp] files chapter 11, you would remain in control of the litigation with [the bank] but the plan would probably say you will pay the proceeds of the litigation to [your corp’s] creditors, up to payment of all creditors in full.  

Let me know what you think.  Jon   

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