Popular Posts

Google+ Badge

Google+ Followers

Thursday, April 3, 2014


      Chapter 13 is not just for consumers. An individual in a sole proprietorship (or who is engaged in some business activity, such as renting properties as a landlord) has Chapter 13 available to him or her, provided that he or she meets the debt limits in 11 U.S.C. §109(e) and has regular income (either via the business activities or from other sources, such as separate employment). Chapter 13 is not available to partnerships (although individual partners may file), corporations or LLCs that operate businesses.

     Chapter 13 has much to recommend it over Chapter 11 if the debtor’s goal is reorganization and preservation of his or her business. For one, a Chapter 13 plan is easier to propose and confirm than a Chapter 11 plan (fewer confirmation standards, no absolute priority rule, and no disclosure statement requirement). The debtor also has the ability to stretch out and pay administrative claims and priority debt over years, rather than meeting the Chapter 11 requirement to pay such claims in full on confirmation. Other benefits include the (much) cheaper filing fee; the right to cure mortgage defaults over the life of the plan; no quarterly U.S. Trustee fee; no monthly operating reports; and no requirement that the debtor’s attorney be approved under 11 U.S.C. §327. The enhanced discharge in 11 U.S.C. §1328(a) also applies in business debtor Chapter 13 cases. 

     One possible disadvantage is the 5 year limit on plan payments; if the debtor needs to "cram down" a secured creditor's claim, the debtor has to do so within the 60 month limit on plans. See Bullard v. Hyde Park Savings Bank (In re Bullard), 494 B.R. 92 (BAP 1st Cir. 2013)(11 U.S.C. §1325 requires that the payments on a cram-down of a secured claim equal the present dollar value of the property as of the confirmation date, and that distribution on account of the claim must occur within five years).

     The “business” Chapter 13, however, has several statutes and rules that apply to it and which may be unfamiliar or “traps for the unwary” for attorneys who ordinarily file consumer Chapter 13 cases, and for individuals in business considering the Chapter 13 option. Here are the more significant issues, with the applicable statutes and rules:

·         Debtor Engaged In Business – 11 U.S.C. §1304

           §1304(a) states that “[a] debtor that [sic] is self-employed and incurs trade credit in the production of income from such employment is engaged in business”. §1304(b) allows the debtor, unless the court orders otherwise, to operate his or her business, and references the debtor’s right to use property in that business, subject to the limitations on a trustee under §363(c) (cash collateral use requirements) and §364 (limitations on incurring credit).

           §1304(c) requires the debtor in business to perform the same duties that a Chapter 7 trustee performs in §704(a)(8); those duties require the debtor to file with bankruptcy court, the United States trustee, and any governmental unit that collects or determines tax arising out of the debtor’s operation, “periodic reports and summaries of the operation of [the debtor’s] business, including a statement of receipts and disbursements, and such other information as the United States trustee or the court requires.” Fed. R. Bankr. P. 2015(c)(1) is more specific; that rule requires that the debtor;

o   Keep a record of receipts and the disposition of money and property received;

o   Comply with §704(a)(8) and include a statement, if payments are made to employees, of the amounts of deductions for all taxes required to be withheld or paid for and in behalf of employees and the place where such amounts are deposited; and

o   Give notice of the case, ASAP after the petition date, to every entity known to be holding money or property subject to withdrawal or order of the debtor, including any bank, public utility company, landlord with whom the debtor has a deposit, and every insurance company which has issued a policy to the debtor having a cash surrender value payable to the debtor.

     MLBR Appx. 1, Rule 13-2(a)(2) also requires that Massachusetts Chapter 13 debtors in business submit the following to the Chapter 13 trustee:

o   Within 7 days after the petition is filed, both evidence of current and sufficient business insurance, and evidence that the debtor opened “appropriate debtor-in-possession checking accounts”.

o   Within 14 days after the petition, a profit and loss statement for debtor’s fiscal or calendar year preceding the year the case is filed, and a profit and loss statement for the period beginning at the end of the prior year and ending on the petition date.

o   Within 30 days of the close of each quarter, a statement of quarterly income and expenses incurred.

     The United States Trustee’s Handbook for Standing Chapter 13 Trustees (10/1/12) states that the Chapter 13 must monitor the debtor and his or her business to “verify that the ongoing business, while in bankruptcy, does not fall in deeper financial difficulty than at the time of the filing of the case.” According to the handbook (Section G(3)), monitoring, depending on the nature of the business, might include “the debtor meeting with the standing trustee’s business case analyst, if applicable, to review the budget, an evaluation of the debtor’s accounting systems, an on-site tour of the business premises, the requirement that periodic operating reports be filed along with bank statements, tax deposits and payment forms, and monitoring of insurance coverage.”

·         Cash Collateral Use
           Cash collateral does not often come up in a Chapter 13, but if: (a) your debtor is selling goods and generating accounts receivable subject to a secured claim; or (b) your debtor is collecting real estate rents from property subject to a mortgage, and the mortgage contains an assignment of leases and rents, you must – right after you file the petition -- either get the secured creditor’s/mortgagee’s permission to use the cash collateral post-petition in a stipulation, or get an order (after motion and hearing) from the bankruptcy court allowing you to use the cash collateral. 

               To accomplish either task in Massachusetts, you need to be familiar with §§363(c) & (e) (as well as the definition of “cash collateral” in §363(a) and what does and does not constitute “adequate protection” for cash collateral use); §552; Fed. R. Bankr. P. 4001(b) & (d); and MLBR 4001-2.

·         Limited Powers as Debtor-In-Possession

           Unlike Chapter 11, there is always a trustee in a Chapter 13 case. Consequently, the debtor’s powers over his or her property and in operating his or her business have limits.

o   As stated above, the debtor can seek to use cash collateral; the debtor also has the right to incur credit under the terms of 11 U.S.C. §364. This means that the debtor can “obtain unsecured credit and incur unsecured debt in the ordinary course of business” without prior court authorization, and that (post-petition) debt will have administrative claim status. 11 U.S.C. §§364(a), 1304(a). If the debtor is unable to obtain unsecured trade credit on these terms, the debtor can file a motion with the bankruptcy court to allow him or her to grant a lien on property; however, if there is already a lien on the property being offered, the debtor has to offer the existing lienholder “adequate protection” of that lien.

o   A business Chapter 13 debtor retains the right under 11 U.S.C. §363(b) to use or sell his or her assets in the ordinary course of business without prior court authorization, and to sell those assets outside the ordinary course with court authorization.

o   The debtor remains in possession of all property in the estate, except as otherwise provided in a confirmed plan. 11 U.S.C. §1306(b).

o   If the debtor’s estate has preference, fraudulent transfer or other avoidance actions, Chapter 13 is silent regarding who brings those actions. The debtor, however, can provide that he or she will pursue the avoidance actions in the confirmed plan, as permitted in 11 U.S.C. §§1322(b)(9) & (11).

·         Claims

           The business debtor has all the rights a consumer debtor has regarding the review of and objection to proofs of claim. The business debtor, however, needs to look out for administrative claims made under 11 U.S.C. §503(b)(9), which are claims for the value of goods received by the debtor within twenty (20) days before the petition date, when the goods were sold to the debtor in the ordinary course of business. Note that MLBR 3002-1 sets a deadline for such claims in Massachusetts: 60 days after the date of the §341 meeting. Business Chapter 13 debtors also need to be aware of the reclamation rights of sellers of goods to the debtor, spelled out in 11 U.S.C. §546(c).

·         Debtor in Business Subject to Chapter 13 Trustee Investigation – 11 U.S.C. §1302(c)

           Per §1302(c), the Chapter 13 trustee must perform the duties specified in §§1106(a)(3) & (4) in a Chapter 13 business case. Specifically, those duties, unless the bankruptcy court orders otherwise, are to “investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business and the desirability of the continuance of the business, and any other matter relevant to the case or to the formulation of a plan.” Once that investigation is done, the Chapter 13 trustee must “as soon as practicable” file a statement of his or her investigation with the court (and provide a copy of such statement to any entity the court designates), “including any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor, or to a cause of action available to the debtor.”

     Section G(2)(a) of the United States Trustee’s Handbook for Standing Chapter 13 Trustees (10/1/12) states that the Chapter 13 trustee, in filling this role, might ask for:

o   Copies of Federal and State tax returns, along with all supporting schedules, for at least the two years preceding the filing;

o   Copies of financial statements furnished to a third party, such as a trade creditor or a bank, within the two years preceding the filing of the petition, including but not limited to the balance sheet, income statement and cash flow statement;

o   Current books and records of the business, including checks and check registers;

o   Monthly profit and loss statements for at least the year preceding the filing;

o   Current schedule of accounts receivable and accounts payable;

o   Current insurance policies; and

o   Lease agreements.

     The Handbook also outlines what the investigative report might address, such as: the nature and location of the business; number of employees; status of federal, state, and local tax returns and tax delinquencies; insurance; business licenses; condition of books and records; prior balance sheets and profit/loss statements; aging of accounts receivable and accounts payable; debts; work in progress; and turnover actions, if applicable.

·         Additional Work – Schedules and Statement of Financial Affairs

           Note that there are many types of business property you have to list in Schedule B, including inventory; accounts receivable; machinery and equipment; office furniture and fixtures; patents; licenses; copyrights; trade names; customer lists; and supplies. The new Schedule I, in ¶8a, requires the debtor to state his or her net income from business operations or rentals, and “attach a statement for each property and business showing gross receipts, ordinary and necessary business expenses, and the total monthly net income” (note that the new Schedule J presumes you identify all of the debtor’s business-related expenses in this statement and not in Schedule J).  The statement of financial affairs has business-related questions that must be answered by an individual debtor, located in questions 18-20. Those questions relate to inventories taken, accountants used, where books and records are kept and by whom, and who received financial statements from the debtor in the last 2 years.

·         Common Chapter 13 Provisions for Consumers and Business Debtors

           A debtor’s status as a debtor in business does not change the major aspects of Chapter 13. The debtor still has to take the pre-petition credit counseling course in order to file the case, and must take the post-petition financial management course in order to receive a discharge. The plan must be filed and confirmed pursuant to the standards in §1325, the plan cannot exceed five years in term, and the concept of “disposable income” still applies – with one twist. The debtor in business is allowed to deduct from his or her current monthly income all “amounts reasonably necessary to be expended … for the payment of expenditures necessary for the continuation, preservation, and operation of [the debtor’s] business.” 11 U.S.C. §1325(b)(2)(B).


           If you are individual debtor who runs even a small side business (like renting out floors in your three-decker residence), the attorney you choose should have at least some passing familiarity with the business issues and how to address them (including making a determination whether you are indeed "a debtor in business" under §1304 and if those business issues do apply to your case). You should also expect to pay the attorney more for a Chapter 13 business case than you would pay for a Chapter 13 consumer case, given the additional reporting and issues involved. [1]

[1] Based on a presentation made to the Worcester County Bar Association Bankruptcy Section, on April 3, 2014. ©Kevin C. McGee

No comments: