1. MGM230-1103B-04 Introduction to Business Law
Phase 4 Individual Project
Sabrina Mergenthaler
Colorado Technical University
Professor Wendy McKain
September 12, 2011
Bankruptcy
2. Types of Bankruptcy
•Chapters 1,3, and 5
Definitions and provisions
•Chapter 7
Liquidation
•Chapter 11
Reorganization
•Chapter 12
Adjustments of debts of a family farmer
of fisherman with regular income
•Chapter 13
Adjustments of debts of an individual
with regular income
(Cheeseman, 2010)
2 parties--Creditor & Debtor
2 types of debt--Secured Vs. Unsecured
3. Acts
•BANKRUPTCY ACT OF 1878
Original article depicting the laws of
bankruptcy
•BANKRUPTCY REFORM ACT OF 1978
Easy to file bankruptcy
Discharge of debt
•BANKRUPTCY ABUSE PREVENTION &
CONSUMER PROTECTION ACT OF 2005
More difficult to file bankruptcy
Less discharge of debt
(McKain, 2011)
Purpose
•Enables debtors to seek relief from
debt
•Restart operations
•Protection from abusive activities by
creditors
•Prevents creditor advantages over
each other
•Creditor protection from debtor
•Speedy, efficient, and Equitable
distribution of assets
•Preserves business
(M.U.S.E., 2011)
4. Tests for Chapter 7 Bankruptcy
•Median Income Test- Does income exceed
or sit below the state’s median family
income index.
•Means Test- a complicated method of
calculation that reflects whether the
debtor has the ability to pay.
(Cheeseman, 2010)
Risks
•Loss of assets
•Irreversible
•Handicaps business operations
•Loss of business
•Appointment of a trustee
5. •Most complex filing
•Favorable for businesses
•Debtors-in-possession
•No trustee
•Creditors’ Committee
•Actions of creditors suspended
•Business continues to operate
Higher Filing
Fees Due to
Court Fees
6. •Intended for individuals
•Similar to chapter 11
•Individuals have 90 days to define
a plan
•3-5 year plans
•Certain Requirements must be
met
•Trustee appointed
•Plans may be modified
•Limitations of debt amount
•Categorizing of debt
7. Benefits
•Fresh start
•Protection from creditor collection efforts
•Protection from wage garnishment
•Protect assets claimed after filing
•No minimum debt required to file
•Quickness of results
•Debt discharge/reduction
Drawbacks
•Decreases credit score
•Loss of assets
•Irreversible
•Remains on credit history
•Risk of criminal activity
•Risk of conversion to Chapter 7
•Invasion of privacy
8. Chapter 7
•Trustee appointed
•No business future
•Suing of partners
•No discharge of debt
•Partner can buy out
partner
Chapter 11
•Business will survive
•Self trustee
•Work with creditors
•Retention of assets
•Complex
9. Decision
•File
•Type
Chapter 11
•Reasoning
Continued operations
Retention of assets
Ability to work with creditors
Debt reduction/discharge
•Process
File
Continue regular operating costs
Operating reports generated
Submit disclosure statement
Submit plan of action
Creditor/Court approval
Carry out plan
10. References
Marples, G. (2008). The History of Credit Cards – It All Started In The 18th Century. Historyof.net. Retrieved from
http://www.thehistoryof.net/history-of-credit-cards.html
A brief History of Bankruptcy. (2011). BankruptcyData.com. Retrieved from
http://www.bankruptcydata.com/Ch11History.htm
Cheeseman, H. (2010). Business Law: Legal Environment, Online Commerce, Business Ethics, and International Issues,
Seventh Edition. Pearson Prentice Hall: Upper Saddle River, New Jersey
McKain, W. (2011). Colorado Technical University. Introduction to Business Law. Live Chat 7
M.U.S.E. (2011). Colorado Technical university. Introduction to Business Law. Retrieved from
https://campus.ctuonline.edu/courses/MGM230/p4/hub1/hub.html
Silverman, J. & Grabianowski, E. (n.d.). How Bankruptcy Works. How stuff works.com. Retrieved from
http://money.howstuffworks.com/personal-finance/debt-management/bankruptcy1.htm
Bankruptcy. (2011). State Bar of Georgia. Retrieved from
http://www.gabar.org/communications/consumer_pamphlet_series/bankruptcy/
Georgia Bankruptcy Law. (2009). Georgia Bankruptcy.com. Retrieved from http://www.georgiabankruptcy.com/7v13.html
Editor's Notes
Since the 18th century, the United States has used a system of credit to allow people to make purchases that can be paid off over the course of time. Initiated by the furniture dealer Christopher Thompson, credit was extended as a means to allow people to make high dollar purchases of furniture and pay the cost off weekly. Eventually this idea was adopted by the banking system in the form of overdraft protection and “metal money.” This metal money was the first form of credit cards, extended by banks to their more prominent customers. Over the years other companies modeled an extension of credit with interest charges and membership fees. Eventually the system which we are most familiar with today was established (Marples, 2008).
As the extension of credit gained wider use, many found themselves in the position of owing more money than they made. As a result, debt forgiveness which has been traced back as far as biblical times, was regulated. Theories on the origin of the word "bankruptcy" stems from a combination of the Latin words bancus (bench or table) and ruptus (broken). When a banker (who originally conducted his public marketplace transactions on a bench) was unable to continue lending and meeting such obligations, the bench was broken to demonstrate symbolic show of failure and inability to negotiate. The frequency of this practice in Medieval Italy resulted in the current term bankrupt and is generally believed to have sprung from the translation of banco rotto, Italian for broken bank (A Brief History, 2011).
Often in life we find ourselves swamped with a debt that is no longer within our control. There are two types of debts: secured and unsecured. With secured debts, creditors have the legal right to something of yours if you fail to make the proper payments. Such debts may include your mortgage loan, in which your home or property is the item which may be secured by the creditor when you fail to repay the loan. Unsecured debts are those in which no property or item can be seized for failure to pay, as with student loans (Silverman & Grabianowski, n.d.). When we see more bills come in than earnings and receive calls from creditors throughout the day--like loan sharks wanting to know where the payment is, and requesting sensitive information on the guise of trying to help one fix their debt problem—we find ourselves in an overwhelming position. Creditors make threats against credit scores—swearing that without the proper action their debt will hurt a score so badly that the debtor will never be able to buy a home or car. While some embrace the idea of calling the numbers on commercials promising to “get you out of debt” others take a more radical approach with faster results: filing for bankruptcy.
This briefing will discuss what a bankruptcy is, and the options within filing for bankruptcy. We will examine the effects of filing bankruptcy for an individual as well as for a business. Concluding this brief will be an advisement on whether or not the client of Sheer & Deer Associates, Paul Ratkins, should file for bankruptcy, and if so, under which form.
Bankruptcy is a series of laws that are intended to balance the rights of debtors and creditors. These laws provide methods for debtors to be alleviated of some debt in order to gain a “fresh start” or a “clean slate.” These laws are divided into chapters. As you can see, the chapters break down the definitions and provisions of bankruptcy, as well as indicate the type of bankruptcy which may be filed. The most common chapters of bankruptcy are chapters 7, 11, and 13 (Cheeseman, 2010).
Upon the beginnings of bankruptcy law many laws were enacted to control the manner in which people could file. However, the bankruptcy reform act of 1978 witnessed some of the easiest methods of filing for bankruptcy. As a result, creditors lobbied the government for more strict procedures. In 2005, the United States government enacted the Bankruptcy abuse prevention and consumer protection act. This act made it more difficult to file for bankruptcy, as well as mandated the terms of debt discharges. In the same way, many accused this ratification of being too “creditor friendly.” Additionally, the government established courts for the specific purpose of handling bankruptcy cases (Cheeseman, 2010).
Under the evolution of the bankruptcy laws, bankruptcy took on new purposes. These include: enabling debtors to seek relief from debt while restarting operations and protecting themselves from abusive collection tactics utilized by creditors; preventing some creditors from obtaining advantages over other creditors in debt collection; protecting creditors from the actions of debtors that would weaken the bankruptcy; providing fast, efficient, and fair distribution of the debtor’s claims; and preserving business (M.U.S.E., 2011)
Chapter 7 is what most people refer to when they say, "I'm filing for bankruptcy." Chapter 7 bankruptcy refers to a liquidation bankruptcy or one in which a trustee sells all non-exempt assets owned by the debtor so that debts can be repaid to the fullest extent. Individuals, corporations and partnerships are all eligible for Chapter 7 bankruptcies. The portion of the debt that can't be repaid through liquidation is discharged, or dismissed. Businesses generally try to avoid Chapter 7, because it is impossible to conduct business operations. However, income produced after the bankruptcy filing is not considered part of the bankruptcy which means the debtor may keep it (Silverman & Grabianowski, n.d.). Since the ultimate goal of the business filing bankruptcy should be to retain as many exempt assets as possible and to discharge as much debt as possible, it is not an advisable option to file a chapter 7 bankruptcy in this case.
Before the act of 2005, favor for granting the discharge of debt for the individual debtor was presumed. This allowed debtors the opportunity for a fresh start, free of unsecured debt. Largely due to the act of 2005, a simple abuse rule provided a means to test a debtor for ability to repay debts. If a debtor was found as having the means to pay at least some of their debt an abusive filing could result and chapter 7 bankruptcy would be denied (Cheeseman, 2010). Some states may require some conditions or terms to be met prior to filing for this type of bankruptcy. The state of Georgia requires for the filing debtor to go through credit counseling prior to filing (Bankruptcy, 2011).
Client, Paul Ratkins, can file chapter 7 bankruptcy.
Chapter 11 is a more complex bankruptcy filing and one that most businesses favor filing. It is available to individuals, partnerships, corporations and other business identities (Cheeseman, 2010). In a Chapter 11 bankruptcy filing, the debtor continues to function, maintains ownership of all assets, and tries to develop a restructuring plan to pay off creditors. Prior to the 2005 act, debtors were given no time limit to configure a plan. However, the 2005 act provided debtors with only 120 days to reorganize their financial structure. Petitioning could extend this period to 18 months (Cheeseman, 2010).
Unlike chapter 7 bankruptcy, the court will not necessarily appoint a trustee unless there has been evidence of fraud, dishonesty, or mismanagement. The debtor is essentially left in possession of any business operations (Silverman & Gabrianowski, n.d.). However, in these types of bankruptcies, a creditors’ committee is formed from the seven largest equity holders. These representatives are permitted to participate in court hearings, and other meetings that involve formulation of a restructuring plan (Cheeseman).
Currently the state of Georgia does not make any specific requirements for filing this type of bankruptcy, however, the state court does recognize a higher cost associated with the filing due to the cost of court fees.
Client, Paul Ratkins can file chapter 11 bankruptcy.
Not unlike chapter 11 bankruptcy, chapter 13 allows for a payment plan to be designed. However, chapter 13 is for individuals, not businesses (sole proprietorships excluded). There are also many requirements which need to be met. For instance, you must meet the state median income. Also, proposed plans can surpass no more than five years. The plan must be submitted to creditors for approval, then must be submitted to the court. When the court determines that the debtor’s plan passes a feasible test (meaning the debtor can make the payments), the plan may be set in motion. In the course of an unforeseen event which causes financial difficulties, chapter 13 plans may be modified (Cheeseman, 2010). Limitations also include the amount of debt that can be held in order to file for chapter 13. This limit stands at $1 million—with a breakdown of $250,000 in unsecured debt and $750 in secured debt (Georgia, 2009). Once a plan is put in motion a trustee collects all funds. A trustee may also be placed to operate business endeavors.
Once all payments are made in accordance with the plan, any remaining unsecured debt may be discharged by the court (Cheeseman, 2010).
Client, Paul Ratkins (as a sole proprietor) could file chapter 13 bankruptcy if his debt had not exceeded $1 Million dollars.
The current economic environment has had a major effect on the survival of businesses. Even those businesses that have always been successful now face problems that seem impossible to overcome, such as decreased sales, collecting payment from customers, inability to obtain credit, and keeping debt payments current. For some, bankruptcy is the only solution in sight.
Filing bankruptcy does not necessarily mean the end of your business, however. While there are bankruptcy types that will force the doors of your business to close, there are other types, as you have seen that will allow you to remain operational. With that in mind, you should weigh the other pros and cons of filing for bankruptcy. Some of the benefits include the gain of a fresh start on your business finances, protection from wage garnishment and harassing creditor collection attempts, protection of certain assets, efficiency in which the debt is handled, and in some cases a reduction or discharge of some debt.
However much these benefits may weigh on your own personal scale, you must also consider how filing for bankruptcy will negatively impact you. For instance, it will lower your credit score, which will ultimately result in a greater reduction of credit available to you; you will lose some assets, the result is irreversible, the bankruptcy will remain on your credit report for several years following resolve and there is a risk of conversion to chapter 7 bankruptcy if certain conditions are meddled with. As a business owner, protecting your assets may be a number one priority, however, irresponsible transfer of certain possessions may be viewed as a criminal act. As a result the court could convert a Chapter 11 claim into a chapter 7 and the business may be lost. Bearing in mind that in some bankruptcies a trustee may be appointed, your sensitive business information may be jeopardized by an invasion to privacy (Georgia Bankruptcy, 2009).
Corporations and partnerships are legal entities separate from their shareholders or partners. They can file Chapter 7 or Chapter 11 bankruptcy in their own right. Proprietorships, however, are an extension of the owner--they can't file bankruptcy alone--the proprietor must file bankruptcy. The individual owner may file Chapter 7, Chapter 11 or Chapter 13 (if the debt limits are met) (Georgia Bankruptcy, 2009).
Chapter 7 bankruptcy may be the best choice when the business has no future. It is usually used when the debts of the business are so overwhelming that restructuring them is not feasible. Chapter 7 is also appropriate when the business does not have any substantial assets. In a partnership facing Chapter 7,there is no discharge of debt. As a result the trustee can sue the partners if the partnership's assets are insufficient to pay all claims for the amount by which the partnership assets fall short of partnership debts. As a result, partners may face a suit by a trustee suing for the benefit of all creditors of the partnership (Georgia Bankruptcy, 2009).
Chapter 11 bankruptcy may be a better choice for businesses with a future. This option allows the partners to work with the creditors in building a plan that works to resolve the debt over a period of time. Best of all, it allows the partners to retain ownership of assets. As well, this option allows the partners to be their own trustee, essentially eliminating an outside source from becoming an invasion to privacy (Georgia Bankruptcy, 2009).
As an indication of our belief in the survivability of the business owned by our client, Paul Ratkins, it is the advisement of Sheer & Deer Associates that Mr. Ratkins file a chapter 11 bankruptcy. This type of bankruptcy will allow for the continued operation of the client’s company, as well as protect him from the total loss of assets. Filing a chapter 11 bankruptcy will open doors of communication between Mr. Ratkins and his creditors to develop a plan that is fair for both parties. Chapter 11 also brings a greater opportunity to have debt reduced or discharged (Cheeseman, 2010).
The process for filing a chapter 11 bankruptcy maintains that the debtor is required to pay all normal operating expenses. Old debt is temporarily put on-hold while a plan is being generated. Monthly operating reports are filed with the Court to establish the ability of the company to pay its debts and expenses. The debtor then files a disclosure statement which details the history of the company, the events that led to the filing and submits a plan of reorganization. Creditors are given an opportunity to review and vote on the plan. After the court approves the plan, the case is removed from direct Court supervision and the debtor continues its operations completing the plan of reorganization over time (Georgia Bankruptcy, 2009).
This presentation has been a recommendation for filing bankruptcy for the client of Sheer & Deer Associates. The client has been advised on which type of bankruptcy to file and how to begin the process. However, all decisions finalizing the bankruptcy are left up to the client. Sheer & Deer Associates hopes you have gained the knowledge you were looking for with regards to bankruptcy, as well—hopes you find resolve to your debt-related situation.
