Bankruptcy Alphabet – S is Sole Proprietorship

by Jeff Curl

Operating a sole proprietorship is a huge topic in bankruptcy that covers a lot of ground.  So lets take a couple of smaller bites and break down what operating a sole proprietorship means in bankruptcy.  We have the pleasure of working with a lot of business owners, and sole props have their own special issues.

You Cannot Just File for the Business

A lot of sole prop owners in financial distress ask if they can file the business only, and not involve themselves personally.  The short answer is no.  Having a license from the city to operate as a DBA (doing business as) does not create a separate legal entity.  Corporations and LLCs are formed as separate entities under the laws of the state where they are formed.  Sole proprietorships do not obtain this legal designation.  So if you are John Smith DBA Johns Auto Shop, you will be filing yourself and business as one.

Filing a Sole Prop in Chapter 7

It is really important to understand what happens when filing Chapter 7 and you are operating a business as a sole prop.  Here are couple of major considerations:

• When you file Chapter 7, all of your assets go into the bankruptcy estate, including the inventory and receivables of the business.  Your Chapter 7 trustee is the trustee of the estate, meaning she or he controls the assets.  Understanding the values of your assets is paramount because you are allowed to exempt and keep a certain amount, but it is not unlimited.  If you cannot protect everything, the trustee may liquidate your unprotected assets.

• The trustee is also responsible for any liabilities that arises from the business. Therefore, there’s a risk that the trustee may demand that you cease operating your business while the trustee administers your assets. This varies by trustee to trustee and varies by the business.  For example, operating a restaurant as a sole prop has many inherent liability potentials, such as payroll taxes, suits by employees against the business owner, and injuries claimed by patrons.  Contrast this with the person working as a consultant with his or her laptop out of their home that raises less concerns from a liability perspective.  This is a factually sensitive discussion you should have with your bankruptcy attorney.

Filing a Sole Prop in Chapter 13

There are several distinction between Chapter 7 and Chapter 13 when it comes to operating a proprietorship.  Heres a couple of important ones:

• The sole proprietor can continue to operate the business in Chapter 13 without the threat of shutdown by the trustee as can happen in Chapter 7.  A sole proprietor can also opt to shut down the business before or during a Chapter 13 as well.

• A Chapter 13 trustee does not liquidate assets like a Chapter 7 trustee.

In other words, Chapter 13 generally offers flexibilities and forgiveness that are not available in Chapter 7.  But sometimes one chapter is better than the other, or sometimes you only qualify for one.  Operating a business leads to a lot of complicated issues quickly in the bankruptcy world, so please consult with a bankruptcy attorney familiar with these complications.

Photo by elycefeliz

What Are the Tax Consequences of a Short Sale?

First off, I am not a CPA—or even a tax attorney. However, a large number of potential clients who visit me to inquire about the advantages of bankruptcy relative to those of a short sale (or outright foreclosure walk-away) when distressed real estate is their primary concern have not realized that there may be tax-related disadvantages to the short sale of a property or walking away via foreclosure.

Indeed, there can be.

Generally speaking, a surrender of underwater or already-foreclosed real estate in the bankruptcy process is a quicker, more cost-effective, and more protective way to walk away from a distressed home without fear of future collections or tax liability than a short sale—and certainly a foreclosure (in Michigan, unless your home is worth more than you owe on it, you cannot simply walk away from a home and let the bank foreclose upon it without opening yourself up to collections efforts for the deficient difference between what the house sells for at a foreclosure sheriffs sale and what you own on the terms of your mortgage note).

One of the primary reasons that bankruptcy is a superior way to let a home go than a short sale, despite is negative reputation, is that there are no tax consequences to the surrender of a home or piece of real property in bankruptcy, particularly not a home that is your primary residence.

When you file for bankruptcy, you are legally insolvent. That being the case, there are no taxable consequences resulting from the discharge of debt or from the surrender of property in bankruptcy.

Outside of bankruptcy, there are various possibilities for the arising of taxable consequence to the surrender or short sale of property.

If a house is sold for less than is owed under the terms of the mortgage note that the home secures, there will be a deficiency resulting from the sale. Thus, the term short sale Home sold for an amount short of what is owed for it. In some short sale deals, the lenders holding or servicing the note may agree to refrain from collecting upon the deficiency (that is, coming after you for it!) as part of the short sale negotiation. (A bad short sale deal involves NO guarantee of protection from collections—and there are many of these out there!) If there is a 2nd or 3rd mortgage on the home (yes, a home equity line of credit is a type of mortgage), it is even more vital and more difficult to obtain such guarantees.

However, even if these guaranties are delivered and acted upon properly by the involved banks or lenders or investors, the deficiency debt resulting from the short sale will almost certainly still be charged off by the holder of the mortgage note(s). That is, the debt will be reported to the IRS as lost business income by the holder of the debt, and they will gain a tax benefit to their bottom-line as a result, but you will be required to pay taxes as if the charged-off debt were personal income that you earned by way of working as a contract employee for that creditor in that year. This is because charged-off debt is treated by the IRS as forgiven debt, and forgiven debt is considered by the IRS to be a form of personal income.

In other words, you will receive a 1099 form from the creditor for the amount of the deficiency that you will have to then pay taxes on, unless you are eligible for forgiveness under the Mortgage Debt Relief Act, which expires at the end of this year unless renewed by Congress, or some other definitional insolvency standard.

There can be additional tax implications beyond this basic charge-off situation as well. For instance, if the real estate involved is a personal residence but not your primary personal residence or if it is commercial real property, there can be capital gain income or prior depreciation recapture income that is treated for taxable purposes like personal income. (Note that taxes owed that are less than 3 years old are not dischargeable in bankruptcy and may not be dischargeable at all depending upon other considerations as well!)

The amount of personal income that is taxable resulting from the loss of real estate can be considerable, often more than a person actually earns in a year from their own, real jobs since so many mortgages were so artificially huge at the height of the real estate bubble and since so many of them were so irresponsibly lent.

If you are considering a short sale and this is of concern to you, it is essential that you examine the tax-protective option of bankruptcy before committing to short sale deal, regardless of how ardent your real estate broker is about the benefits. If for not other reason than, although must people think of a Chapter 7 surrender of a home when they think of bankruptcy, there is the additional option of stripping a 2nd or 3rd mortgage in order to save a home and make it worth keeping that is availabe in a Chapter 13 bankruptcy.

Toni Braxton has debts discharged with Ch. 7

Last week, singer Toni Braxton had most of her debts discharged under Chapter 7 bankruptcy.  A judge at the U.S. Bankruptcy Court in Los Angeles issued an order discharging the majority of her eligible debts.

Braxton filed for Chapter 7 bankruptcy last September and listed $1.6 million in assets and $18.3 million in debts.  The order does not list which debts were discharged, only that most of the debts that existed at the time of her filing  were discharged.

In having the debts discharged, Braxton is no longer responsible for repaying the debts and debt holders are not allowed to take collection actions against her.

Sixth Circuit BAP Reverses Dismissal With Prejudice of Dischargeability Fraud Complaint – In re Burer

Vincent Howard and our Moreno Valley personal bankruptcy lawyers were interested to see a recent bankruptcy appeal in which foreclosure was an issue, but not the foreclosure of the debtor. Rather, in In re Burer, the Bankruptcy Appellate Panel of the Sixth U.S. Circuit Court of Appeals heard the case of a creditor, Silvia Valdes Reyes, who alleged the debtor, Brenda Burer, defaulted on an agreement to sell her a mobile home. This robbed the recently foreclosed Reyes of a $15,000 down payment, she alleged, and Burer should not be permitted to discharge this debt in bankruptcy. Reyes’s attorney later moved to dismiss her motion without prejudice for practical reasons, but the bankruptcy court instead dismissed with prejudice, providing no explanation. The BAP reversed.

Reyes was foreclosed in 2008 and was living with her children in a motel when she started negotiations to buy a mobile home from Burer for $22,000. She paid Burer $15,000 in cash and agreed to pay the remaining $7,000 at closing. However, the closing never took place, and Burer stopped responding to Reyes’s phone calls. When the two women finally spoke, Reyes asked to close the deal or have her money refunded, and Burer said Reyes would have to sign a document saying she was no longer interested in order to get a refund. She signed, but no refund arrived. Reyes later learned that Burer did not own the mobile home at the time of the sale. In late 2009, Reyes sued, prompting Burer to file for Chapter 7 bankruptcy just before trial.

Reyes then filed an adversary proceeding, seeking to have the $15,000 debt declared not dischargeable. The adversary proceeding headed for trial over Burer’s objections, but during its pendency, Burer’s attorney withdrew, saying he could not ethically continue to represent Burer. Burer successfully filed for two extensions of time before trial on the adversary proceeding. However, when Reyes’s attorney asked for a two-week continuance — citing in part unsuccessful attempts to reach Burer — the continuance was not granted. The attorney appeared at the trial and asked to voluntarily dismiss the adversary case without prejudice, saying Reyes had an emergency and couldn’t be reached. Instead, the bankruptcy court dismissed the case with prejudice, with no further explanation. Reyes and her attorney later appealed to the Sixth Circuit’s BAP.

That panel reversed, finding the bankruptcy court abused its discretion by failing to explain its order. Recent Sixth Circuit precedent explains the process for dismissing a complaint with prejudice after a request for dismissal without prejudice. The court must give notice; the plaintiff must be given an opportunity to be heard in opposition; and the plaintiff must have the opportunity to withdraw and continue the litigation. This is important because a dismissal with prejudice is considered a rejection on the merits, and will be considered final and settled. The bankruptcy court failed to do any of this, the BAP noted. Failing to explain why it chose to dismiss with prejudice was an abuse of discretion, the panel said. It reversed with orders to the court to provide notice and give Reyes the opportunities noted above.

Vincent Howard and our Santa Ana individual bankruptcy attorneys are interested to know what reasons the bankruptcy court might have had for its original decision. Courts are run by judges who are human, and sometimes they get impatient with endless delays to cases created by apparent poor planning by the litigants. However, in this case, it’s hard to believe that Reyes was penalized for the two previous delays that were granted to Burer. It’s also possible that personal dislikes or prejudices played a role; the judge may have disliked the attorney or Reyes as people, or had a more sinister problem with them. In our practice, Vincent Howard and our Gardena consumer bankruptcy lawyers try to stay aware of these factors, so we can avoid having to fight a negative and potentially case-ending outcome into the appeals courts.

JPMorgan Chase Accused of Bankruptcy Fraud in Class Action Suit

A class action lawsuit being brought against JPMorgan Chase alleges that the bank engaged in fraudulent activity in tens of thousands of bankruptcy cases.

The suit claims that the bank actively deceived many people involved in the bankruptcy process, including Chapter 7, Chapter 13, and Chapter 11 trustees; bankruptcy judges; creditors; creditor attorneys; debtors, debtors in possession, and debtors’ attorneys; and the Office of the United States Trustee.

Among the charges being leveled against Chase are that the bank did the following:

• Committed fraud, perjury, and intentional misrepresentation in bankruptcy court by producing false title transfer evidence (sources claim that the bank used PhotoShop in some cases) in order to “prove” its stake in thousands of bankruptcy cases.
• Provided manufactured evidence to willfully deceive those involved in the bankruptcy process about who truly held class members’ non-negotiable promissory notes.

What Is Chase Actually Accused Of?

In plain English, Chase is facing charges of providing false evidence regarding home mortgages in bankruptcy cases. Specifically, the lawsuit alleges that:

• Chase fabricated documents that recorded its chain of ownership of residential mortgage loans. In order to be able to claim ownership of mortgage debt in bankruptcy court (or any court), a person must have a hard copy of the mortgage’s promissory loan (also called a Master Loan Note, or MLN). Because of electronic mortgage registration systems and securitization of mortgages (two factors that greatly contributed to the expansion and burst of the housing bubble), however, most banks no longer hold paper MLNs.
• Chase presented falsified documents in bankruptcy court. In order to “prove” that it was the lender to whom a bankruptcy filer owed money, Chase allegedly presented these fabricated documents to bankruptcy courts (because it did not have actual documentation).
• Chase rewarded lawyers for speedy action. During a bankruptcy case, filers are protected from collection actions like foreclosure by the automatic stay. But creditors can petition the court to lift that stay in order to collect on certain debts. In Chase’s case, the charges claim, the bank rewarded attorneys for producing false documents quickly and convincing the court to lift the stay quickly so that Chase could foreclose or collect money on a bankruptcy filer’s home.

Who Is Affected By the Class Action Suit?

The class named in the suit (Ernest Michael Bakenie v. JPMorgan Chase Bank, N.A., filed in the Central District of California) includes bankruptcy filers who live in California. To find out whether you are a member of the class, you can consult with a bankruptcy lawyer in your area.

Plaintiffs in the suit are seeking damages, restitution, injunctive relief, and disgorgement of profits.

Podcast #9 – Why cutting your own hair is a bad idea

In this podcast, Jeena talks about her attempt to cut her own hair and the disastrous result. We also talk about why acting as your own lawyer is penny wise but pound foolish. Then we move onto LegalZoom, a popular DIY website for many legal issues.

We address frequently asked questions:

• Can I file my own bankruptcy?
• What can go wrong?

Fresh Start Episode 9 – Doing Your Own Legal Work [ 13:19 ] Play Now | Play in Popup | Download

Do you have questions? Schedule a consultation. We’ll sit down review your options. We hate spam just as much as you

Mortgage Lender Allows Large Principal Reduction To Avoid Foreclosure

 In another example of bank’s becoming cooperative in mortgage modifications for primary residences, an attorney colleague told me this week that one of his clients was offered a substantial principal reduction as part of a deal keep the client in his home. The bank foreclosed, and the attorney defended the mortgage foreclosure on behalf of the client. The client’s home was over $100,000 under water. The case went through state court mediation. The client was seeking an interest and payment reduction. 

  The mortgage company representative said it was his company’s new policy to keep people in their homes and avoid foreclosure. The bank offered to mark the mortgage balance down to fair market value through a permanent mortgage balance reduction. The bank wrote off over $100,000 of mortgage debt as part of the homeowner’s payment reduction. The homeowners have no personal liability to repay the amount of mortgage deduction.    This windfall for the homeowner may be an anomaly, and it also could be due to the attorney’s negotiation skill (the particular attorney is skilled in all types of legal negotiations). I find that the story is consistent with what I see as a gradual change in mortgage lender policy. Mortgage companies are becoming flexible to make reasonable concessions required to keep good customers in their primary residences. 

Trailer Bridge and creditors agree on reorganization plan

This week, Trailer Bridge and its creditors were able to reach an agreement on a debt reorganization and repayment plan.  The company filed for Chapter 11 bankruptcy in November with $82.5 million in unpaid bonds.

Trailer Bridge is a shipping company based in Jacksonville.  It continues to send 4 ships to the Dominican Republic and Puerto Rico twice a week, and has not had to lay off employees during their bankruptcy.

According to the court documents, the agreement states that Trailer Bridge’s note holders will own 91 percent of the company.  In addition, Trailer Bridge will pay its creditors a pro-rated amount of $65 million.

To learn more about restructuring debt under Chapter 11 bankruptcy, contact the West Palm Beach Chapter 11 bankruptcy attorneys of Eric N. Klein & Associates, P.A. by calling 561-353-2800 today.