Sole Proprietor/ S Corporation/ & chapter7

[Stev]

Hello all,

First of all finding this forum has been a balm like effect. I thank everybody here.

I read Steve's Blog with great interest. Thank you for sharing the details.

Here's our story..;-) 2005 we sold our business but kept the S Corp(calling it Scorp1) with its big creditlines and credit cards. At that point we had paid off all credit card debts and credit was great.

2005 we bought Corp2 - another small business franchise that produced very little income/still produce very little. We got very nice creditline and cards because of our tract record.

We sold our town home and bought a fixer upper (where we live now after some fixing) and an investment property (4 hrs) away. Important point here: we bought the investment property as a primary residence as well. We did not fill out any application for sign it ( In other words my loan guy must have made the earnings claim, we did not bother to ask)
Dont know what he put down for income etc.
Both was on a option arm loan with monthly payment less than interest.

After much looking we started a small specialty food store in 2007 end as a sole proprietorship. We used a lot of our creditline and cards in getting it running /fixtures/ freezers etc.After about a year of running it, we are not making any profit.

We burnt most of the proceeds of the 2005 business sales in living expenses and 3rd of it into this sole proprietorship (About 100K). About another $140K from credit lines and credit cards of the two businesses.

Bottomline. Our home is worth less than owed, the investment property even worse. And at the rate of debt sevice we were headed quickly to zero money. So we used balance transfer checks from other cards and fed the accounts, some to the business and some towards mortgages and minimum payments. Oh btw I have been looking for a job for almost 7 months in the tech industry as soon as it became clear that we could not expect earnings from the business for sometime. But as the job situation went from bad to worse, it became clear that we'd be out of fuel before we ever got a chance to dig ourselves out (Its amazing how fast the min payments add up).

We were tempted to cash some more balance tranfer checks but we didn't take the offer. That was Jan. End of Feb still no job. So we decided to pull the cord today. We went to the bank and withrew the cash in checking about 10K. And closed the account. Called mortgage company told them to cancel autopay, it was due tommorow.. For the first time in 10 years we will have a late pay tommorow. I read Steve's blog and panicked but was able to order 2 years of records over the phone (cost $48).

We are not behind any payments yet besides American (12 day)

Are we acting too fast. Should we have waited sometime before closing the account. We have All business accounts with the same bank. I am worried we might trip a panic button for the bank.

We are planning to move the business accounts out but it will take 2-3 weeks.

2ndly, will using the balance tranfers to feed business, mortgage etc. considered in bad faith?

3rdly, The fact that we used the creditlines of other corps to fund the sole proprietorship ok?

Most importantly, we plan to keep our doors open at the store. But we need to order. To do that we need to payoff the vendors last bill. is that ok/preferential or fraudulent? I am sure some of their bills wont be paid at the end. Can we bleed all the inventory as possible?

We plan to file chapter 7 . We havent filed taxes for 2007 or 2008 No income though. We are working on filing 2008 and 07 right now. We havent done anything for ourselves in 3 years. No vacation, no restaurants, no nothing , just undying hope.

I have so much questions. but you guy's posts has been super useful. Yesterday hit both my wife and me very hard. Matter of fact yesterday was when we gave up on the hope of a turn. Today we feel much better and maybe it will be a different turn around. One without the heavy bags of debt.

We anxiously await your comments.

[StartingOver08]

It sounds like you are doing the right thing by filing now.

As you know, filing Ch 7 is a business decision. Interview several attorney's that are familiar with small businesses and BK; however, just based on what you have posted so far, you may only need to file a personal Ch 7. Of course, you will need to close the S-Corps.

The S- corps are considered your assets, even if they are just liablilities now. You will need to provide the statements for each of the business checking acccounts, LOC's, cc's etc - probably for 2 yrs. You did the right thing by ordering the statements right away. Once you are behind, the bank cuts off all access to your accounts electronically and it becomes much more difficult to get the history.

The BK will be a big relief - just this part before you file and during the process can be a little nerve wracking

One of the tendencies of small business owners, myself included, is to value our assets too high. I don't know if you have equipment (freezers etc) in your small speciality food store, but see if you can get a valuation of equipment and inventory in writing (obviously a third party, fire sale type valuation). You will need to make sure the assets of the store, since you plan to keep it at the moment, fit inside your exemptions. Check your states BK exemptions on www.LegalConsumer.com to make sure this is doable. If you are in Fl (like Steve was) then the exemptions are tough because they are so small.

It also sounds like, depending upon how upside down you are, it may be best to give up the two homes. First, before you meet with an attorney get a true idea of the homes value. You can get a free CMA based on recent sold comparable properties from most realtors. Make sure the sold properties are within the last 90 days. Once you have an accurate figure, you will know if you need to walk away or keep your primary. In this market, if you are having to go BK, best to rid yourself of ALL the debt. Just start with a clean slate.

I don't think the loan issue from 4 yrs ago will negatively impact your BK.

Have you checked for payments to insiders yet? (Family or friends paid within the past year). This will affect your timing of the filing. It does not sound like you are acting too fast. After all, two years of solid work, with no return and just bleeding debt is enough punishment for anyone! It makes more since to cut your losses now then to keep digging yourself further and further in the hole.

Because of the complexity of your case - make sure the attorney you select is going to be there with you at the 341. Make sure they are not part of a BK mill type operation as having a good attorney really, really makes a difference when you have any sort of complex BK.

It is difficult to say much else since we don't have your actual income or debt, but it sounds like you have made the right decision!

[smallbiz]

Thank you both for the info provided. We shut down our small business in Dec and filed ch 7 and had the 341 meeting in Feb and am waiting it out now. The other day I received a letter of abandonment from the trustee and wondering what it means. It does not list everything only certain items.

Like a lot of businesses we were bleeding feeding it and finally gave up. The other main point is we have an SBA loan and not sure how all of this will end. Any information/advice is greatly appreciated.

[StartingOver08]

The letter of abandoment is just what you want from the Trustee. It means the Trustee is not interested in your assets! So you should expect a discharge after your sixty days - congratulations!

As to the SBA loan, that should have been in the filing too and gets discharged along with your other debt. Check with your attorney, but that is the advantage of filing a personal Ch 7 when you have closed the business. You get rid of all personal debt liability (PG's) on business debt.

[smallbiz]

thank you for the reply. i wasnt sure how to take this as it stated that it may be adverse to me. i thought the trustee washed his hands of it and i was going to be left to deal with the sba. thanks again

[Stev]

One of the tendencies of small business owners, myself included, is to value our assets too high. I don't know if you have equipment (freezers etc) in your small speciality food store, but see if you can get a valuation of equipment and inventory in writing (obviously a third party, fire sale type valuation). You will need to make sure the assets of the store, since you plan to keep it at the moment, fit inside your exemptions.

Thank you Starting over08. We dont plan to keep our store. We just want to keep it running and sell off inventory for a couple of weeks or month. But we need to order at least minimally to do that and pay those vendors for their prior invoices. Is that OK?

And regarding insider payments, we have sent money to my wife's little brother and sister for their study abroad. But it has been very minimal as they are on partial scholarship. Part of their tuition. About 2 thousand dollar cash withrawal every semester ( The reason being, we send western union)

[StartingOver08]

Thank you Starting over08. We dont plan to keep our store. We just want to keep it running and sell off inventory for a couple of weeks or month. But we need to order at least minimally to do that and pay those vendors for their prior invoices. Is that OK?

It sounds like you are attempting an orderly liquidation of your store just prior to filing, which should be ok. There is a very interesting article by Moran Law regarding just this topic. Take a look at this:

There is no clear or universal answer to whether a failed business should file a Chapter 7, which is a liquidation proceeding. It depends on the value and nature of the assets; the attitudes of creditors; and the availability of management to oversee the process.

Companies can go out of business without filing bankruptcy: they liquidate their assets and cease operations. Creditors have a right to recover their claims from the assets of the corporation. If there are no assets, the corporation cannot be further harmed by lawsuits that try to collect from the corporation.

The danger to management in this approach is the tendency of some creditors to assume that the business's failure to pay means that there is some sort of skullduggery afoot, and sue the officers as well as the corporation to collect the debt. While the claim against the individuals may be invalid, the individual has to appear and defend in the lawsuit, or a judgment will be entered against him. Sometimes, the individuals are liable.

Personally managing the wind up has advantages, if you are willing to devote the time and energy to the process. On the other hand, filing bankruptcy may protect assets from creditor action, preserving value for the payment of taxes and employees.

Doing it yourself has advantages
Management can usually get better price for assets since they know the market, know the asset and are motivated to get highest recovery
Outside of bankruptcy, you control who gets paid with the available funds
You can act swiftly to limit exposure of management or investors by addressing debts guaranteed by insiders first, subletting space, returning leased equipment, etc.
Creditors are protected from having to give back preferential payments to the bankruptcy trustee
Assets can be sold to insiders so long as the price is fair
But
May prevent management from accepting new employment
May require cooperation from creditors and lessors
May increase likelihood that disgruntled creditor will sue individuals too
Bankruptcy is simple
Bankruptcy trustee becomes responsible for liquidating assets, returning equipment, and dealing with creditors, freeing management to turn to other endeavors
Trustee has powers under Bankruptcy Code to sell leases despite anti assignment provisions and to avoid levies and writs of attachment, recovering value for creditors that isn't possible outside of bankruptcy
Filing bankruptcy seems to reduce the instance of creditors naming management as well as the business in collection actions
The automatic stay prevents aggressive creditors from diverting cash that could be used to pay taxes, employees, and guaranteed debts or recovering property needed for wind up
But:
Trustee unlikely to get top dollar for saleable assets
Insiders may be prohibited from buying technology, intellectual property or projects in development
Trustee's fees and expenses are paid off the top
Trustee can recover preferences to trade creditors and to insiders and challenge pre petition transfers of assets if legally fraudulent
Bankruptcy process frequently slow and inexact
Claims are paid according to priorities in the Bankruptcy Code
This choice is not necessarily an either/or decision. Management can liquidate assets as far as feasible, and file bankruptcy thereafter to let the trustee mop up.
Winding up outside of bankruptcy
If you elect to close up shop outside of bankruptcy, consider the following issues. Involve the board of directors, if there is one: be forthcoming about the situation and the alternatives. Exploit the contacts and expertise of outside directors in the effort
Identify the assets
Figure out what the business owns and what it might be sold for.

Intellectual property, work in development, customer lists; licenses; partnership relationships.
Which of these assets be sold to raise cash?

Security deposits with landlords, taxing authorities,
Can they be recovered by terminating lease, sub letting, or filing returns?
Real property leases:
Is the price below market or in desirable location making the lease valuable to others?
List debts for which officers are personally liable
Check real property and equipment leases, credit cards, and trade accounts where the contract may be in the name of an individual or an individual has guaranteed the debt
Officers, directors and those with check signing authority may be personally liable by law for the trust fund portion of unpaid employment taxes or sales taxes of the business
Segregate assets that are collateral for secured debts
Secured creditors have a property interest in the asset and the proceeds from its sale. Creditors become secured creditors when the business granted a security interest in specified assets, usually at the beginning of the financial relationship. Sale of the asset without the permission of the secured creditor may breach the security agreement and may be a fraud on the secured creditor.
Leased property belongs to the lessor; check the lease for any restrictions on assigning the lease to another entity

Get fair market value for all assets sold
The value of the business's assets belongs essentially to the creditors: management cannot give the assets away or sell them for less than their value.

Remember, the assets are only worth what someone will pay for them, here, now and in their present condition. With that in mind, find the best deal for what you have to sell. Sales may be for cash, for deferred payments, or for a piece of the future action, so long as you get a commercially reasonable, albeit liquidation, price.
Expose assets to the market, through brokers; contacts with competitors, suppliers, and partners; listing with electronic auctions, etc.

Make a Paper Trail
Document the condition of assets, especially intellectual property, at the time of sale and your efforts to find a buyer in the time available. If there is later a challenge to the disposition of assets, you have a record to support the sale at the price you received.

Develop plan for payment of debts to the extent possible
Pay trust fund taxes first: ear mark the payment for application to the trust fund portion of the tax Pay vendors or employees essential to the wind up process

Pay debts for which individuals are jointly liable with the business

Arrange for final tax returns and issuance of w-2's to employees

Preserve records
Back up financial and other vital data now on computers so that the records remain available despite what happens to the computers it now lives on

Store paper records

http://www.moranlaw.net/failing-startup.htm

[FloridaGuy]

Howdy.

Hi Stev,

Thanks for refering to my blog. It has been a long trip for sure! I have been fairly quiet on the forum, due to some of the things occurring recently. We can see light at the end of the tunnel.

StartingOver08 posted great info. I actually spoke to the owner of the article for some advice as well. (Actually had to pay a consult fee... not a freebie... He's not cheap, either )

My lawyer suggested trying to stay in my store as well to liquidate... however I was WAY behind in rent, and then figured out... any rent due would not be able to be included in BK. AND, may cause problems as well with the BK. So I vacated. Luckily, I was able to move some inventory online.

Keep reading this forum, & get consultations. Our case was by far, not normal at all. Most cases seem to go much smoother, even if complicated by business. We just happened to get a very creditor friendly trustee, who in my opinion pushes the limit of the law.

[Stev]

Hi Steve,

Thanks for the reply. I have not yet met a lawyer. Although talked to one and another appt.

My concern is when do I start liquidating vs. running it.

As its a food store. As soon as some of the essentials go .. people stop coming.

So if I order from my vendor by paying his old invoice ... does that constitute preferential?

I am thinking of listing the business on the internet and make a genuine attempt to sell the store it at a good price which I will set aside for the trustee to decide how to distribute. It will be much more than just the asset sale.

Also, did you pay yourself during the period from the business and where did the proceeds of the liquidation go?

I am just in the process right now. Just getting behind payments. when should I liquidate if I have to?

Interesting comment on the rent. why doesnot back rent get wiped out?
I did not know that. I was planning on stopping rent payment in march which is due on the 13th.

One has to include the lease as liability as well I guess?

[FloridaGuy]

The back rent does get wiped out. However... any rent AFTER the date of filing is still due and would not be able to be wiped out. This may also cause preferential treatment issues.

As you read through the forum, you will see most recommend not paying ANY bills except necessities for 2-3 months prior to filing. (i.e. Food, health ins., etc.) All three attorneys I spoke to prior to filing said quit paying. Also, filing within 6months or so of cash advances (i.e. balance transfers) is a bad thing.

In addition, commercial rental landlords do NOT have have to request a relief of stay if they are evicting you, like a bank/mortgage company does. (At least in FL) But you will need to speak to a lawyer in your area.

If you can sell the business prior to filing... I would do it. My situation came to a head too quickly and in a very specialized business. Not just anyone could buy it or step in and start running it.

[BigJohn]

I am still buying inventory; I have to in order to keep the business open. I pay by check or debit card. But then, our BK13 hasn't been confirmed.

[Barkri12]

Small business owners and entrepreneurs regularly agonize over the incorporation question--and about related topics such as when a limited liability company makes sense and whendoes an S corporation really save an owner taxes.

This obsessing over more sophisticated (and expensive!) entity options is too bad, however. New small business owners can count at least five great reasons to start a small business as a sole proprietorship.

Reason 1: Simple Setup

As compared to incorporating or forming a limited liability company, sole proprietorships are a breeze. All you really need to do is start. That's it.

Note: State and local governments usually want you to get a business license so they can begin taxing your new business. But getting a business license in many cases is pretty easy. Check the phone book or call your local state or municipal government offices.

Reason 2: Easier Accounting

If you run your business as a sole proprietorship, you keep your accounting truly easy. If you're the only worker, you won't even have to do payroll. Not having to do payroll saves tons of time, lots of money, and means you avoid doing between five and ten payroll tax returns a year: quarterly federal and state returns, the annual federal unemployment tax return, W-2s, and so forth.

What's more, you won't have to prepare balance sheets as part of your business tax return. Your sole proprietorship's income and deductions will typically be reported inside your individual tax return on a single page of paper.

In comparison, corporations and partnerships often do have to prepare balance sheets for their tax returns and a boatload of other supporting schedules. Commonly a corporate tax return runs between ten and twenty pages in length. Yikes.

Reason 3: Minor Children as Tax Shelters

If you employ your minor children in your business, a sole proprietorship offers up one of the sweetest small business shelters there is. Amounts you pay your minor children count as a tax deduction for your business--which saves you income taxes and self-employment taxes. But the amounts your minor children earn probably aren't taxable to them for either income tax or Social Security and Medicare taxes purposes if they make less than the standard deduction amount.