Sole prop to LLC

[GWBcasualty]

OK. Just to briefly recap, I can fully exempt everything I own including the inventory of my biz.

However, I am still planning my BK when it comes to ensure continuing operations of my biz, relationship with my vendors and protecting myself from any future debt.

1) I can file, exempt the inventory, discharge all my debts. List the debts with vendors (invoices - no liens or formalities... long standing relationships). Reassure the vendors that I intend to honor my debt with them and continue operating.
The downside of that is that any future debt with vendors could not be discharged in BK.

2) Same as above, but form a LLC after/during BK and have all future biz activity be under the LLC umbrella.

3) Form a LLC now. Transfer to the LLC assets AND debts. File afterward, that way my vendors wouldn't even know I filed.... (they have no SSN or anything, again very informal relationship)... I could exempt my interest in the LLC under CA System 2 with even greater ease because the outstanding invoices would reduce the value of the assets and if the economy worsen I could just shut down the LLC.

I know #1 and #2 are feasible and I have nothing to hide/explain to the trustee... how about #3 which would be my favorite? Is there anything in the law that forbids the transfer of debt from an individual to a LLC??

[StartingOver08]

In #3, are you transferring "new" debt to be incurred after you form the LLC or are you trying to transfer existing debt that you now owe as a sole proprietor?

[GWBcasualty]

In #3, are you transferring "new" debt to be incurred after you form the LLC or are you trying to transfer existing debt that you now owe as a sole proprietor?

Existing debt and existing assets.

[StartingOver08]

How would you do that? I only ask because in the normal course of business a new LLC begins from the inception date of the corp. How would you "assign" debt to an entity that was incurred prior to the existence of the entity unless the entity "purchased" the assets and the debt?

[HHM]

As #3, I am not sure what you mean by the invoices reducing the value of assets. It doesn't work that way in BK. The value of the business is its "liquidation" value (i.e. what you could sell your assets for) minus "secured debt".

#3 seems awfully complex for what you need to accomplish. StartingOver is correct, you cannot simply "assign" debt and "transfer" assets. The lenders on the debt would need to agree, and the company has to "buy" the assets. Otherwise, guess what, that is an avoidable transfer in BK and the exemption becomes moot.

For your BK, simply do number 1, then after the BK, if evaluate if their are any tax advantages to operating as an LLC, if yes, then form one, if not, don't bother.

[GWBcasualty]

As #3, I am not sure what you mean by the invoices reducing the value of assets. It doesn't work that way in BK. The value of the business is its "liquidation" value (i.e. what you could sell your assets for) minus "secured debt".

Yes. #1 is definitely easier, but let me try to explain what I mean... when a LLC is formed you can "sell" assets from a sole prop to a LLC.

Contribution of Assets

If a sole proprietor contributes assets to a single-member LLC (SMLLC) taxed as a disregarded entity, no transaction occurs for tax purposes, as he or she is deemed to continue holding the assets as a sole proprietor. However, for state law purposes, the LLC holds title to the business's assets after the conversion.

Let's just assume for simplicity that my inventory has a liquidation value of $10K and that I have outstanding invoices of $10k with vendors. If I form an LLC and my contribution to the LLC are the inventory and the liabilities, I could value the inventory at cost (say $15K) and when I list as an exemption my interest in the xyz LLC, I would list $5k (asset - accounts payable).

The only advantage over #1 is that my vendors wouldn't have to know about the BK filing.

Sorry if it's unclear.

[HHM]

That is not how it works in Bankruptcy.

Your invoices are meaningless for a bankruptcy valuation. Unless those invoices are somehow secured to the property (not likely), they have no bearing. Surprisingly, BK takes a rather direct approach on this issue. The value of a company is the liquidation value of its hard assets and outstanding receivables. The only accounts payable that matter are secured creditors, if there are no secured creditors, then there is no offset for valuation.

[GWBcasualty]

That is not how it works in Bankruptcy.

Your invoices are meaningless for a bankruptcy valuation. Unless those invoices are somehow secured to the property (not likely), they have no bearing. Surprisingly, BK takes a rather direct approach on this issue. The value of a company is the liquidation value of its hard assets and outstanding receivables. The only accounts payable that matter are secured creditors, if there are no secured creditors, then there is no offset for valuation.

Thanks.
So if I do #3 nobody should care since the invoices are meaningless?

If I go with #1 (which is likely) I still have to list the invoice on my list of debts even if unsecured?

[Mensa1]

#3 might accomplish your goal. Not having to list your Vendors.

Other than that it does nothing for you, in fact due to late transfer it may complicate things due to the T'ee having a harder look at everything. Just my opinion.

Seems as though you are set on doing #3 so have at it. GL, let us know how it works out. Maybe you luck out and draw a busy T'ee who sees little to no upside compared to the time invested to unearth the pound of flesh.

[HHM]

Thanks.
So if I do #3 nobody should care since the invoices are meaningless?

If I go with #1 (which is likely) I still have to list the invoice on my list of debts even if unsecured?

Actually, that is not what I said, if you do #3, the invoices don't matter in that they do not offset the value of the inventory and assets, and the trustee can go after the assets. If the inventory and assets are worth $25,000, you could have $500,000 in outstanding invoices and the liquidation value of the LLC is still $25,000. The only unknown for me is how CA exemption scheme 2 would apply in this situation. But, if the exemption works like in most states, you will actually lose the exemption on the "stuff" in the LLC because you (the debtor) no longer have legal title. The trustee can still step into your shows as owner of the LLC, and sell the assets. I think you run a huge risk that the trustee simply shuts you down if you go option 3.

[GWBcasualty]

According to closed cases that I studied on Pacer it would be exempted using the WC under "Stocks and Interests in Business". In one filing they formed two INCs a few months before filing and exempted them.... is a small corporation treated differently than a LLC??

I agree that going that route offers the only benefit of not listing the vendors and could raise some flags... not having anything to hide that would only mean a longer process and added stress and, no, I am not set in going that route. Just want to make sure I know everything involved and make sure I am not breaking any law or BK rule.

I appreciate your input.

[HHM]

Exactly, I can't really speak to the particulars of that exemption. I understand exempting the "Value" of the shares or ownership; but if I were on the other side, I would argue that the exemption only protects the shares from being sold by the trustee to a 3rd party (that is the value), but the "rights" associated with the shares or ownership are still part of the BK estate and can allow the trustee to exercise control over the business and liquidate it.

But, if it has worked for others, then it will probably work for you.

However, I think you still have the issue with assigning the debt to the LLC. Just because "you" assign it to the LLC does not extinguish your personal liability. You would still need to list the invoices in your BK. (unless the vendors were willing to agree to the assignment and release your personal liability).

[Mensa1]

On a little different bent here, with regard to closely held Corps and LLC's, doesn't the T'ee look at net share value only. As in the case of an entity that owns property or any other commodity that is encumbered, (combo of secured and unsecurted debt), and the encumbrance from a 3rd party comm'l lender is equal to or greater than the market value of the property or assets, hence 0 share value. Doesn't the T'ee then avoid dealing with the entity in total?

I realize that the OP is contemplating forming an entity now which may be a recent transfer situation, but the above relates to entities that have existed for years. Appreciate any thoughts on that, especially HHM.

[HHM]

On a little different bent here, with regard to closely held Corps and LLC's, doesn't the T'ee look at net share value only. As in the case of an entity that owns property or any other commodity that is encumbered, (combo of secured and unsecurted debt), and the encumbrance from a 3rd party comm'l lender is equal to or greater than the market value of the property or assets, hence 0 share value. Doesn't the T'ee then avoid dealing with the entity in total?

I realize that the OP is contemplating forming an entity now which may be a recent transfer situation, but the above relates to entities that have existed for years. Appreciate any thoughts on that, especially HHM.

Basically correct, a business entity would have zero value if the amount of the secured claims against the business assets exceeds the value of the asset.

For example, many real estate investors will hold real property in an LLC. However, if the mortgage on the property (probably in the name of the individual, not the LLC) exceeds the value of the property, the LLC is worth Zero. Hence, there is nothing for the trustee to do.

[Mensa1]

Basically correct, a business entity would have zero value if the amount of the secured claims against the business assets exceeds the value of the asset.

For example, many real estate investors will hold real property in an LLC. However, if the mortgage on the property (probably in the name of the individual, not the LLC) exceeds the value of the property, the LLC is worth Zero. Hence, there is nothing for the trustee to do.

What if a combo of secured and unsecured debt, and the real property has equity in it with the secured debt, but then the entity also owed unsecured debt in addition, and the net total of equity is still less negative number, so zero share value. Can/will the T'ee strip the RE out of the LLC, or liquidate it to pay a portion of the unsecured creditors, after the secured is fully paid?

So the question is, how is the secured and unsecured debt handled inside of an entity when the net equity is zero, net share value zero?