Chapter 13 Bankruptcy
Chapter 13 bankruptcy is often called a wage-earner plan or a debt-consolidation plan.
It was originally set up for people who have a steady regular income and who could, if given time, pay at least a por tion of their debts. Gradually, the protection of a Chapter 13 bankruptcy was expanded to include people who did not have a steady income—for example, salespeople and waitstaff.
In a Chapter 13 bankruptcy, the debtor discloses his or her income and sets up a plan for paying creditors over a three- to five-year period. The debtor is not as likely to have assets at risk of being taken, like he or she would under a Chapter 7 bankruptcy, because money is being paid to the creditors. The steady monthly payments—often made through an automatic wage deduction—that the debtor makes to the Chapter 13 trustee are distributed to the different creditors in accor- dance with a plan of repayment that the debtor filed with the bankruptcy court.
In these ways, a Chapter 13 bankruptcy is a lot like a Chapter 11 bankruptcy.
or her goals. If he or she is willing to give up personal and business assets, he or she would choose a Chapter 7 bankruptcy. If the small business owner wishes to keep running the business, his or her only options are a Chapter 11 or Chapter 13 bankruptcy. As noted before, a Chapter 11 bankruptcy is not a realistic option for most small business owners. This leaves a Chapter 13 bankruptcy—the wage earner’s plan.
In a Chapter 13 bankruptcy, the small business owner works out how much profit the business makes after paying business expenses—rent, gas, supplies, etc. This profit is then applied to pay both personal living expenses and money to the court—the Chapter 13 trustee—for payment to creditors.
30 Bankruptcy for Small Business
Businesses need credit. Supplies have to be ordered and money is needed to tide the business over until customers pay for the goods or services provided, but few creditors will loan money to a small business with out a personal guarantee from the business owner. Thus the business’s and the proprietor’s finances rapidly become intertwined. This con nection comes at several stages.
When the business is just beginning, tools, equipment, and sup plies have to be purchased in order for the business to have a product to sell. The ultimate source of the funds for these expenditures is the money and credit of the proprietor. He or she, in turn, has only a few sources of funds. A few people will have personal savings or relatives and friends who are willing to invest enough to buy these goods outright. Most aspiring small business owners will need to borrow from a bank or other financial institution. As noted earlier, banks will not make a loan without some guarantee. A few people will have sufficient credit standing to obtain unsecured loans (getting money without collateral), but most will need to pledge an asset such as the business equipment, their home, car, etc. Landlords will typically require that individuals sign leases, rather than having the lease only in a company name.
t He i nterplay of B Usiness and
p ersonal d eBt 5
Then, there is the start-up phase. Most businesses do the work and get paid when the work is completely or partially finished. Unless the business is a part-time or second job type of operation, this means taking on more debt to tide you over until the funds start coming in. This phase can last a long time. It is not uncommon for a business to be unprofitable for as much as a year or two. During this period, pro prietors often turn to credit cards, or if they are lucky, draw on a line of credit secured by their start-up loan.
The next period when personal and business finances become inter twined is while the business is operating successfully. Proprietors will often begin using a company car for their transportation. They may buy items like cars, tools, trucks, and computers themselves and take them to the business operation for use by the business. Many times it is very hard to reconstruct what belongs to whom. The proprietor will forget he or she bought the car he or she is driving in the company name, or that the company work truck was bought by him or her personally.
At least with vehicles there are titles to look at. With computers, office equip- ment, and work tools, it is much harder. For example, pro prietors often go to the computer store and pay for the computer per sonally and take it to the office, or they may take a computer bought with company funds home for personal use.
The next stage is when the business begins to hit rough spots. It is the end of the week or the month and there is not enough money for payroll. The proprietor may have only one source of money—his or her per sonal bank account. Even if the business has enough money for the payroll, the proprietor’s family must be fed and his or her personal bills paid. If the business is not generating enough to cover this, the proprietor will have to use personal funds to tide him or her over.
If he or she is lucky, he or she can do so by drawing money out of savings. If not, he or she must use a credit card or a line of credit. Typically, the pro prietor has difficulty obtaining a loan to cover expenses during these business slowdowns,
32 Bankruptcy for Small Business
either because a bank will not loan to someone who does not have good cash flow or because it will take too long for a loan to go through.
The last stage is when slow times become chronic. There is too little money coming in for too many periods of time. Of course expenses are cut, but one can cut only so deep without killing the business. Somewhere along the way, propri- etors often make a mistake that will be discussed further in Section 9, especially if it has been a long time since the proprietor paid him- or herself or took a draw and personal credit is exhausted. All too often, the proprietor does not forward sales tax to the government or does not send the money withheld from employee payrolls. This creates a personal liability for the proprietor and officers of the company, and it creates another debt—this time to the government. Or some- times owners will not file their income taxes, figuring they can cross the bridge of tax liability when they get the business back on its feet.
In addition to business-connected debts, the proprietor also has the same situa- tions that create debt as the rest of the general public. Proprietors have mar riages break up, or they or their family members get sick and accrue doctor and hospital bills. Their cars break down, furnaces give out, and roofs leak. All of these circumstances put a strain on the owner’s personal finances. And it is the owner’s personal financial health that is often the underpinning for the business cash reserve. If something like this happens in the propri etor’s personal life, the busi- ness may be starved for money or attention. An owner who is home sick or injured cannot run a business.
For these reasons, a small business owner is much more likely to have money problems than a person working for a wage or salary.
The Interplay of Business and Personal Debt 33
When people consider bankruptcy for themselves or their business, they experi- ence all sorts of vague fears based on snippets of informa tion they have heard over the years, advice from well-meaning friends and family members, and the rising of their own fears and concerns.
The most common concerns are:
• it will ruin my credit;
• notice of my bankruptcy will be put in the newspaper and become public;
• it will ruin my spouse’s credit;
• I will lose my home and cars;
• I will lose all of my other property;
• they will sell my property at auction in front of my home;
• if I file bankruptcy, my spouse will have to file also;
• my spouse and I will lose our jobs;
f oUrteen m ytHs aBoUt d eBt
and B ankrUptCy 6
36 Bankruptcy for Small Business
• I will lose my license;
• I will not be able to get student loans;
• I will not be able to have a bank account;
• I will be put in jail if I do not pay my bills;
• the debts will go away in time; and,
• I will never have credit again.