Can I Run a Business While In Bankruptcy?

running a business in bankruptcy

You can run a business while in bankruptcy in Michigan. However, depending upon the value of that business, you may need to file a Chapter 13 rather than Chapter 7 bankruptcy.

This Article will explain how you can run a business in bankruptcy—and when it is dangerous to file for bankruptcy when running a business.

First, some basics regarding the Michigan bankruptcy process.

Chapter 7 Bankruptcy: Your Business Is An Asset

Chapter 7 bankruptcy is a “liquidation” bankruptcy.

This means that your debts (unless of the non-dischargeable type) are fully discharged, without need for any payment. It also means that, if you own property that cannot be fully “exempted,” it may be seized and liquidated.

An exemption is a legal protection for certain types of property in bankruptcy. The US Bankruptcy Code is the Federal statute underpinning the bankruptcy process. The “exemptions” are provision of that Code.

Each exemption provision is applicable to one type of property. Each of them, with just a few exceptions, caps the value that can be exempted or protected in that type of property.

Some types of property have no exemption available to protect it at all.

When property cannot be exempted in Chapter 7, it may be seized by the Chapter 7 Trustee and “liquidated,” or sold off, in order to generate a pool of money from which your creditors are at least partially repaid.

In Chapter 7, the assets of your Bankruptcy Estate (subject to Trustee liquidation) include everything you own and everything you have an interest in or a claim to as of the date that you file the bankruptcy case.

This includes business ownership interests.

Business Liquidation in Chapter 7 Bankruptcy

There is no exemption for business ownership interests under either the US Bankruptcy Code or related Michigan State law.

Thus, the question for you, as a business owner in Chapter 7, will be whether your business has any real fair-market value. The next question, then, will be, if the business does have “book value,” how much value is that?

This question is important because the Chapter 7 Trustee will simply not bother to liquidate an asset that has no value.

The Chapter 7 Trustee is also required to consider settlement offers from debtors. (That is, the Trustee will consider a lump sum payment in “settlement” of her right to seize and liquidate an asset if it is reasonable and cost-effective for your creditors in terms of the Trustee’s attorney fee expenses and general hassle.)

The value of your business is also important because it isn’t quite true that there is NO exemption available to protect some or all of that value.

In fact, the US Bankruptcy Code contains a so-called “wildcard” exemption that can be used for this purpose.

The wildcard exemption is an all-purpose exemption that can be used for any type of property at all. Including a business.

However, the wildcard exemption is not, as are the others, a “stand-alone” exemption.

It is a portion of the “homestead” exemption otherwise available to protect the equity in your home. If you don’t need to use it all as a homestead exemption because your  home doesn’t have that much equity, is underwater, or because you are a renter, $12,000 of that exemption can be used as a wildcard.

What Is the Value of Your Business in Chapter 7 Bankruptcy?

How to value a business for Chapter 7 purposes is a question that has come up many times in Bankruptcy Court litigation.

The 2 basic methods used for the valuation of a business for bankruptcy purposes are:

1. Asset-Based (“Fair Market”) Valuation

2. Going Concern Valuation

Asset-Based Valuation

An asset-based or “fair market” valuation simply compares the total cash value of all assets and receivables and claims owned by the business with the value of the debt owed by the business. If the result is positive, the business has value in that amount.

Going Concern Valuation

Going concern valuation is premised upon the  Chapter 7 Trustee’s statutory ability to step into your shoes and continue to operate your business for a limited period of time if it is in the best interest of the parties (meaning your creditors).

This valuation methodology examines the value of your business as a whole, as you would sell it to a buyer interested in operating the business itself. It will incorporate not only the value of assets and receivables but also the future income and profitability of the business, going forward.

A Third Method: Forced Sale Valuation

At least one judge here in the Eastern District of Michigan Bankruptcy Court has declined to follow either method. In that case, the judge adopted a third business valuation methodology: Forced Sale Valuation.

This method is essentially a form of Going Concern valuation that takes into account the fact that Chapter 7 Trustees are required to perform their tasks within a reasonable amount of time.

A Chapter 7 Trustee cannot wait for years and years for the optimal high-bidding buyer, in other words.

The judge adopting the Forced Sale methodology rather than the other 2 methods went on to schedule an evidentiary hearing as to what dollar-value this actually amounted to, in that case.

Any way you cut it, valuing your business in Chapter 7 bankruptcy will be a fact-specific exercise, in other words.

When you file your Chapter 7, you cannot be assured that your valuation method or your value will be accepted by the court. Your creditors will push back if they don’t like your numbers. And your judge will have the final word on the subject.

The cost of getting it wrong will be—your business.

Running a Business in Chapter 7: Yay or Nay?

If you no longer intend to run a business during or after your bankruptcy, Chapter 7 bankruptcy can be an effective means of settling things with your personal and business creditors while allowing the Chapter 7 Trustee to do the dirty work of liquidating your remaining assets.

If you do intend to run a business with more than $10,000 of positive value by any applicable valuation method, a Chapter 13 bankruptcy may be a safer road to travel.

Running a Business in Chapter 13 Bankruptcy

Running a business in Chapter 13 bankruptcy is a far safer prospect than Chapter 7.

There is no asset liquidation in Chapter 13 bankruptcy, for starters.

Asset Exemption in Chapter 13 Bankruptcy

In Chapter 13, you must still list and value all of your assets. You must still apply all available exemptions to those assets in your bankruptcy petition paperwork.

However, the consequence of failing to fully exempt any asset, including a business, is not liquidation. Instead, it will require that you directly pay that non-exempt asset value to your creditors through the Chapter 13 payment plan.

In Chapter 13, you “reorganize” rather than “liquidate” your debt. Each month, you make a payment equivalent to your after-expense, average monthly, household take-home pay to the Chapter 13 Trustee assigned to your case.

The Chapter 13 Trustee then takes those funds and pays, in this order, your:

  • Michigan bankruptcy attorney;
  • Trustee’s fees;
  • Secured debt installments;
  • Arrearages on secured debts;
  • Contract and lease payments;
  • Priority unsecured creditors (such as child support recipients);
  • Non-priority unsecured creditors.

If all of your assets are successfully exempted, those non-priority unsecured creditors need only receive a non-negative amount of money for your Chapter 13 plan to be approved by the Court. That is, they may be required to simply split a single penny between them. All of the remaining debt that you owe to such creditors “on paper” is then, at the end of the Chapter 13, totally discharged without further payment.

Just as in a Chapter 7 bankruptcy.

However, if the non-exempt value of your business or other assets is, say, $20,000, this  will not be the case. In this example, you must make a monthly Chapter 13 plan payment in a large enough amount to first pay all that you must to higher priority creditors and then to leave a pool of at least $20,000 for your unsecured creditors to split amongst themselves.

Profitability Required for Business Operation in Chapter 13

Other than this value-based consideration, the other key difference for business owners in bankruptcy is that, in Chapter 13, you remain in possession of your assets.

That is, you retain the ability to operate your business. In fact, you likely need it in order to generate the income required to make the monthly Chapter 13 Plan payment to begin with.

The only time you would not be allowed to continue to run a business in Chapter 13 is when the business is operating at a loss.

The Chapter 13 Trustee will object to the confirmation (court approval) of your Chapter 13 Plan if you are paying a smaller Plan payment each month than you would if you did not operate a money-losing, failing business.

If this is the case, to stay in the Chapter 13 process, you will need to close your business and send those funds to your existing creditors, instead, as part of your monthly Chapter 13 plan payment.

Other Issues Running a Business in Bankruptcy  

There may, in certain instances, other issues you may encounter running a business in Chapter 13 bankruptcy.

Cannabis Businesses in Bankruptcy

For instance, your business must be legal under Federal law.

You must remember that bankruptcy is a Federal legal process and not a Michigan State law-based process. Thus, if you are, in particular, running a cannabis business that is legal under Michigan law, you will not be allowed to run that business while in a Federal Chapter 13 bankruptcy process. (A Chapter 7 case involving such a business will also encounter a motion to dismiss.)

The reason for this is that cannabis, as of this writing, remains a controlled substance under the Federal Controlled Substances Act (CSA). The Chapter 7 and Chapter 13 Trustees may not facilitate or profit from an enterprise that is criminal under Federal law.

Titling or Business Ownership or Commingling Issues

If you have engaged in “unorthodox” business management practices, you will also encounter trouble in the bankruptcy process.

Titling or transferring business assets or funds to other people (even a spouse) will result in fraud allegations. If you don’t own your business “on paper,” instead operating it through a spouse or some other willing individual “for liability purposes,” you will encounter push-back from a Chapter 13 Trustee in particular.

If you have commingled business and personal funds, using your business operating bank account as if it were your personal checking account, this will also cause trouble for you and your business.

Talk to a Metro Detroit Bankruptcy Attorney about Your Business

All of this should alert you to the necessity of consulting an experienced Metro Detroit, Michigan bankruptcy attorney before filing any Chapter 7 or Chapter 13 bankruptcy as a business owner.

Attorney John Hilla has successfully represented hundreds of clients through Chapter 7 and Chapter 13 bankruptcy processes in Michigan.

Located in Livonia but offering service to clients in Monroe, Southfield, Ann Arbor, Farmington, Westland, Taylor, Inkster, Pontiac, Bloomfield Hills, Royal Oak Ferndale, Flint, Saginaw, and Bay City, as well as everywhere else in southern Michigan, we offer free virtual consultations and friendly, one-on-one service.

We ensure that your bankruptcy matter is handled not only with experience and competence but also understand and kindness.

Click the button below to directly schedule your free consultation or contact us at (313) 380-0492.