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Business, personal debts often
overlap in bankruptcy
By Janet
Bigham Bernstel • Bankrate.com
When 1-year-old Jay-Jay was diagnosed with leukemia,
his parents counted on the insurance company to pay most of the
medical bills. It didn't. Expensive procedures and drugs, like the
$450 a day Zofran injections that helped the infant to eat during
chemotherapy, were considered experimental and not covered.
Then Jay-Jay's dad had a partial
layoff and his mom's budding home business suffered as she attended
her baby. The medical bills rose, the credit cards were maxed out
and the creditors became predators. They sought help.
"The attorney first suggested my wife and I
get a divorce," says Jay-Jay's dad, a Baltimore resident who wishes
to remain anonymous. "That way, Medicaid and Social Security would
kick in and at least pay the medical bills. But divorce was not
an option. Then he recommended bankruptcy."
Bankruptcy was an option for more than 1.4
million people in fiscal 1998, according to the Administrative Office
of the U.S. Courts. Business filings accounted for less than 50,000
of that number, but experts caution that personal bankruptcy is
often intertwined with business debt. Either can bring the other
down.
Jay-Jay's mom could never get another loan
to help her business grow due to the family's personal medical catastrophe,
and she could not turn to the family's credit cards because they
were tapped out. Entrepreneurs are increasingly using personal credit
cards to pay for business startups or expansion and many could
be at risk of defaulting on those debts.
"The business fails, they (the owners) go back
to work as employees and can't afford to pay back $100,000 in credit
card debt," explains Sam Gerdano, executive director of the American
Bankruptcy Institute in Alexandria, Va. "So it's a business failure
which gets reported as consumer bankruptcy."
Closing
the doors
Most of the 1998 filings were done under the Chapter 7 provision
of the federal bankruptcy code. It's the only chapter that allows
complete liquidation for businesses and individuals alike. The other
three chapters, 11, 12 and 13, involve some type of reorganization.
As Gerdano describes it, Chapter 7 is an orderly going-out-of-business
sale. It's a last-ditch effort that wipes out most debts, with a
few exceptions such as tax obligations.
It's very common for a small business in financial
trouble to use payroll and withholding taxes to meet bills, according
to bankruptcy attorneys. It's also very dangerous. The IRS gets
its tax dollars in approximately 90 percent of all delinquent cases.
"If you're the principal of your company,"
says Tim King, bankruptcy attorney for Bederson & Co. of West
Orange, N.J., "and you don't pay the payroll taxes for employees,
and your company files bankruptcy, the IRS will go after you personally
for the withholding taxes."
Working
it out
If the company does owe taxes, and it's a sole proprietorship, the
best option is to file for Chapter 13, according to John Ventura,
bankruptcy lawyer and the author of The Small Business Survival
Kit and The Bankruptcy Kit. Chapter 13 is not available
to incorporated businesses, but allows individuals with certain
levels of debt to reorganize, protect personal property and take
five years to pay back debts and tax obligations.
An incorporated business owner who wants to
stop the creditors from knocking, but still feels there's hope for
the company, should file for Chapter 11. It legally allows the owner
to break contracts, and with the court's blessing. New agreements
replace any prior pacts.
Chapter 12 gives the family farmer breathing
room to reorganize debts.
Heed
the warning signs
It's the rare business that doesn't feel a financial pinch at
some point. Recognizing when the pinch has turned into a stranglehold
is key to avoiding bankruptcy. Don't wait too long, says Richard
Levin, law partner for Skadden Arps Slate Meaghre & Flom in
Los Angeles, and principal author of the Bankruptcy Code
and Bankruptcy Act of 1978. Find a good accountant early and listen
to the advice. Most of all, watch the cash flow.
When the business outlook has gone from rosy
to deep red, King recommends the following:
- Consult with an accountant or lawyer who
has insolvency experience.
- Be honest that there is a problem.
- Crunch some numbers and figure out how to
cut costs.
- Be hard-nosed about employees you may have
to lay off, like family members with inflated salaries.
- Explore a workout situation with creditors.
Third-party negotiators like accountants, attorneys or the Consumer
Credit Counseling Services can ease the way.
Splattered
credit
The consultant from CCCS recommended bankruptcy for Jay-Jay's family.
His dad held off, afraid that a pending experimental operation would
cost another $250,000. If he had already filed for Chapter 7, the
new debt would again be his responsibility. He was also concerned
about his credit record. But as many businesses and individuals
discover, by the time they consider bankruptcy, the credit record
is badly marred. Even an incorporated business is not insulated
from personal credit damage.
"People used to say that a certificate of incorporation
is a bankruptcy discharge in advance," Levin says. "But these days
the big lenders get personal guarantees, so the guy may wind up
in bankruptcy even if the corporation doesn't."
Jay-Jay's dad is still struggling to pay monumental
bills. His mother's business is dead and she is working part time
for someone else. Their attorney warns that this year is the last
chance to file, due to the pending Bankruptcy Reform Bill of 1999,
which will make Chapter 7 more difficult to file. So before that
takes place, and with Jay-Jay in full remission, Jay-Jay's dad says
he is finally giving up his struggle.
Janet Bigham Bernstel is a freelance writer. To
comment on this story, please e-mail the Bankrate.com
editors
-- Posted: March 22, 1999
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