As a firm that regularly counsels business owners and individuals considering bankruptcy, we frequently encounter a number of misconceptions about what bankruptcy means and what it can accomplish. Here are some of the most common myths and misconceptions we come across in our practice.
That a company has filed for bankruptcy protection does not mean it is going out of business. In fact, companies that just need some breathing space but have the prospect of rehabilitation can file for protection under Chapter 11, which is a reorganization proceeding. In very broad terms, Chapter 11 enables companies to continue their operations, address their outstanding debt, shed burdensome leases, and reemerge as ongoing businesses at the end of the bankruptcy process.
In contrast to Chapter 11, Chapter 7 is a liquidation proceeding where the company does cease operations. Chapter 7 may be an appropriate option for a business that has significant assets available for liquidation; however, Chapter 7 is rarely a good choice for a failed business that has few or no assets of value. Unlike an individual, a business that files for Chapter 7 does not receive a discharge (forgiveness) of its debts. More importantly, particularly for a closely held business, filing for Chapter 7 may result in unwanted scrutiny by the bankruptcy trustee (a third party appointed to marshal and liquidate assets) of the business owners’ compensation and other financial transactions with the company, which could result in an attempt by the trustee to recover payments made by the company to the business owner(s) prior to the bankruptcy filing.
There is no requirement in any section of the Bankruptcy Code that a debtor (the company or individual that files for bankruptcy) be insolvent. In fact, it is not infrequently the case that debtors, both corporate and individual, have assets that exceed their liabilities. Businesses may have assets that exceed liabilities but may still benefit from filing for bankruptcy because it allows them to restructure certain debts and shed burdensome lease obligations while continuing to operate as a going concern. As explained in the next section, because individuals who file for bankruptcy can exempt certain property from the reach of creditors, those individuals may have assets that exceed their liabilities but still be able to discharge certain debts by means of a bankruptcy filing.
Both state and federal laws protect certain assets from the reach of creditors. These assets are called exempt assets. A few limited examples of exempt assets include federally qualified retirement accounts like 401(k)s, most ordinary household goods and furniture, some amount of equity in a home (this varies from state to state and under federal law), and some amount of equity in a car (this also varies). This means that a person can file for bankruptcy protection, keep whatever property is exempt, and still discharge his/her debts.
While personal income taxes of newer vintage are not discharged (forgiven) in bankruptcy, some income taxes that are older may be dischargeable. Generally speaking, if a specific tax return was last due more than three years before the bankruptcy filing, the return was filed more than two years before the filing, and there are no additional assessments relating to that tax year that occurred less than 240 days before the filing, the taxes for that year may be dischargeable.
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