Filing Bankruptcy for a Business: 6 Mistakes That Damage the Case in the First 30 Days

Six Reasons

As a business in bankruptcy, your case is most fragile in its first 30 days, and it usually falls apart for one of six reasons. Owners file without a lawyer or under the wrong chapter, they miss paperwork deadlines, they spend cash collateral without permission, they do not pay post-filing taxes, they skip required meetings, or they repay favored creditors or insiders. Most of these mistakes are avoidable.

After you file, the business becomes a debtor in possession, and its owners run it as fiduciaries. A U.S. trustee watches for careless or self-interested acts, and flubs become reasons to dismiss or convert your case to Chapter 7. It is your bankruptcy, but it is no longer just your business. Filing gives you time. The breathing spell is there, but it is easily broken. The U.S. trustee can ask the court to dismiss or convert your case for late reports, withholding of information, and lack of insurance.

The first and worst mistake owners make is to file on their own instead of with a lawyer. Corporations, limited liability companies, and partnerships are all required to have counsel to file. A court can throw out your case immediately if you do not. Filing under the wrong chapter is a related mistake, and it takes many forms. If a corporation, LLC, or partnership files Chapter 7, it cannot get a discharge in the end. Subchapter V is open only if its debts total $3,424,000 or less, at least 50% of that from its business.

The second error is to miss paperwork deadlines. The schedules and statement of financial affairs must be submitted with the petition or within 14 days of it. The list of 20 largest unsecured creditors is also due with the petition. Small business debtors must also attach their latest balance sheet, a statement of operations, a cash-flow report, and a federal tax return with the petition, or say under oath that none exist. It costs $1,738 to file, and the court may dismiss your case if you fail to pay it.

The third major mistake is spending cash collateral. Exactly what counts as cash collateral? Most obviously, cash. Also deposit accounts, cash equivalents, and proceeds, rents, and profits from property a lender holds a lien on. Do not spend cash collateral unless you get the secured creditor to agree, or your bankruptcy judge approves. Segregate and account for the money in the meantime. If you have cash collateral, it may be impossible to operate without spending it, but using it without permission, even for a good purpose, may cause your case to be dismissed or converted to Chapter 7. Also, do not forget to close old bank accounts and open new debtor-in-possession ones. For example, the U.S. trustee for Region 16 will require you to close existing bank accounts at filing, and open new ones in your business name as a debtor in possession.

Mistake four is failing to pay post-filing taxes. As debtor in possession, you must pay employee withholding and other taxes in a timely way. If you do not, the U.S. trustee may ask the court to dismiss or convert your case. The IRS can also ask to make the owner or officer who let the problem happen liable for all of the missed payroll trust fund taxes if the failure was willful.

Mistake five is to skip meetings. Send your top business person and attorney to the initial debtor interview, 341 creditors meeting, status and scheduling conference, and any others the court requires. Failing to attend can be a reason for dismissal or conversion. At the initial debtor interview, the trustee will ask questions to determine if the business will survive, including if there is a viable business plan, and will review the reporting deadlines, like the monthly operating reports. Subchapter V is on its own clock. You must give the court a debtor’s report at least 14 days before the first status conference, which must happen within 60 days of filing. You must also file a plan within 90 days.

The last big mistake is paying favored creditors or insiders. For most payees, the trustee can grab back debts repaid while insolvent 90 days before filing, but the period jumps to one year if you paid an insider. Parties who count as insiders include relatives, general partners, corporate directors and officers. To be clawed back, a payment must first have given the creditor getting it more than it would have gotten in a Chapter 7 liquidation. Payments that were in the ordinary course of business may be safe, and all money returned must be divided between all creditors. Likewise, the trustee can try to undo other transfers by relying on state statutes, which often run longer. The trustee may even undo a fraudulent transfer made within two years before bankruptcy.

Consult with an Attorney

At a minimum, consult with an attorney. Ask about the right chapter, your schedule and deadline obligations, closing old bank accounts, and opening new debtor in possession accounts. If you have cash collateral, get your secured lender’s approval for its use, or if it does not consent, get permission from your bankruptcy judge in advance. Keep paying taxes. Lastly, make sure you have top people in place to go to court and appear for you.