6 Things the Trustee Does When a Business Bankruptcy Goes to Chapter 7

The trustee will sell your company’s assets and use the proceeds to repay its creditors. It’s the trustee’s job to get maximum value out of business assets - and to investigate any possibility of wrongdoing that might enhance repayment. Here are the bankruptcy trustee’s main jobs:

• selling company property to repay creditors;
• questioning you about your company’s finances;
• going through company records to find its property and debts;
• reaching back in time to take back some assets you spent;
• paying creditors of different kinds from the proceeds of the sale, in certain orders;
• and closing the case at the end.

Your trustee will be chosen by the Office of the U.S. Trustee. The trustee represents neither you nor any creditor. Your business will be liquidated and it will receive no discharge. By contrast, individual debtors frequently receive discharge.

Property of the Estate

With very limited exceptions, all of your company’s assets become “property of the estate” upon commencement of the bankruptcy case. In other words, they come under the control of the trustee. In general, the trustee is entitled to sell these assets. That covers current assets like inventory and company receivables. The trustee takes title to your property subject to the usual liens. Your business is probably closed. That still leaves receivables, equipment or other goods, and so on. The managers of your company should not take any action to dispose of property. Your firm may be allowed to continue for limited times, under court order.

Next comes the “341 meeting of creditors.” (The number is the applicable Section of the Bankruptcy Code.) It is a meeting at which the debtor is questioned under oath. This meeting occurs generally 21 to 40 days after the case’s filing. The trustee’s questioning helps determine the exact nature of the debtor’s assets. She will ask whether you have books and records available, and inquire into the whereabouts of your business assets.

If the bankruptcy trustee wants your company’s business records, she will demand them. Among other things, you’ll have to turn over bank statements, tax returns, financials, and related records. The process is very intrusive. You also are questioned about corporate assets and how the company was managed. Were any assets transferred to anyone?

When a company that’s on the verge of bankruptcy repays its owners or other “insiders” before filing, the bankruptcy trustee can undo the repayment transaction and “claw back” the funds. The “lookback period” in a bankruptcy case is the period before filing during which prebankruptcy transactions are reviewed to see if they should be undone (for example, giving creditors preferential treatment.) For insider repayments it’s one year. As to non-insider creditors, the lookback is 90 days. But that debt must be old, meaning you owed it before, and not incurred close to the time of bankruptcy. Legal defenses may apply. The repayment transaction must total at least $8,575 in a business-debt case. For fraudulent transfers the statutory lookback period is two years. If the repayment was intentional fraud, it can be clawed back even if it wasn’t to the debtor’s owner or insider.

Classes of Creditors

In a business debt liquidation, things are prioritized according to statute. The process starts with the filing of “proofs of claim” by creditors. The bankruptcy trustee reviews each one to determine its legitimacy. If the claim’s false, the trustee objects. Section 726 lists six separate classes of creditors. Each class must be paid in full before any of the next class of claims will be satisfied. Unpaid wages get priority. They receive up to $17,150 per employee. These are wage debts that arose within 180 days of filing the case, or on the debtor’s closure if that occurred earlier. By law, your trustee is paid from what is distributed to creditors. The amount is capped on a sliding scale according to the amount of the liquidation proceeds. On $1 million distributed, the trustee’s fee can’t exceed $53,250.00.

As for taxes, when a corporation files, no separate bankruptcy taxable entity is created. The Internal Revenue Service just requires the corporate debtor’s trustee to file the returns for it. Form 1120 is the corporate federal income tax return. Once the business has been liquidated, all sale proceeds and recoveries have been distributed according to the various statutory claim “classes,” and the trustee has filed her “final report,” the court will close the case. Because every case involves different amounts of assets, disputes, claims and the rest, there’s no fixed timeframe. Asset cases drag out. A “no-asset” case may go through very fast.

Personal Repayment Responsibility for Business Debts

Individuals who incorporate their businesses to limit their liability often ignore the issue of possible personal repayment responsibility for business debts. Creditors may still pursue any co-debtor or guarantor who, for instance, personally guaranteed corporate debt. Bankruptcy doesn’t shield these people. If as an individual you personally guaranteed your business’s debt, that could pose a personal-credit issue. If you have any unpaid employment trust fund taxes from the business, they may become your personal liability.

In a bankruptcy, cooperate with the trustee, keep company books and records intact and organized, answer all of her questions, and do not sell or move any company property. Think ahead. Don’t be surprised. Before filing, speak with a lawyer who’s experienced in this field.