051-shawn-stone

Understanding Bankruptcy

A discussion with bankruptcy lawyer Shawn Stone

John DeBevoise:

Greetings everyone, and welcome to another serving of Bizness Soup Talk Radio. If it’s in business, it’s Bizness Soup. I’m your host, John DeBevoise.

John DeBevoise:

Today our guest is Shawn Stone, a bankruptcy attorney out of Arizona who’s going to be talking about when, what, where, and how bankruptcy can work for you, whether you are the creditor or the debtor, if you’re the landlord or the tenant.

John DeBevoise:

We’re going to be talking about the seven, 11, the 13, everything that you need to know about covering your assets and making sure that your business stays in business. Sign up, sign in, sit down. Bizness Soup is now on the table. Shawn, welcome to this serving of Bizness Soup.

Shawn Stone:

Well, thank you so much for having me today.

John DeBevoise:

Shawn, your area of operations out there in Arizona, is you deal in the bankruptcy code. And out there in the not so tropical weather out there, you’re dealing with businesses. And in this particular case with Bizness Soup, we’re talking about small businesses, and getting even more of a rifle shot, restaurants. The pandemic has affected a lot of businesses and oftentimes in any business, bankruptcy is the last hurrah. Just what is bankruptcy, or as we often refer to BK?

Shawn Stone:

Bankruptcy is for people or businesses that just can’t afford to pay their debts. So, that is basically wiping out the debt of the business in order to allow, most of the time, the principals to be able to get on with their lives.

John DeBevoise:

The principal would be like the restaurant owner or the operator and such, those are the principals. And then they have all these creditors that could be the bank, could be the trade fixtures, the suppliers, anyone that they are indebted to.

Shawn Stone:

That’s correct. In the context of a small business is that most of the time it’s the owners of the businesses, or the ones who have the personal guarantees. So it’s not just a matter of what’s going to happen with the businesses, is it going to stay open, is it going to close, but you also have to look at the personal guarantees of the owners and what kind of obligation are they going to have to these creditors if the business doesn’t survive.

John DeBevoise:

So often in small business, you have a, as you said, the personal line of credit, where you are personally guaranteeing the debt that your business is obligated to. And oftentimes that includes a HELOC or a home equity line of credit. So if I go into bankruptcy for the business, it’s quite possible that I’ll have to drag myself or my family into it as well on the personal side?

Shawn Stone:

That’s right, yeah. Just because the business files a bankruptcy and the business ceases to operate, it does not mean that the creditors that the business owes money to, won’t go after the owner, who’s the one that guaranteed that loan, or the lease, or the equipment, things like that.

John DeBevoise:

Well, that can also happen in a divorce where they will come after the spouse for the joint credit that has gone on, but that’s a different subject on the personal side of it. There seems to be quite a menu in the bankruptcy code. We have the most popular, is the seven and 11 and the 13.

John DeBevoise:

Sounds like I’m in a convenience store, ordering up number 13 up on the shelf there. What is the difference, and how would a business apply, and how would these different code numbers apply to business?

Shawn Stone:

Well, throughout the country, by a landslide Chapter Seven bankruptcy is the most popular. The Chapter Seven bankruptcy is a liquidation style bankruptcy. Most states will look at state law to determine what you can keep in a bankruptcy. Those are called exemptions.

Shawn Stone:

For example, I’m an Arizona. So in Arizona, you can have an exemption of up to $6,000 equity in a vehicle, or you’re going to have equity of up to $150,000 in equity in your house. That means we take the value of whatever the collateral is, the house, the car, and then you subtract out the loan and then what is left over, that’s the equity.

Shawn Stone:

So anything that’s not protected with the exemption can be lost. Now that’s in a personal bankruptcy. In a business bankruptcy, businesses are not afforded the benefit of exemptions. So when you’re filing a Chapter Seven bankruptcy for a business, the business is almost always going to cease operations officially the moment that the case is filed, and you essentially hand the keys over of the business and the bankruptcy process takes over.

Shawn Stone:

A Chapter 13 bankruptcy is the second most popular type of bankruptcy, and that’s only used by individuals as opposed to businesses. So a business can’t file a Chapter 13 bankruptcy. However, the principals of a business, I mean the owners of the business can file a Chapter 13 and continue to operate the business. So, whereas in a Chapter seven, the business is going out of business, in a Chapter 13, the business can continue operations.

John DeBevoise:

All right. So if I file Chapter Seven, I’m just basically wiping my hands and saying, “I quit. I can’t do this anymore. Here are the keys. Here are the assets, liabilities too.” And I walk away.

Shawn Stone:

That’s exactly it.

John DeBevoise:

And fall on my sword in court, kind of.

Shawn Stone:

You’re conceding and it’s done for the business.

John DeBevoise:

Right. Okay.

Shawn Stone:

And I skipped over Chapter 11, because I want to talk about the two Chapters of bankruptcies that are most popular. Third, most popular is a Chapter 11 bankruptcy. Chapter 11 bankruptcies are more often than not filed by businesses, and these are more often than not usually situations where the business wants to continue operations.

Shawn Stone:

Years ago when there was the GM bankruptcy, that was a Chapter 11 bankruptcy. And there are still GM vehicles on the road today, because they were able to continue operations. I’m speaking in generalities, because I don’t want to get into too many specifics.

John DeBevoise:

Sure.

Shawn Stone:

But that’s an example of a big business that filed bankruptcy that is still able to operate. It’s a situation where the creditors can adjust some of their debts, but in order to continue operation, there’s a lot of moving parts to a Chapter 11 bankruptcy. They can often be very, very expensive. And there’s just a lot of moving parts. You really need to make sure that you’ve got a lawyer that knows where they’re doing. That is not for the faint of heart.

John DeBevoise:

What are some of the things that may push you into an 11, knowing that you have a viable business, but suddenly you can’t operate? Is it a call of a note, a balloon payment, a loss of a business or a contract?

John DeBevoise:

What are some of the more frequent reasons that a company will go into 11, knowing that if they take their time and if they get a relief of their debt for a little while or restructure, that they can come out of this smelling better?

Shawn Stone:

You know, it can be any one of those items. If you have one buyer of your product or service that dries up, for example, you hear that companies that provide merchandise to Walmart, Walmart is often their biggest customer. And if that relationship dried up, if Walmart was no longer buying these products, the business might be in a situation where they are no longer able to operate, or maybe not able to service the debt that they have.

Shawn Stone:

But maybe they’ll file a Chapter 11 bankruptcy, they’ll adjust some of the debts, and maybe they can’t operate with the debt that they had with their doing business with Walmart. But however, if they were to get rid of some of the debt, then maybe they could still be viable and remain open. And that would be a situation where, whichever level would come into benefit.

Shawn Stone:

There are situations where property values plummet and the Chapter 11 bankruptcy is filed in order to wipe out some of the inequity, the amount of the property that’s upside down. Let’s say if you owe a million dollars on real property and the property is only worth, say $600,000, because the economy crashes, then there’s an opportunity to basically give the lender a haircut of the $400,000. So to take the million dollar loan and bring it down to 600,000.

John DeBevoise:

That would be through the bankruptcy and the court would say, “All right, this property is only worth 600, no longer the million. So bank, here’s your chance to pony up and write down the loan.” So do they rewrite the loan at that point, or do they just credit you with 400,000, and would that be considered a taxable income?

Shawn Stone:

I’m not a tax guy, but I can tell you that the general principle of bankruptcy in taxes is that there’s typically not a taxable event when there’s a bankruptcy involved. Obviously you want to get with your tax person. I am not a tax person, but that’s my understanding of the tax situation.

John DeBevoise:

Okay.

Shawn Stone:

And the loan is not rewritten. Bankruptcy is a hammer. Most of the time bankruptcy is obviously not the first option and folks have already gone to the creditors to say, “Listen, this is what’s going on. I’m not getting the rent I was getting before, for example, and I need some sort of a deal or else I’m going to lose the property.”

Shawn Stone:

So bankruptcy is a hammer and the bankruptcy code allows you to do certain things, such as bring down, it’s called a cramdown, bringing down the value or the amount that’s owed on the loan. So it’s not a consensual type situation. It’s more of a, “Hey, this is the law. This is what you’re going to do.”

John DeBevoise:

We’re talking with Shawn Stone. He is an attorney out of the Phoenix area, and we’re talking about bankruptcy. What happens when you have no other choices, whether it be a seven, 11 or a 13, we’re talking about how to cover your assets and stay in business. With the bankruptcy code, most restaurants, as I’ve been talking a lot about restaurants, are under a longterm lease.

John DeBevoise:

And with the pandemic, there’s been a tremendous restructuring of the income, and a lot of time releases are based upon percentage of income, but what does a bankruptcy do to my relationship with my landlord? Do they have the right to throw me out, or can I renegotiate the lease? Where do I stand with my landlord?

Shawn Stone:

In a commercial context, at least in Arizona, I haven’t seen any COVID related laws or forbearances with regard to commercial leases. The protections are really in place for the individual consumers, not the businesses. So landlords are typically looking at the matter from dollars and cents.

Shawn Stone:

Does it make business sense to work with my tenant, or does it make business sense for me to get this tenant out so I can get a new tenant in that’s going to pay?

John DeBevoise:

Sure.

Shawn Stone:

Or does it make sense for me to get this tenant out so that way I can go after the personal guarantees? So it’s all negotiation. So there’s lots of landlords out there that will work with their tenants, because they know that if this tenant leaves… Or maybe I’m getting some money, or maybe I can get some reduced rent, then I’ll be able to have something coming in as opposed to kicking this tenant out and I’ve got nobody coming in.

Shawn Stone:

I don’t know if somebody told me or I read on the internet that Yelp estimates that some 60% of restaurants are going to be going out of business. The restaurants are some of the hardest hit areas for the reason that they didn’t have access to a lot of the PPP money, because server wages are very, very low.

Shawn Stone:

And the servers rely on the tips to bring their wage up to a market rate, and if people are not coming in and sitting down at the restaurant and ordering drinks, there’s no money coming in. So the PPP money was able to help non hospitality type businesses, but when you have situations where you can’t afford to keep your employees on the payroll, or the food costs are such that it doesn’t make sense, you can’t do it at volume, this is really completely devastating to the businesses.

John DeBevoise:

And that’s another story that we’ve covered on who actually got the PPP and unintended consequences of the acts of Congress. That’s another story. As to other things that are covered, can I renegotiate my lease if I go into a reorganization? I tell my landlord, “Hey, you know what? I’m not getting the business that I had. It’s not worth it.” Can I force the court and the court’s hammer to come down on my landlord?

Shawn Stone:

In the context of the Chapter 11 bankruptcy, you’re going to want her to try to negotiate with the landlord if you want to stay open. Because ultimately if you’re not living up to the terms of the contract, then more often than not, if the landlord wanted to, they can get you out.

Shawn Stone:

Now, there might be some contractual limitations, but everything’s on the table as far as negotiation goes. And in lots of Chapter 11 cases, you’ll have what we call pre-packaged bankruptcy, where the debtor, or the would be debtor, the business, that before they file bankruptcy, they go to all their creditors and say, “Listen,” landlord, supplier, all the vendors and say, “I’m going into a bankruptcy. Let’s work out some terms that are going to be amenable to the vendor, to the creditor so that way we can get to… We’re both unhappy. I’m paying you something and I can continue to buy from you and operate my business.”

Shawn Stone:

And so you can go into the bankruptcy with a prepackaged, everybody knows what the rules are, there’s no surprises, and those are the cleanest bankruptcies. They’re not always the easiest to do, they don’t always happen, but that is not uncommon in the context of a Chapter 11. Everybody already lined up and everybody already know what the game rules are going to be, even before the bankruptcy that gets filed.

John DeBevoise:

In most trade fixtures, anything that isn’t attached to the ground is considered a trade fixture and just the cursory real estate law, such as the kitchen in a restaurant, those are trade fixtures and they are so often financed. And that financing is usually through a third party finance company, through a banking organization. Can I force the non collection or repossession of my trade fixtures by going into bankruptcy and force my hand on my creditors that are financing or carrying the paper on my trade fixtures?

Shawn Stone:

One of the fundamentals of bankruptcy is that it stops all collection activities the moment the case is filed. So the moment the bankruptcy case gets filed, the automatic bankruptcy state kicks in. And what the automatic bankruptcy says in a nutshell is that no creditor can act and further into collection of a debt.

Shawn Stone:

That means repossessing or taking back property, collection calls, collection letters, any of these types of things. And so the moment the bankruptcy gets filed, you notify the creditors and they have to cease those collection activities. The landlord can’t lock you out, and these types of things. So, it stops all collection efforts the moment the case gets filed.

John DeBevoise:

What about wages and retirement plans such as 401(k)s that I’d be funding my employees. And let’s say I bounced a check or there’s wages from the last pay period. What happens with those debts?

Shawn Stone:

The principal, the owner of the business, they’re ultimately responsible for the wages of their employees that are on pay. But if the business is filing the bankruptcy, then the employees that don’t get paid, they can file a claim in the bankruptcy in order to try to get paid.

Shawn Stone:

So this is a situation where if your employer goes out of business, you’re in trouble. But what you touched on a moment ago is what I see all too often, is that a bankruptcy is always the last thought, right?

John DeBevoise:

Right.

Shawn Stone:

You always try a million other things. And whether it be in a business context or an individual context, I see all too often you have owners and individuals of the businesses that liquidate their retirement to stay afloat, or throw good money after bad, or go and get crazy high interest rate loans through these online lenders.

John DeBevoise:

Or they start factoring their receivables as well.

Shawn Stone:

And they have daily withdraws. What they mean is, is that they get a loan, the business gets a loan, in those are personally guaranteed by the owner, and they get these high interest rate loans. And basically the lender has a security interest to anybody that comes in, and they often have daily withdraws, industry rates are over the top, and there’s no way that the business is going to able to repay these loans.

Shawn Stone:

And so what happens is that the business goes out of business and can’t afford to pay the loans, then the owners are on the hook, and then the owners are looking at personal liability on that.

Shawn Stone:

So one of the struggles I have as a bankruptcy lawyer, is that I can’t get to folks early enough in the process and say, “Hey, listen, if you’re tapping into your retirement, things are not going well. You need to have a long look at the situation. Does it make sense to jump ship now, knowing that statistically these are the way things are going to go?”

Shawn Stone:

Same thing with the high interest rate loans, the business loans, the business funding loans.

John DeBevoise:

It’s kind of like those pay day advance loans that are-

Shawn Stone:

That’s exactly it.

John DeBevoise:

And that’s part of the Five Points to Bankruptcy. If You Don’t Know Them, You’ll Get There Quicker. And one of them is doing the irreversible type loans that are over the top, as my guest, Shawn Stone who works in the bankruptcy arena of law, is providing us.

John DeBevoise:

If you’d like the Five Steps to Bankruptcy. If You Don’t Know Them, You’ll Get There Quicker. Well, just go to bizsoup.com and ask for them. They are free. Just sign up. So you were talking about, you go back in, you start borrowing against your retirement plan.

John DeBevoise:

Of course, you take the money out, you get taxed on that, or if you cash out, but if you borrow it and don’t pay it back, then you’re still paying back your retirement plan. What about your employees? If you’ve been paying into their 401(k) under a contract, what about that contract with them if you are donating to their retirement?

Shawn Stone:

That’s part of their compensation. So, that is safe. Now what people run into problems with is that they are supposed to be paying into their employees retirement, and they’re not. So basically they’re stealing their employees money. And you see this also in the context of payroll taxes.

Shawn Stone:

You see situations where times get tough and there is a crunch on the pocketbook of the company, so the employers will take the payroll taxes out of their employee’s paycheck, and then not pay that money over to the taxing authority, which that’s essentially stealing. It’s a big, big deal. Don’t do that.

Shawn Stone:

And be even before that happens and if you’re tempted, you’ve got to have a good, hard look at your business and say, “Listen, does it make sense for me to continue operation if I can’t afford to pay the payroll taxes that I’m taking from my employees?”

Shawn Stone:

Because that’s not your money, that’s your employees money that you are to send over to the taxing authorities.

John DeBevoise:

And of course the employee can then file a claim with the labor board and say, “I haven’t been paid.” And there’s nothing worse than going to war with a government agency with unlimited resources.

Shawn Stone:

Or a former employee that you owe money to.

John DeBevoise:

Yes.

Shawn Stone:

It’s about to be a disaster, for sure.

John DeBevoise:

How has the CCP, or whatever acronym or flavor you want to put on the pandemic, how has that affected the filings, or do you see a low before a big storm of filings? Because businesses, such as the restaurant industry, hasn’t been able to keep the doors open and pay their employees and just keep going. Do you see an upsurge or a potential upsurge in the filings?

Shawn Stone:

As of right now, I think people just don’t know what to do. And if people don’t know what to do, whether it be in business context or individuals, they do nothing. So right now, things are relatively slow compared to things last year. But I think just absolutely, without a doubt, I think it’s coming. I thought it would already be here, the tidal wave of bankruptcy filings.

Shawn Stone:

But there’s talk of more money coming out as far as stimulus money, who knows there might be more government assistance towards businesses. So while there’s uncertainty as to what’s coming and what’s available, I’m not seeing a lot of bankruptcies happening, but the writing’s the wall. I’ve talked to a lot of people that are in the early stages of trying to figure out what to do.

Shawn Stone:

And not everybody’s ready for bankruptcy right now, but people need to keep their eyes open to look for the signs, so that way they don’t find themselves in a situation where they’re throwing good money after bad, they’re liquidating their retirements, just to try to keep a business afloat that just really needs to be in a DNR in order to not bring the entire family unit down.

Shawn Stone:

Small businesses is personal, and the small business owners don’t want to admit conceit, it’s difficult.

John DeBevoise:

Sure. It’s very difficult to give up. Perhaps you’ve worked in another job that has given you the resources to get into this dream job of owning your own business, and then the virus comes along and just shut you down. And it’s very difficult to walk away from a dream.

John DeBevoise:

What about government loans? You’ve got all this money that is just flowing out in the direction of small businesses. A lot of it’s gotten siphoned off, but if I go into bankruptcy and these government loans or programs that have been put out there by the government of recent months, am I obligated to those like student loans? Can they be BK’ed as well?

Shawn Stone:

I’m not intimately knowledgeable of all of the loans. I believe that, what is it, the EDIL, which is the most popular, that’s actually maybe not in every situation, but to my understanding, the people that I know that have gotten the EDIL loans, those are non-recourse, meaning that the government can not go and sue, or the SBA, Small Business Administration, cannot go out for the principal to collect that debt.

Shawn Stone:

I am uncertain. I can’t remember whether they can go after the business, but typically there’s really no sense in suing a small business that’s no longer in operation, and the reason for that is, is that it doesn’t have anything. So that’s why you had a personal guarantee. So that way, if the business does close, creditors want to be able to go after the personal guarantor.

Shawn Stone:

And this is something you need to check in your loan documents, if you’re going to get it. The EDIL loan, to the best of my understanding, is a nonrecourse loan where the creditor cannot go after the owner of the business if they don’t pay.

John DeBevoise:

Were speaking with Shawn Stone, a lawyer out of the greater Arizona area who practices in the field of bankruptcy. And we’re talking about business bankruptcy, in particular, the hard hit restaurant industry. In the area of the CCP, in the virus, the pandemic, are you seeing any type of abuses in the courts where companies are taking advantage of this pandemic to rewrite contracts or write down their debt obligations to lenders?

Shawn Stone:

I haven’t seen a lot of it right now, but things are slow. I mean, courts are physically closed, all the hearings are done through, at least in Arizona, through Zoom or over the phone. And it’s just too early to tell exactly what’s going to be happening.

Shawn Stone:

Again, we don’t know how long is it going to take, we don’t know what the longterm effects are going to be, we don’t know what stimulus money’s going to be coming out, we don’t know what more assistance is going to be available to businesses and individuals.

Shawn Stone:

And with all of these uncertainties, it creates inaction. Nobody’s really moving or acting right now, because nobody knows exactly what’s going to happen. I heard something on the radio and the other day that COVID is going to die off on its own before we get a vaccination. So with all of this uncertainty, how long it’s going to take, nobody’s really making any [inaudible 00:22:08] see what happens. Hurry up and wait.

John DeBevoise:

In the case of bankruptcy, it often is hurry up and wait, you get a reprieve. It’s a short lived reprieve, but at least you can stop answering the phone and saying, “I don’t have it right now. Quit calling me.”

Shawn Stone:

Right. And lenders are more understanding during these times, but there is lots that are giving breaks to their borrowers, for the people that they have contracts with, but that’s a temporary fix. A lot of these lenders want to get paid back everything, lump sum, that wasn’t paid.

Shawn Stone:

So once things settled down and we know where things are going, there’s going to be a lot of people that have to come up with a lot of money to get back on track, and I just don’t see that everybody’s going to be able to do that. That’s going to be another one of those contributing factors that’s going to cause a spike in the bank filings.

John DeBevoise:

The banks and the government taxing authorities are two of those areas that I’m not seeing any forgiving activities. You may be able to pay your property taxes later, without penalty, but you still have to pay the full value of it. As opposed to trying to get a write down on the valuations, and the banks are saying, “Well, we feel your pain.”

John DeBevoise:

What I’m seeing is that either they’re going to come up with, “All right, you can pay off your back debt in 90 days, or we’ll just put it on the back end, along with interest and you can continue to pay.” Both those entities are seemingly getting all of the money regardless of the business conditions.

Shawn Stone:

That’s my understanding of where things are going as well. Is that within the context of businesses and individuals, you’ve got to pay the money. You’re not getting anything for free. Maybe the stimulus money for free, but as far as your loans and your contracts, it’s going to get paid. They’re not saying, “Oh, don’t worry about it.” This is not happening.

John DeBevoise:

Yeah. Shawn, I can’t thank you enough for enlightening us into the world of bankruptcy. It is the last call when it comes to your business efforts, it’s a respite. If you want to walk away from it, just throw the keys to the wind and let them take it. Well, that’s one way to do it.

John DeBevoise:

But we recommend that you work with your creditors as our guest, Shawn Stone from Stone Law in Arizona is recommending, work with your creditors. And if that doesn’t help, well, then the government has an entity known as the bankruptcy court to give you a respite for a while and restructure.

John DeBevoise:

And if you’d like the Five Steps to Bankruptcy. If You Don’t Know Them, You’ll Get There Quicker, we’ll tell you what you’re doing now, before you get to bankruptcy and perhaps you can head them off. So tune into Biz Soup, go to bizsoup.com, where you will find not only the transcripts, but also this show, the podcast, the show notes and links to our guest, Shawn Stone. Shawn, thanks for being a part of this serving of Bizness Soup.

Shawn Stone:

Thank you for having me.