Bite-Sized Bits of Knowledge

The Involuntary Bankruptcy Trigger and Bankruptcy Basics

The Involuntary Bankruptcy Trigger and Bankruptcy Basics

Bankruptcy is a common trigger of an involuntary transfer. If a partner goes bankrupt, you could find yourself partnered… with a partner’s creditors. 

Generally, you want to keep it in the family (or within the existing partners with whom you’ve agreed to be in business), which is why it is highly advisable to build in triggers for bankruptcy to protect the business from this eventuality.

Why is this situation so fraught for a business?

When You’re Partners with a Creditor: An Untenable Situation

Read Transcript

Hi. Welcome back to another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time. Transfers is a huge concept. We’re going to break it up into a lot of videos. And we’re going to break up some of the concepts into a lot of videos. So, for example, today we’re going to talk about involuntary transfers, and we’re going to break it up into pieces.

So big picture, involuntary transfers is a concept of where you’re forcing someone to transfer their shares in the event of certain conditions. So, high level, for example, we’re talking about bankruptcy, divorce, death, disability, termination of employment, or just what’s called dissociation or abandonment. 

All these situations are bad. And all these situations leave your business in a very vulnerable position. And so you want to have it thought through and have it planned, so that when it happens, you just look at the agreement and say, “Here’s what we agreed, here’s what’s going to happen.” And there’s no conflict or limiting conflict. All of what we’re trying to teach you here is, in large part, to try to limit chaos, court costs, and conflict. 

So, in today’s video, we’re going to jump in to bankruptcy. Bankruptcy is a really interesting animal. There’s lawyers that only focus on bankruptcy. It’s all they do. So if you find yourself in a business with a partner who’s now filed for one variation of the many different kinds of bankruptcies or assignments for the benefit of creditors, you don’t want to have a situation where your shares or your company is now in business with a creditor of a partner. 

 

This creditor may not be qualified. They may be disinterested. They may be not a good fit for the business. You may not like them. They may not like you. They may not fit into the culture. There’s a lot of reasons why this is a very bad situation. Especially, I would say, the creditor just wants their money. They just want their money. They just want to get paid. They’re going to do everything they can to get paid. They’re going to be annoying. They’re going to maybe try to sell their shares in a voluntary transfer.

So you got to think about it. So bankruptcy is bad. You don’t want to be in business with the creditor of a partner. And so this is an example of what would trigger the partner subject to a bankruptcy to have to sell their shares back to the partners that are already in existence. Those existing partners will buy them out.

Mechanics again, in a different video. The concept is the same. The next thing we’re talking about is divorce as another trigger for involuntary transfer. 

So don’t forget to download the free materials in the description. One is a business planning stress test. Another is a formation chart. And there might be some other things in there that might be of help to you as well. 

So thank you for stopping by and stay tuned for more.

Here are those free downloads mentioned in the video:

Now, let’s take a more in-depth look at how bankruptcy itself works.

What Exactly Is Bankruptcy and How Does It Work?

Quite simply, bankruptcy is a legal tool that can be used when an entity cannot pay back their debts or obligations. It allows for that entity to recover financially while still enabling creditors to recover at least some of what they are owed.

Bankruptcy can be started in two ways:

  1. The debtor files a petition for bankruptcy
  2. The bankruptcy process can be started on creditors’ behalf

The first option is by far the most common.

Once the process starts, the debtor’s assets will be evaluated and measured, and some of them may be used to pay back part of the debt that is owed. Typically, bankruptcy is overseen by a trustee, and the debtor and judge on the case never actually meet.

In order to go through bankruptcy, a debtor must complete a number of procedural steps, such as: 

  • Offering detailed financial information to the trustee and the bankruptcy court
  • Going through credit counseling before they can file
  • Attending a mandatory creditor’s meeting
  • Filling out over 20 bankruptcy forms

What Are the Different Types of Bankruptcy?

In the U.S., six kinds of bankruptcy exist: Chapter 7, 9, 11, 12, 13 and 15. Of the bankruptcy cases filed in 2021, Chapter 7 and 13 accounted for 98.7%.

Here’s a bit more on what is different about each type of bankruptcy:

Chapter 7

Under this type of bankruptcy, it is possible for any assets that aren’t protected by an exemption to be sold by your court-appointed trustee, and the net proceeds distributed to creditors.

Chapter 9

This type of bankruptcy deals specifically with financially distressed municipalities – in other words, cities, school districts, townships, and so on. The goal here is to come up with a plan for how to resolve debt between creditors and the municipality.

Chapter 11

Want your business to stay open while you restructure the debt you owe to make payments more manageable? Chapter 11 is probably what you’re looking for. Sometimes called “reorganization bankruptcy,” this type of bankruptcy is designed to help businesses restructure their assets, business affairs, and debts.

Chapter 12

Did you know that there is a specific kind of bankruptcy for “family farmers” and “family fishermen”? If someone works in one of these professions and suffers financial distress, they can enter into Chapter 12 bankruptcy and come up with a 3-5 year plan to pay their creditors back.

Chapter 13

Known as the “wage-earner’s bankruptcy,” Chapter 13 was created to enable people earning regular paychecks to restructure their debt so that they can pay back some or all of their creditors.

Chapter 15

This is a very specific type of bankruptcy that applies in situations where bankruptcy filings in foreign countries impact financial interests in the United States. It allows U.S. courts and foreign courts to cooperate.

Understand Bankruptcy – and How to Prevent Another Owner’s Bankruptcy from Impacting Your Business

Now that you know a bit about bankruptcy and the dangers of the involuntary bankruptcy trigger, the next step is to learn how to build safeguards into the structure of your business itself. Get in touch to talk to an experienced Florida business planning attorney.

Originally published 02/10/2022. Updated 03/07/2024.

Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose®
Email: barry@haimolaw.com
YouTube: http://www.youtube.com/user/haimolawtv

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YOU ARE NOT OUR CLIENT UNLESS WE EXECUTE A WRITTEN AGREEMENT TO THAT EFFECT. MOREOVER, THE INFORMATION CONTAINED HEREIN IS INTENDED FOR INFORMATIONAL PURPOSES ONLY. EACH SITUATION IS HIGHLY FACT SPECIFIC AND EXCEPTIONS OFTEN EXIST TO GENERAL RULES. DO NOT RELY ON THIS INFORMATION, AS A CONSULTATION TO UNDERSTAND THE FACTS AND THE CLIENT’S NEEDS AND GOALS IS NECESSARY. ULTIMATELY WE MUST BE RETAINED TO PROVIDE LEGAL ADVICE AND REPRESENTATION. THIS INFORMATION IS PROVIDED AS A COURTESY AND, ACCORDINGLY, DOES NOT CONSTITUTE LEGAL ADVICE.

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