TAXPAYER ADVISORY GROUP

Many people are familiar with the two most common types of bankruptcy proceedings, Chapter 7 and Chapter 11.  In simplified terms (pertaining to businesses), a Chapter 7 bankruptcy is a liquidation of the company’s assets for the benefit of its creditors.  A business Chapter 11 allows a company to operate under court supervision while its debts are resolved and/or reorganized.

This article introduces three additional ways to resolve a company’s debt, each having a place under the appropriate circumstances.  It is beyond the scope of this article to discuss the circumstances or mechanics of the procedures in detail.  The advice of a competent professional should be sought before deciding any particular course of action to resolve a company’s debts.

1. Compromise With Creditors  This method involves negotiating with creditors a compromise of the debts owed.  The creditors are usually separated into classes, and a compromise is then offered to each class.  Since the owner/executive is often very close to the situation, a compromise with creditors is best handled by a competent professional.

2. Assignment For The Benefit of Creditors Used for corporations, an assignment for the benefit of creditors accomplishes many of the same objectives as a Chapter 7 bankruptcy.  In an assignment, however, the assets of the corporation are assigned to a fiduciary called the assignee, and the process is not generally court supervised.  The assignee sells, or otherwise disposes of the assets to obtain the highest and best value, much as a trustee would do.  While the role of the fiduciary is similar to the role of the trustee in bankruptcy, the assignee can often dispose of the assets much more quickly than can a trustee.  In either an assignment or a Chapter 7 bankruptcy the creditors of the corporation are paid according to their legal priority.  Legal priorities of payment in an assignment do not usually take place under federal law and as a result there are some differences in payment priorities.

One of the benefits of an assignment for the benefit of creditors is that the fiduciary can often act much more swiftly than can a trustee.  Such flexibility has an advantage when the assets of an ongoing business are sold without discontinuing operations.  In such a case, many of the intangible assets of the company may be preserved, and the yield to creditors may be increased.  Such higher yield to creditors can also benefit principals of the corporation who have formal or statutory guarantees on the debt of the company.  Further, dealing with a known fiduciary selected in advance by the troubled company can have advantages.  For example, under appropriately structured legal circumstances, one or more of the principals of the troubled company may organize a corporation to purchase the assets of the troubled company. 

3. New Corporate Startup (Newco) This method may be an alternative to bankruptcy when money is owed to the IRS.   SEQ CHAPTER \h \r 1A new corporate startup (Newco) is where a new corporation is formed and purchases the assets of the existing corporation (Oldco), the proceeds being turned over to the taxing authority with  senior lien on the assets of Oldco. (There is a procedure known as an Application for Certificate of Discharge whereby the taxing authority will allow a third party to purchase assets on which a tax lien exists, paying the funds to that taxing authority and by so doing the tax lien is removed.)  The purchase of Oldco's assets by Newco generally includes all assets at net value (auction value less senior liens, i.e., UCC bank liens, etc.) plus trade names, phone numbers, etc.  Newco will generally assume a business name, i.e., doing business as, to be the same as what Oldco was known as. Oldco's employees become hired by Newco and Oldco is formally closed. Generally from an outsider looking in there is no real change, i.e., same name, same employees, same service. Legally, however, it’s a new entity with no tax liability. It is important to view a new company startup as strictly an asset purchase whereby the assets of an existing company are purchased by another company and the existing company is closed. Often, the IRS can act more quickly and predictably than a bankruptcy court.

Again, the advice of a competent professional should be sought before deciding any particular course of action to resolve a company’s debts.