Business Disputes

Workouts and Bankruptcy Issues

We know that in troubled times, many business owners begin to evaluate whether or not bankruptcy is an appropriate option.  The difficulty in working through these issues is exasperated by the presence of tiered entity structures and the rules that govern how partnership-like entities will be treated, vis-à-vis its owners. 

Bankruptcies of entities may be challenged as being in bad faith, if say, the bankruptcy is being pursued with no real hope of reorganization, or where there is little evidence that actual creditors stand to benefit from a reorganization.  See, e.g., In re Albany Partners, Ltd., 749 F.2d 670, 674 (11th Cir. 1984).  In fact, when a company has been used as a sham to perpetrate various frauds on creditors, whereby a principal used the shell entities to line his or pockets, the purported entity may be viewed as a “dummy corporation” or sham, and the court may thereafter find that the entity is, in fact, an alter ego of the principal.  See e.g., Feltman v. Prudential Bache Securities, 122 B.R. 466 (S.D.Fla. 1990).  Under such circumstances, much like piercing of the veil standards, the entity appears to be an instrumentality of fraud, controlled by an individual who has used the entity for fraudulent purposes, and therefore, the entity will be disregarded.  See, e.g., Kanov v. Bitz, 660 So.2d 1165 (Fla. 3d DCA 1995).  Of course, beyond bankruptcy court, criminal liability may arise if a bankruptcy petition is filed for the purpose of perpetrating a fraud.  See 18 U.S.C. § 157. 

Trustees in bankruptcy can seek recovery of transfers made prior to the filing of the petition, with reference made to an applicable state’s law on fraudulent transfers (i.e., the state’s version of the Uniform Fraudulent Transfer Act). 

Tax liabilities can burden entities and individuals, and prompt bankruptcy filings.  However, changes in the Federal law make it harder for tax liabilities to be discharged, even if sufficiently “old and cold.”  Proper regard must be given to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  Taxpayers considering bankruptcy will find it prudent to consult with both bankruptcy and tax counsel, before embarking on the filing of any petition.

If banks are engaged in the "evergreening" of loans, or there are other lender liability issues, then consumers of bank services must remain skeptical of the bank's reaffirmation efforts.  Bank misconduct must be reviewed by those with banking expertise.

Debt modification and workouts raise complex tax issues.  Quite often, a previously incurred debt is satisfied with an amount of money that is less than the face of the debt, and as such, cancelation or discharge of indebtedness income arises, absent some exclusion because of insolvency or bankruptcy or certain elections (e.g., qualified real property indebtedness), that may further necessitate the filing of IRS Form 982.  If you are in need of advice regarding workouts, as it may touch on interests you have in LLCs and other partnership-like entities, please contact us.