After eight years of failed efforts by banks and credit card companies, the biggest overhaul of U.S. bankruptcy laws in the last 27 years is now a reality. When it takes effect in October 2005, this massive reform of our bankruptcy laws will impact everyone - not merely those HVACR contractors and businesses that are on the brink of financial ruin or even thinking about bankruptcy.

At the heart of the reformed bankruptcy law is a needs-based means test. This re-quires that a debtor's assets and income are considered when deciding whether the applicant is abusing the system by seeking to obtain a fresh start through bankruptcy liquidation, instead of repaying debts under a bankruptcy repayment plan.

Many small business owners who find themselves in financial trouble file for personal bankruptcy. A sole proprietor, for example, is personally liable for the debts of the business. The owners of many small HVACR businesses have also personally guaranteed business loans.

Chapter And Verse

Different types of bankruptcy are often referred to by the chapter under which they are covered in the Bankruptcy Code.

Chapter 7, for example, accounts for the majority of nonbusiness bankruptcies; it is often referred to as "straight bankruptcy." In a Chapter 7 bankruptcy, the debtor is allowed to keep certain exempt properties while all other property is sold to repay creditors.

The new law will make it much harder to qualify for a Chapter 7 filing. Consequently, it will push more debtors into Chapter 13 filings, where they are put on a repayment plan of up to five years.

Chapter 13 is often referred to as "wage earner" bankruptcy. It enables individuals to propose and carry out a repayment plan under which creditors are paid over time.

Chapter 11 is used mainly by businesses that want to keep operating and pay creditors under a plan of reorganization.

Chapter 12 is a special provision governing family farms that have a regular annual income. It operates similarly to Chapter 13.

The changes that become effective in October 2005 will open a new chapter - Chapter 15 - that addresses cross-border solvency cases.

Bankruptcy To Call Your Own

HVACR business owners and managers usually contemplated bankruptcy to buy breathing room for operations that were deeply mired in debt. The concept of bankruptcy, after all, is to help a business develop a rational and fair plan to pay debts and continue in operation. Unfortunately, in the past many debtors used bankruptcy laws to escape troublesome leases and employee benefit obligations as well as to restructure debt. But, no more.

Small contractors and businesses in bankruptcy will soon be required to file regular financial reports listing not only their profits and losses but also their anticipated cash receipts and disbursements. Court-appointed trustees will be much more involved in the debtor's business than before, reviewing its business plan and analyzing whether it has a realistic shot at surviving.

Expedited Chapter 11

Although many experts feel that the tighter deadlines and greater scrutiny mean more small businesses won't survive bankruptcy, the new rules also make it easier for some businesses to enter into bankruptcy.

The new law established an expedited form of Chapter 11 reorganization for small businesses with less than $2 million in aggregate debts. The new process includes a standard form for disclosure statements and reorganization plans, uniform national reporting requirements and rules, enumerated duties that must be performed on schedule, and a general rule that reorganization plans must be filed within 180 days.

After that period, the business's creditors can submit a reorganization plan for the business. That ends the old practice in which creditors were often barred from proposing a plan for years due to repeated judicial extensions.

Under the new rules, if no reorganization plan is filed within 300 days, the bankruptcy case can be dismissed or converted into a Chapter 7 liquidation.

Dealing With Debtors

Your business does not have to be on the brink of financial ruin to feel the effects of bankruptcy. According to the U.S. Chamber of Commerce, bankruptcies cost businesses $40 billion in unpaid bills every year. The new bankruptcy reform law will benefit businesses that are owed money, whether they are giant credit card companies or small contractors that have been stiffed by a customer or supplier.

Credit card companies and every business that extends credit to their customers will benefit from the harsher repayment requirements of the new law. How should your business deal with customers or suppliers in, or about to enter into, bankruptcy? What are your rights as a creditor under the new reform?

Landlord/tenant - The new law amends the old rules to give tenants who declare bankruptcy 120 days to assume or reject a lease. This is double the initial time permitted under the old 60-day rules. The bankruptcy court may, of course, extend the 120-day period for an additional 90 days for cause. Any extension subsequent to the additional 90 days is available only with the consent of the lessor.

Two new rules have been established for landlords seeking to evict tenants. The first allows the continuance of any eviction proceeding in which the landlord obtained a judgment of possession prior to the filing of the bankruptcy petition. The second deals with evictions based on "endangerment" of the rented property or "illegal use of controlled substances" on the property.

Creditors' committee - The new rules suggest that small business concerns be added to the appropriate creditors' committee, those groups responsible for determining who will be paid what, if the claim the small business concern holds is disproportionately large in comparison with its annual gross revenue. Thus, a small business that has a large claim against the debtor can be added to the creditors' committee and thereby play an active role in the case while doling down their costs.

For the first time, creditors may be represented by someone other than an attorney at the first creditors' meeting. This will reduce the cost of representing the HVACR operation's claim against the debtor once the reform bankruptcy rules take effect.

Trade creditors - The claims of unsecured trade creditors have been expanded, but remain subordinate to the interests of a secured creditor. Voluntary returns of trade goods by a debtor are also explicitly made subordinate to the interests of secured creditors.

Business Bankruptcy

The primary focus of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is in its consumer bankruptcy provisions, especially the so-called "means test." There are, however, plenty of changes in store for business bankruptcies as well.

To prevent abuse in large, corporate bankruptcies:

  • Greater restrictions would be placed on fraudulent transfers to insiders.

  • Protection for the insurance benefits of retired employees would be increased.

  • Discharge of debts incurred in violation of securities laws would be prohibited.

    The new law's supporters - lawmakers and the financial services industry - argued that bankruptcy was the last refuge of gamblers, impulsive shoppers, divorced or separated fathers avoiding child support, and multimillionaires who buy mansions in states with liberal homestead exemptions to shelter assets from creditors. But no more.

    Between 30,000 and 210,000 people (3 percent to 20 percent of those who dissolve their debts in bankruptcy each year in exchange for forfeiting some assets) would be disqualified from doing so under the new bankruptcy reform law according to the American Bankruptcy Institute.

    Escaping taxes will soon be more difficult for everyone. Gone is the so-called "super discharge" in Chapter 13 plans. Some courts have also allowed debtors to discharge taxes due within three years of the date of bankruptcy or assessed within 240 days (six months) under Chapter 13 plans.

    Taxes resulting from failure to file a return, untimely filing of a return, or fraudulently filing of a return will not be dischargeable under Chapter 13. In other words, the playing field between Chapter 7 and Chapter 13 has been leveled and tax liabilities remain a debt even in bankruptcy. Failure to file a tax return or untimely filing generally makes a tax liability nondischargeable under Chapter 7.

    As a result of the new bankruptcy law, attorneys are anticipating a decline in their business as well as a reduction in the number of lawyers willing to handle bankruptcies. Under the new law, bankruptcy attorneys will be liable for any misleading statements or inaccuracies made in a client's case.

    Although seeking protection under the bankruptcy laws will soon become more difficult, remember, an HVACR business does not have to be on the brink of financial ruin in order to take advantage of the new bankruptcy rules. The bankruptcy reform law will benefit businesses that are owed money.

    Mark E. Battersby has been providing professionally prepared editorial material for more than 25 years. He regularly reports on the news and developments within tax and financial arenas.

    Publication date: 06/20/2005