Wait! The @#$% Trustee is Selling My Stuff for Pennies!

facial expressionDebtors are often dismayed by the amounts received or recovered by the trustee administering their bankruptcy estate assets. A debtor may think the rural land she inherited from Grandpa is worth a fortune. Or, more likely, a debtor may believe his slip and fall case will fund his retirement. When a debtor files a Chapter 7 bankruptcy case, all of the debtor’s assets become property of his bankruptcy estate. 11 U.S.C. §541. The trustee is the sole representative of the bankruptcy estate with full authority to sign deeds and bills of sale and to settle and release claims. 11 U.S.C. §704. Of course, all of the trustee’s actions must be approved by the bankruptcy court, usually upon a motion and proposed order filed by the trustee. Many debtors have a hard time understanding and/or accepting this fact. After all, HE is the one who slipped on the grape and hurt his back! Can a Chapter 7 debtor object to the trustee’s proposed sale of assets or settlement of claims? Sometimes a debtor can talk his lawyer into filing an objection to a trustee’s proposed action. However, in most cases, the debtor lacks standing to object to the trustee’s administration of estate assets.

There are many written opinions on the bankruptcy standing issue and the rulings are generally consistent. A person must have a “pecuniary interest” in the outcome of a bankruptcy proceeding in order to have standing to object to a trustee’s actions. In order to establish a pecuniary interest, a debtor must demonstrate a reasonable possibility of a surplus distribution after all creditors’ claims are satisfied. See Spenlinhauer v. O’Donnell, 261 F.3d 113 (1st Cir. 2001); In re Cult Awareness Network, Inc., 151 F. 3d 605 (7th Cir. 1998); In re Richman, 104 F.3d 654 (4th Cir. 1997); In re Andreuccetti, 975 F.2d 413 (7th Cir. 1992); In re El San Juan Hotel, 809 F.2d 151 (1st Cir. 1987); Gregg Grain Co. v. Walker Grain Co., 285 F. 156 (5th Cir. 1922).

The Seventh Circuit case In re Cult Awareness Network is one of the most frequently cited cases on the bankruptcy standing issue (probably because the underlying facts are so interesting). The Court’s ruling and its reasoning are consistent with the other cases cited. The Cult Awareness Network (“Cult Awareness”) was a non-profit entity engaged in anti-cult advocacy and cult victim support. In 1996, Cult Awareness filed Chapter 11 reorganization case in the Northern District of Illinois after it became embroiled in legal disputes with churches it had alleged to be cults. One such church was the Church of Scientology. Cult Awareness failed to get a plan confirmed and ultimately the case was converted to a Chapter 7 liquidation proceeding and a trustee was appointed.

The Chapter 7 trustee auctioned Cult Awareness’s trade name, mailing lists, telephone records and similar assets to an individual alleged to be associated with the Church of Scientology. The debtor filed an objection to the trustee’s motion to confirm the sale. The Bankruptcy Court ruled that Cult Awareness lacked standing to object to the sale because it lacked a “pecuniary interest” in the outcome of the sale. The District Court affirmed the opinion of the Bankruptcy Court.

On appeal, the Seventh Circuit upheld the rulings of the lower courts. The Court of Appeals confirmed that a debtor must show a “reasonable possibility of a surplus after satisfying all debts” in order to have a pecuniary interest and standing to object to the trustee’s actions. Cult Awareness, 151 F. 3d at 608 (citing Andreuccetti, 975 F 3d at 417). Cult Awareness argued that there was a possibility of a surplus distribution because judgments against it were on appeal. The Court found that the possibility of a surplus recovery was too remote. “The purpose of the pecuniary interest rule ‘is to insure “that bankruptcy proceedings are not unreasonably delayed by protracted litigation by allowing only those persons whose interests are directly affected by a bankruptcy order to appeal.”‘” Id. at 609 (citations omitted). The opinion further stated:

[c]ourts consistently have noted a public policy interest in reducing the number of ancillary suits that can be brought in the bankruptcy context so as to advance the swift and efficient administration of the bankrupt’s estate. This goal is achieved by narrowly defining who has standing in a bankruptcy proceeding.

Id. (quoting Richman, 104 F. 3d at 656-57).

In sum, the overwhelming majority of Chapter 7 cases are “no asset” cases that result in no distribution to creditors whatsoever. Very few cases result in a surplus distribution to the debtor. I believe the law is clear that if a debtor wants to object to a trustee’s sale of assets or settlement of claims, it is the debtor’s burden to demonstrate that there is a reasonable likelihood of a surplus distribution that confers a “pecuniary interest” in the outcome. Otherwise, the debtor lacks standing to contest the trustee’s actions.

As always, I assert my DISCLAIMER. I would very much be interested in your opinions and comments.

Single Member LLCs: Confusing and Messy in Bankruptcy

questionman.001

Single member limited liability companies cause a lot of confusion in bankruptcy cases.   A small business owner operating through an LLC often considers the assets and liabilities of the company to be his, personally.  He acquired the company’s assets through his own toil and he likely guaranteed the company’s debt. He may know that “technically” the LLC is a separate entity, but he probably feels that he and his company are one and the same.  He is not alone.  The IRS ignores single member LLCs for most purposes. Many lawyers would also ignore the distinction and include the individual owner as a defendant in a lawsuit involving the business of the LLC.   Loosely speaking, rightly or wrongly, single member LLCs are widely ignored – except in bankruptcy court.

Consider the following: if the individual owner of a single member LLC files bankruptcy (any chapter) –

  • Are the assets of the LLC property of the debtor’s bankruptcy estate?
  • Can the individual debtor claim the assets of the LLC as exempt?  What if the assets are necessary for the debtor’s trade?
  • Does the bankruptcy filing of the individual debtor stay the collection efforts of the LLC’s creditors seeking to recover from the LLC’s assets?

The answer to these questions is, NO.  The individual and the LLC are separate legal entities, and the assets and liabilities of the individual are separate from the assets and liabilities of the LLC.   See Miss. Code Ann. §79-29-311; In re Chang, Bankr. S.D. Miss., Case No. 10-51012 NPO (Dk#123); In re Modanlo, 412 B.R. 715 (Bankr. D. Md. 2006), aff’d, 266 F. App’x 272 (4th Cir. 2008); In re Desmond, 316 B.R. 593 (Bankr. D.N.H. 2004).

If the primary cause of the debtor’s financial difficulty is business related, a Chapter 11 reorganization of the LLC may be the only option if saving the business is paramount.  In such a case, filing a bankruptcy for the debtor, individually, is likely the wrong course of action.   Filing a Chapter 13 case for the individual will not help because the LLC’s debts cannot be modified or adjusted.  In an individual Chapter 7 case, the debtor risks losing his business altogether.  Although the assets of the LLC are not property of the bankruptcy estate, the LLC membership interest is subject to the control of the trustee. LLC membership interests are intangible personal property under Mississippi law.  Miss. Code Ann. §79-29-701. Even if the LLC interest has no obvious value, the trustee may have an opportunity to sell the LLC interest. I know of one case in which a competitor of a debtor’s business offered the trustee $10,000.00 for the LLC interest just to close the debtor’s business and shut out the competition.  You should carefully consider the potential consequences before filing a bankruptcy case for an individual who operates his business through a single member LLC.

One last word of caution – don’t get too creative in attempting a “work around.”  An individual bankruptcy case filed as “John Q. Debtor” d/b/a “John Q. Debtor, LLC” will face tough scrutiny and may be dismissed as filed in bad faith.   Also, efforts to “dissolve” the LLC with the Secretary of State to transfer ownership of assets prior to filing an individual bankruptcy will not work.  Mississippi law prohibits most distributions from an LLC if the LLC is insolvent.  Proper procedures for winding-up the business must be followed before in-kind distributions can be made to the member(s) of an LLC.  See generally, the Revised Mississippi Limited Liability Company Act,  Miss. Code Ann §79-29-101, et. seq., and, specifically, Miss. Code Ann. §79-29-609 which limits distributions by insolvent LLCs.  The Bankruptcy Judges in the Southern District have made it clear that they follow the mandates of the Mississippi Code regarding dissolution and that they treat LLCs and their owners as separate legal entities.

If you ultimately determine that it is in the best interest of an individual debtor with an LLC to file bankruptcy (because of problems with personal indebtedness such as medical bills or credit card debt, e.g.), it is important that the schedules and statements properly reflect the membership interest in the LLC.

  • The debtor should not include the assets of the LLC in the schedules.
  • The debtor should include the membership interest in the LLC on Schedule B, Line 13 – “Stock and interests in incorporated and unincorporated businesses.”
  • The debtor should place a value on the membership interest in the LLC.
  • The debtor should not include debt secured by assets of the LLC on Schedule D – “Creditors Holding Secured Claims.”  If the debtor personally guaranteed the secured debts of the LLC, then the debtor should include the LLC’s creditors on Schedule F – “Creditors Holding Unsecured Nonpriority Claims.”
  • The debtor should not include the LLC’s secured debt on the Statement of Intent, and the debtor will not have the option to reaffirm the debt or surrender the property.

Personal Note: The debtor should be prepared to provide the trustee with the LLC’s tax returns, bank statements, a detailed list of assets and liabilities.  The easier you can make it for the trustee to assess the case, the faster the debtor will receive a discharge and get on with his fresh start.

DISCLAIMER