CLIENT CHOOSES BETWEEN CHAPTER 11 AND CHAPTER 7 BECAUSE OF $1.0M JUDGMENT

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Client is part owner of an S corporation. Business started 15 years ago. It imports and distributes high value items such as appliances and furniture. It has several retail outlets. Last week, it lost a civil case where a judgment for $1.0M was awarded in favor of plaintiff for breach of contract. The business has no money to pay the judgment. What can the plaintiff do with the judgment? It can enforce the judgment by placing a lien on all assets of the company such as receivables, inventory, bank accounts and other assets. Any asset in the name of the company can be attached and sold to satisfy the judgment. For a relatively small business like this, a $1.0M judgment that is being enforced can create chaos and literally bring the business to its knees! Any person engaged in business can tell you that this is the way it is. Judgment creditor can get all of the assets of the business and sell them for cash until the $1.0M judgment is paid in full. And until the judgment is paid in full, the unpaid balance incurs 10% annual interest. So even if the business paid back $100,000 in the next 12 months, at the end of next year, it would still owe $1.0M. 

So what can client do as part owner of this business? Client can file a Chapter 11 for the business if client wants to continue doing the business. The Chapter 11 reorganization will allow the business to present a plan to the court that stops the enforcement of the judgment, or prevent the enforcement of the judgment. It is preferable, in fact, necessary to file the Chapter 11 before the judgment lien attaches to the assets of the company. If the judgment lien has already attached to the assets of the business, the nature of the judgment claim changes from unsecured to secure. This change in status can make or break the Chapter 11 case. A Chapter 11 plan can propose partial or even no payment to unsecured creditors. But the plan has to pay secured creditors in full. Therefore, the difference in cost to the business is $1.0M if the judgment is secured. If the judgment is unsecured, the business can get away with paying only a partial of the $1.0M, for instance, 5% or $50K, or even nothing if the plan proposes zero distribution to unsecured creditors.

If client no longer wants to continue doing business, the best option is Chapter 7. In Chapter 7, all claims against the company, including the judgment of $1.0M will be filed in the bankruptcy case. All assets that the business has legal or equitable title to will constitute the bankruptcy estate under administration of the trustee. The trustee will sell all of the viable assets to convert them to cash. Whatever cash is generated will be used to pay all creditors. All creditors in the same class will get equal treatment in payment of dividends. So, if the judgment lien is secured, the $1.0M will have priority over all the unsecured claimants. For example, after selling all inventory and collecting all receivables plus cash in the bank, the bankruptcy estate has $300K of cash. First the trustee will pay himself for services rendered and the trustee will pay his lawyers. Let’s say trustee and his legal fees is $200K. The $100K left will be paid to the judgment lien holder because it is secured. Since there is nothing left, the unsecured creditors will get nothing. 

Client, who is part owner of the business and the other owners of the business, can walk away from the business without any personal liability on their part (unless they signed personal guaranties). Then can thereafter start another business by establishing a new company and start fresh with a new business that has no liability.

If this business is profitable, except for the problem with the $1.0M judgment, client should choose Chapter 11, and he should do so before the judgment becomes a lien on the business assets. If this business is not profitable, client should choose Chapter 7 so he can get rid of a business that is losing money and so that he can forget about the $1.0 M judgment and start fresh anew.

“JESUS CHRIST IS THE SAME YESTERDAY, TODAY, AND FOREVER.” HEBREWS 13:8

Lawrence B. Yang is a graduate of Georgetown University with a Master’s Degree in Law and specializes in Bankruptcy, Business, Real Estate and Civil Litigation.  He speaks English, Mandarin and Fujian and has successfully represented thousands of clients in California, including companies overseas.  Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., MAILSTOP 58 BUILDING A-1 SUITE 1125, Alhambra, CA OR at 20274 Carrey Road, Walnut, CA 91789.