Lawline Online Course: A field Manual for Involuntary Bankruptcies - Thursday, 11/5/2020 at 3:00pm EST
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You may have an identifiable problem that is killing your business or personal finances. The best example of this is owning property which is in foreclosure, or a problem venture with its own identifiable assets and secured creditors. Like a coyote in a trap; you’d bite off your leg to be free of it.
That’s one possible bankruptcy strategy. Transferring the problem assets into a new entity which can reorganize in Chapter 11 to solve the problem, while the viable business continues outside of bankruptcy.[1]
This solution presents its own potential problem: “New Debtor Syndrome.” However, this problem can be dealt with.
Bankruptcy cases must be filed in “good faith.” Lack of good faith can be jurisdictional and result in a case’s dismissal.[2]
“New Debtor Syndrome” sounds like a Stephen King thriller. It’s really a form of “bad faith” Chapter 11 filing.
Indicia of New Debtor Syndrome include:
(1) transfer of distressed property into a newly created corporation;
(2) transfer occurring within a close proximity to the bankruptcy filing;
(3) transfer for no consideration;
(4) the debtor has no assets other than the recently transferred property;
(5) the debtor has no or minimal unsecured debt;
(6) the debtor has no employees and no ongoing business; and
(7) the debtor has no means, other than the transferred property, to service the debt on the property.[3]
Thus, you see the solution’s own potential problem.
Still, there is an important exception to the “New Debtor Syndrome” (the “Exception”).
This is where:
(1) the property’s transferor was in need of bankruptcy relief; and
(2) that the secured creditors are not in a worse position because the transferee filed for Chapter 11 relief instead of the transferor.[4]
The Exception is best used where:
(a.) The Transferor has a property subject to a foreclosure proceeding.
(b.) The Transferor could file for bankruptcy relief. However, the property is a discreet problem for the Transferor and filing for bankruptcy may create larger problems than what exists already;
(c.) Transferring the property to a new entity will enable a faster, less complex, less expensive reorganization.
The Exception’s factors were first stated in In re Beach Club, Inc.[5]
(1) Was a valuable piece of property with a large equity cushion transferred to the new debtor, in which there is manifestly a very large equity cushion?
(2) Was the liability of the Transferor unaffected by the transfer? and
(3) Was the new entity created for a good business purpose, e.g. preventing the Transferor’s destruction?
(a.) The Transferor could file its own Chapter 11 case.
(b.) The Creditor can receive adequate protection[6];
(c.) A feasible and workable plan of reorganization is possible;
(d.) The Transferor is subject to potential liability in the case; and
(e.) Other safeguards exist in the court, including the appointment of a trustee.
These factors were distilled to:
(1) the Transferor of the property was in need of bankruptcy relief; and
(2) that the secured creditors are not in a worse position because the transferee filed for Chapter 11 relief instead of the Transferor.[7]
The ethos behind the exception is:
To find “bad faith” here would be tantamount to saying that it would be preferable to wreck [the Transferor and] obtain for [the Creditor] a similar, if not identical, disposition that is obtainable here, and would further award [the Creditor] a substantial windfall of property equity.[8]
We aren’t suggesting filing Chapter 11 cases with questionable bona fides. However, you may meet a problem warranting this out-of-the-box thinking. It’s worked for our clients. Pass it on.