Tuesday, November 21, 2006

James Shenwick Outline of Speech at NYS Society of CPA on S Corporations and Closely Held Corporations and BAPCPA on November 17, 2006

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November 17, 2006

New York State of CPA’s-S Corp and Closely Held Company Committee


I. Valuation of Small Businesses in Bankruptcy

A. S Corporations are a tax concept and not a bankruptcy concept.

B. Valuation of S Corporations and Closely Held Businesses are

important in bankruptcy-unlike publicly traded corporations where shares are traded daily valuation is more difficult

C. Bankruptcy Code section 541 creates a “hypothetical estate” when a person or entity files for bankruptcy and those interests must be valued

D. Types of Bankruptcy for Corporations. Corporations may only file for chapter 7 or chapter 11 bankruptcy

i. Chapter 7 is a “liquidation” and Chapter 11 can be a “liquidation” or reorganization.

E. When valuing closely held entities in bankruptcy attorneys look at the following assets:

i. Cash and checking account balances

ii. Accounts receivable (not more than 90 days past due)

iii. Inventory

iv. Real estate or under market leases

v. Furniture, Fixtures and Equipment

vi. Goodwill (do small businesses have good will?)

Less liabilities

F. Minority Discounts and Shareholder Agreements

i. What would a hypothetical investor pay to own 5% of the shares of the ABC Corp.?

ii. What happens if the ABC Corp. has a shareholder agreement or otherwise restricts the transfer of those shares?

iii. Who are the likely parties to buy shares in a closely held corporation? (existing shareholders?)

G. Personal Service Corporations for professionals, doctors, artists and others?

i. What is the value of this asset if the professional files for bankruptcy and then ceases to work for that corporation?

ii. Should professional service corporations liquidate or reorganize?

H. Confirmation Standards in Chapter 11. To confirm a chapter 11 bankruptcy plan one of the standards is that creditors must receive $1 more than they would get in a chapter 7 bankruptcy filing so valuation is an important issue.

I. Trustee Role in Closely Held Corporation Bankruptcy Case. If an individual files for chapter 7 bankruptcy and owns shares of stock in a closely held corporation the Bankruptcy Trustee is obligated to investigate the assets owned by the debtor and value those assets. If the assets have value the Trustee is required to sell those assets and distribute the proceeds to unsecured creditors and if the assets have no value they are abandoned back to the debtor when the case is closed.

II. Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) and Small Business Cases

A. BAPCPA which took effect on October 17, 2005 is the greatest change to bankruptcy law in the last 25 years and while most of those changes effected personal bankruptcy many changes also affected corporate bankruptcy and small business cases.

B. Small Business Cases-a “small business debtor” is a person or organization engaged in non-real estate commercial or business activities with an aggregate secured and unsecured debt of not more $2,000,000.

C. Types of Creditors in Bankruptcy. There are 3 types of creditors in bankruptcy cases: unsecured creditors (trade vendors, credit cards), secured creditors (mortgages and Uniform Commercial Code-1 and security interest creditors) and administrative and priority creditors (non-dischargeable taxes, claims incurred after the date of a bankruptcy filing, student loans, divorce obligations).

D. Filing and Reporting Requirements of BAPCPA. BAPCPA imposes new duties on small business debtors and on the United States Trustee in small business cases. The filing and reporting requirements include financial statements, federal income tax returns, profitability information, projected cash receipts and disbursements, a comparison of projections to actual results and certification of compliance with tax filings and payments. Small business debtors must maintain insurance appropriate to the industry and the debtor must allow the United States Trustee or representative to inspect the debtor’s business premises, books and records.

E.United States Trustee must conduct an initial debtor interview early in the case to begin to investigate the debtor’s viability, inquire about the debtor’s business plan, information the debtor of its obligations and develop an agreed scheduling order. The United States Trustee may inspect the debtor’s business books and records and is expected to monitor the debtor to determine if they can confirm a plan. If confirmation of a plan appears unlikely, the United States Trustee must make a motion in the Bankruptcy Court for conversion or dismissal of the case.

F. The Disclosure Statement and Plan process has been simplified by BAPCPA by permitting the small business debtor to make its required disclosures regarding the plan (a) in the plan itself, (b) in a prescribed form or (c) in a separate disclosure statement. The hearing on the disclosure statement can be combined with the plan. The small business case plan must be filed no later than 300 days after the date of the order for relief (the date the bankruptcy petition was filed). The Bankruptcy Court must confirm the plan no later than 45 days after a plan is filed. It is difficult to obtain extensions for any of these deadlines.

G. Judges Discretion pursuant to BAPCPA also removed some of a Bankruptcy Judge’s discretion in deciding whether a case should be converted or dismissed. The factors in deciding whether a case should be converted or dismissed are: substantial or continuing loss, the absence of a reasonable likelihood of rehabilitation, gross mismanagement of the estate, failure to maintain appropriate insurance, unauthorized use of cash collateral, failure to comply with an order of the court, unexcused failure to satisfy timely any filing or reporting requirement, failure to timely file or pay taxes owed after the date of the bankruptcy filing, failure to file a disclosure statement, or to file or confirm a plan within the time fixed by the Bankruptcy Code or Court Order.

H. Motion to Dismiss. The Court is also required to reach a decision on a motion to dismiss not later than 30 days after the motion is filed and to render a decision no later than 15 days after commencement of the hearing.

I. Multiple Filings and the Automatic Stay. If a debtor files a bankruptcy petition within 2 years of an order dismissing a prior small business case or within 2 years of the order confirming a plan in a prior small business case the automatic stay will not apply to the new case.


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