§ 10.6 — Partnership and Corporate Debts and Assets May Impact Eligibility

Revised: April 25, 2016

[1]

Access to Chapter 13 for individual partners and the owners of closely held corporations may be complicated by spillover effects of the debts and assets of the partnership or corporation.

[2]

A general partner who files Chapter 13 must schedule the debts of the partnership because it is the law of most states that general partners are at least secondarily liable for the debts of their partnership.1 Partnership debts may be contingent and/or unliquidated and excluded from the eligibility calculation for an individual partner;2 however, the partnership debt must be scheduled, and its status in the eligibility calculation may be contested.

[3]

As a general rule, the debts of a corporation or LLC are not the debts of an individual shareholder, member, officer or director; thus, the debts of even a closely held corporation need not be listed in the individual’s schedules.3 However, corporate debts should be scheduled if attributable to an individual owner or principal by guaranty or indemnity4 or a prepetition judicial determination that the debts of the corporation are personal obligations of the individual.5 Also, it is the corporate law of some states that officers or directors of an insolvent corporation have a special fiduciary relationship to creditors that can include personal liability for debts incurred during the corporation’s insolvency.6 Scheduling any such debts as contingent liabilities will not affect the debtor’s eligibility7 but will protect the debtor’s right to manage and discharge those corporate claims through the Chapter 13 plan.

[4]

Ownership of assets by the debtor’s partnership or corporation may be good news and bad news to the Chapter 13 debtor. The value of assets owned by a separate partnership or corporation are not included for purposes of calculating the value of the Chapter 13 estate. For example, only the value of the debtor’s personal property interest in the partnership is included for purposes of the “best interests of creditors” test at confirmation under 11 U.S.C. § 1325(a)(4).8 Exclusion of partnership and corporate assets from the best-interests-of-creditors calculation minimizes the amount that the debtor must pay to unsecured claim holders to accomplish confirmation. Care must be taken to identify property the debtor has contributed to the other entity. For example, even though the debtor and a nondebtor are partners in a business, it is not always true that the debtor and the nondebtor have contributed equally to the partnership. Assets may be property of the partnership, property of the Chapter 13 estate or property of the nondebtor, depending on the facts.9 It has been held that partnership assets must be “excluded” from the Chapter 13 estate to determine whether an individual partner is eligible to file Chapter 13.10

[5]

The bad news is that a debtor who has contributed assets to another entity cannot use an individual Chapter 13 case to protect those assets. The automatic stay will protect the debtor’s estate but will not protect assets owned by the separate corporation or partnership.11 For example, when the debtor contracted to allow a partnership to use equipment on the eve of filing, although the equipment was technically owned by the debtor, it became partnership property and could not be administered through the debtor’s individual Chapter 13 plan.12 When the debtor has conveyed assets to a corporation, however closely held, the filing of an individual Chapter 13 case will not protect corporate assets from the collection efforts of corporate creditors.13 It has been held that a Chapter 13 debtor cannot dissolve the debtor’s corporation during the Chapter 13 case in order to manage secured claims of the corporation through the Chapter 13 plan.14

[6]

Partnership law and domestic relations law have entwined to affect eligibility of Chapter 13 debtors. Under the law of the Commonwealth of Puerto Rico, a marriage creates an entity called a “conjugal partnership.” All earnings and property of the marriage are assets of this separate entity and are not available to the individual husband or wife without the knowledge or consent of the other spouse. As a result, a husband was not eligible for Chapter 13 because he had neither assets nor future earnings from which to fund a plan in a case in which the husband filed in Puerto Rico without the consent or knowledge of the wife.15

[7]

If several partners each file individual Chapter 13 cases, it may be necessary for each partner to include all partnership debt in the schedules.16 The effect of ascribing all partnership debt to each partner may be to render each individual partner ineligible for Chapter 13. The principal defense to this outcome is the argument that partnership debt is contingent in an individual partner’s Chapter 13 case.17

[8]

Timing may be unusually important in the partnership situation. If the assets of the partnership have been liquidated and are insufficient to satisfy the claims of partnership creditors, the liability of individual partners for the deficiency may be fixed as a matter of state law. If the Chapter 13 petition of an individual partner is filed before the fixing of liability for partnership debts under state law, the debtor’s argument that claims derivative of the partnership are contingent is enhanced.

[9]

The Supreme Court of the United States has interpreted the broad concept of claim in § 101(5) to include the liability of individual partners for partnership debt in a Chapter 13 case. In United States v. Galletti (In re Galletti),18 the IRS assessed a partnership for unpaid employment taxes but did not assess the individual partners within the three-year limitation period in 26 U.S.C. § 6501. When an individual partner filed Chapter 13, the Ninth Circuit concluded that the IRS did not have a claim:

[A]lthough under [California] law each individual partner is liable for the debts of the partnership, a claim against the partnership does not automatically give rise to a right to collect against the individual partners. Instead, a creditor may collect a debt for which the partner is jointly and severally liable only by first obtaining a judgment against the partner. The IRS has obtained no judgment against Debtors. The time for doing so has expired.19
[10]

A unanimous Supreme Court reversed the Ninth Circuit. The Supreme Court held that assessment of the taxes against the partnership extended the three-year limitation on collection to 10 years. Because the individual partner did not contest liability for the partnership debt, neither California partnership law nor the Bankruptcy Code required a judgment to establish a claim against the individual partner in a Chapter 13 case. This holding is consistent with many other decisions acknowledging that defenses—such as a statute of limitations—bear on the allowance of claims, but liability and characterization for § 109(e) purposes are not sensitive to ordinary defenses.20


 

1  See United States v. Galletti (In re Galletti), 298 F.3d 1107 (9th Cir. Aug. 8, 2002) (Kleinfeld, Graber, Bolton), as amended, 314 F.3d 336 (9th Cir. Nov. 20, 2002) (Kleinfeld, Graber, Bolton), rev’d, 541 U.S. 114, 124 S. Ct. 1548, 158 L. Ed. 2d 279 (Mar. 23, 2004), discussed below in this section.

 

2  See § 15.2  Is Partnership Debt Contingent?.

 

3  See In re Faulkner, No. 5:01-BK-50944E, 2002 WL 32114473, at *2 (Bankr. E.D. Ark. Sept. 6, 2002) (unpublished) (Evans) (Judgment against wholly owned corporation is not a debt of the debtors notwithstanding that the debt was listed in the Chapter 13 schedules.).

 

4  See § 15.3  Are Guaranties Contingent?.

 

5  See § 15.6  Are Claims through and against Debtor’s Corporation Contingent?.

 

6  See Berres v. Bruning (In re Bruning), 143 B.R. 253 (D. Colo. July 22, 1992) (Kane); Bay 511 Corp. v. Thorsen (In re Thorsen), 98 B.R. 527 (Bankr. D. Colo. Mar. 28, 1989) (Clark). See also In re Lane, 215 B.R. 810 (Bankr. E.D. Va. Dec. 4, 1997) (Shelley) (Upon the voluntary dissolution by the debtor of the debtor’s corporation during the Chapter 13 case, the debtor became a fiduciary obligated by state law “to liquidate the corporation and distribute its assets to its respective obligees.” Assets owned by the corporation could not be used by the debtor individually and paid for through the Chapter 13 plan because the assets were owned by the corporation, and the debtor “has no equitable property right . . . stemming from her position as stockholder in the corporation.” That the debtor was personally obligated as guarantor of the corporation’s debt did not create secured claims that could be managed through the Chapter 13 plan.).

 

7  See § 15.1  What Is Noncontingent Debt?, § 15.2  Is Partnership Debt Contingent?, § 15.3  Are Guaranties Contingent?, § 15.4  Are Contract Debts Contingent?, § 15.5  Is Tort Liability Contingent?, § 15.6  Are Claims through and against Debtor’s Corporation Contingent? and § 15.7  Are Prebankruptcy Judgments Contingent?.

 

8  See § 90.1  In General: Plan Payments vs. Hypothetical Liquidation. See, e.g., In re Doddy, 164 B.R. 276, 279 (Bankr. S.D. Ohio Feb. 7, 1994) (Perlman) (The plan fails the best-interests-of-creditors test because it fails to take into account the value of the debtor’s one-third interest in a real estate partnership. Applying Ohio law, the debtor’s interest in the partnership is personal property although the partnership property itself would be excluded from the Chapter 13 estate. The filing of the Chapter 13 case dissolved the partnership, and only the “mechanical step” of winding up the partnership stands between the debtor and liquidation of the debtor’s interest in the partnership. “[The] debtor’s estate for purposes of liquidation analysis should include any distribution to which debtor will be entitled upon completion of that [winding up]. . . . The court thus must estimate the value of the surplus debtor will receive after liabilities to partnership creditors are paid, in order to determine whether the proposed plan meets the ‘best interests of creditors’ test set forth in § 1325(a)(4).”).

 

9  See In re Schyma, 68 B.R. 52 (Bankr. D. Minn. Dec. 9, 1985) (Kishel).

 

  10 See In re Ross, 173 B.R. 943, 945 (Bankr. E.D. Okla. Oct. 25, 1994) (Cornish) (Statements and schedules reflect an agreement between the debtors and their son “wherein each party owns a one-half interest in some farming equipment. . . . The Debtors . . . have partnership assets which would have to be excluded in order for the Debtors to be eligible for Chapter 13 relief.”).

 

11  See In re McCormick, 381 B.R. 594 (Bankr. S.D.N.Y. Feb. 8, 2008) (Morris) (Debtor could not extend benefit of automatic stay to wholly owned limited liability company.); In re Faulkner, No. 5:01-BK-50944E, 2002 WL 32114473, at *2 (Bankr. E.D. Ark. Sept. 6, 2002) (unpublished) (Evans) (Automatic stay does not apply to enforcement of judgment against corporation wholly owned by the debtor. “[T]he Debtors are asserting that the enforcement of Construction Services’ judgment against [Fordyce Concrete, Inc.] will shut the company down and make the chapter 13 no longer feasible. . . . Individuals may not forestall the collection of corporate debts by filing a chapter 13 bankruptcy case; a corporation is a separate entity, and if its debts are to be discharged, they must be discharged in a separate bankruptcy case filed by the corporation.”); Fisk v. Allis Chalmers Credit Corp., 36 B.R. 924 (Bankr. W.D. Mich. Jan. 27, 1984) (Howard).

 

12  In re Robertson, 84 B.R. 109 (Bankr. S.D. Ohio Mar. 4, 1988) (Calhoun).

 

13  In re Loughnane, 28 B.R. 940 (Bankr. D. Colo. Apr. 12, 1983) (Gueck).

 

14  See In re Lane, 215 B.R. 810, 812–14 (Bankr. E.D. Va. Dec. 4, 1997) (Shelley) (At the petition, the debtor possessed two trailers and a tractor titled to her wholly owned corporation. The debtor personally guaranteed the corporation’s debt on the vehicles. The debtor voluntarily dissolved the corporation a month after filing the Chapter 13 case and proposed a plan that paid 100% of debts secured by the (former) corporation’s collateral and 20% to other unsecured creditors. Under Virginia law, “upon dissolution of a corporation, claims held by creditors against the dissolved corporation must be satisfied before any remaining assets are distributed to the shareholders. . . . In effect, the Debtor wishes to pierce her own corporate veil, as she claims that she did not fully comply with the requisite corporate formalities. . . . If the corporate veil is pierced, argues the Debtor, the vehicles can be treated as belonging to the Debtor personally, not to the Corporation. This argument is flawed. . . . [T]he Debtor should not be permitted to utilize the corporate form on the one hand to protect herself from individual liability for the Corporation’s debts, then on the other hand nullify the existence of that Corporation to avoid reckoning with the obligations incurred by the Corporation while it was a viable entity. . . . [T]he Debtor in the case at bar holds neither an equitable nor legal interest in the vehicles that would allow her to pay the secured debt incurred by the Corporation through her Chapter 13 plan. The vehicles are legally titled in the Corporation’s name. . . . [T]he Debtor has no equitable property right in the vehicles stemming from her position as stockholder in the Corporation. When she dissolved the Corporation, the vehicles should have been released to the Creditors in satisfaction of the debt incurred by the Corporation. . . . The Debtor is a fiduciary obligated by statute to liquidate the Corporation and distribute its assets to its respective obligees. . . . [T]he Debtor has no other interest in the vehicles, thus precluding her from treating the Creditors as secured under her plan.”).

 

15  In re Gomez Molina, 77 B.R. 368 (Bankr. D.P.R. Aug. 21, 1987) (Lamoutte).

 

16  See, e.g., Miami Valley Prod. Credit Ass’n v. Tegtmeyer, 31 B.R. 555 (Bankr. S.D. Ohio July 21, 1983) (Anderson).

 

17  See § 15.2  Is Partnership Debt Contingent?.

 

18  298 F.3d 1107 (9th Cir. Aug. 8, 2002) (Kleinfeld, Graber, Bolton), as amended, 314 F.3d 336 (9th Cir. Nov. 20, 2002) (Kleinfeld, Graber, Bolton), rev’d, 541 U.S. 114, 124 S. Ct. 1548, 158 L. Ed. 2d 279 (Mar. 23, 2004).

 

19  In re Galletti, 298 F.3d at 1114.

 

20  See § 16.2  Effect of Defenses and Counterclaims.