Rents and Profits as Bankruptcy Assets

 Posted on December 07, 2016 in Asset Protection

Beyond considering whether your assets have net value on the date of filing, do they generate rents, profits, or proceeds afterwards?

Bankruptcy Assets and Timing of Filing

Our last four blog posts have been about special kinds of assets with special rules in bankruptcy. Those rules are often exceptions to the general rule that looks at your assets as of the day you file your bankruptcy case.

These asset-timing issues are very important, especially in Chapter 7 “straight bankruptcy.” That’s because you need to know whether you can keep everything you own as you get your fresh financial start. Usually you can keep everything, because it’s all protected by property “exemptions.” But you have to know what the law considered to be your assets in order to determine whether there are exemptions that cover them.

Today we take on another important exception to the assets-as-of-the-date-of-filing general rule.

Fair Market Value

You and your bankruptcy lawyer list the values of your assets in the “schedules” filed with the bankruptcy court. Usually the valuation standard is “fair market value.” What could you fairly get for the asset in an appropriate market for that kind of asset?

That’s why it’s appropriate usually to use “garage sale” prices on stuff you could only sell in a garage sale-like setting. Consider the type of asset and the “market” you could realistically sell it in, and what sale price it would generate.

Business and Investment Assets

In many situations assets used in a business or investment have little or no net fair market value. Or they have little or no net value, or equity, which is what counts. (The secured creditor or lessor comes ahead of the bankruptcy trustee and your unsecured creditors.)

If you operated a business, all or most of its equipment may be borrowed against or leased, with no equity. Even your business supplies, inventory, and earned receivables are often collateral on a bank or SBA loan. Whatever small equity you may have often fits within an exemption. Whatever assets are not secured against a debt may not be worth much and so can also be exempt.

Similarly, if the business is still operating its total value could easily be less than the debt against it.

Same thing with investment property, like a rental home you own. It may well be underwater—leveraged so that there’s no equity. Or it has no practical equity because the costs of selling it would eat up whatever equity it may have. Or possibly the bit of net proceeds could be exempt. Or the potential non-exempt proceeds may be small enough for a trustee not to bother with it.

Rents and Profits

But your assets for bankruptcy purposes don’t just include the present value of your assets at the time of filing. They also include the subsequent “[p]roceeds, product, offspring, rents, or profits of or from” those assets. Section 541(a)(6) of U.S. Bankruptcy Code.

This means that even if an asset has little or no present value, a trustee may still be interested in it because of the rents and profits it could generate.

Rental Property

Consider rental real estate you own that clearly has no equity, but you have a renter paying rent. You may think this asset is safe from the bankruptcy trustee and your unsecured creditors. But even if the trustee agrees that there’s no equity, the stream of rental payments is property that is subject to turnover to the trustee on behalf of your creditors. The exception is if those rental payments are considered part of the collateral secured by the mortgage holder. Talk with your bankruptcy lawyer about how to protect that income stream either way.

A Closed Business with Incoming Receivables

After closing your business you may have nothing of value for the bankruptcy trustee in equipment or inventory. Or you may have some tangible leftover business asset that you are happy to get rid of. But don’t forget the receivables—ongoing profits that continue to be paid to you. That stream of income, as modest or significant as it may be, is an asset that the trustee can claim for your general creditors. Again, that is true to the extent that income is not collateral of a secured creditor or can’t be exempted.

An Operating Business

One of the problems with filing a Chapter 7 case while owning a business that is still operating is this issue of ongoing profits and proceeds from the business. Even if the business has no net value because of the debts against it, the receivables and other forms of profit are subject to turnover to a bankruptcy trustee. That’s why Chapter 13 is usually the better solution with an ongoing sole proprietor business. And a Chapter 11 may be with a corporation or limited liability company (LLC).

The Exception for Earnings from Services

To be clear, the assets of your Chapter 7 bankruptcy case do NOT include the proceeds of your labor done AFTER you file your bankruptcy case. The Bankruptcy Code explicitly excludes “earnings from services performed by an individual debtor after the commencement of the case.” Section 541(a)(6).

So, the ongoing proceeds and profits of your business or rental property ARE at potential risk. Your personal income from your labor after your Chapter 7 case is filed is not.