Sales Tax Obligations and Chapter 11 Business Reorganization

Minnesota Department of Revenue levies sales tax on any number of transactions common to small businesses, most often being on sales of taxable goods and services. Sales tax is considered a “trust” tax, as it is collected by the retailer and must be held in trust for the State until remitted on the appropriate due date. Responsibility for paying sales tax falls not only on the business but also at times on the company’s principals.

Since the sales tax money collected never actually belongs to the business, use of the tax money for any purpose other than direct remittance to the State is expressly  disallowed. In practice, however, it is common for businesses to merge the sales taxes collected with its own operating funds, thus at times risking that some of the taxes may be used to cash flow general operating expenses rather than remittance to the State. When this happens and a business cannot timely remit the sales tax to the State, the domino effect happens quickly and can be synonymous with the end of business operations. For retailers, non-payment of sales tax obligations means their sales tax vendor permit may be quickly revoked. Once revoked, no more sales are allowed. For a business such as a restaurant or bar, their liquor license additionally can be posted and the business prevented from further purchases of liquor, wine and beer inventory.

When past due sales tax is the problem, Chapter 11 can leverage certain relief that  may not otherwise be available to the small business in a non-bankruptcy context.  Specifically in Chapter 11 business reorganization, past due sales taxes can be statutorily repaid over five years at low interest, and under some circumstances sales tax permits and liquor licenses can be reinstated while personal collection may also be stalled to allow time for the business to reemerge with a confirmed Chapter 11 plan.

While a multitude of factors should be considered before filing Chapter 11 business reorganization, the repayment of sales tax obligations over five years that is prescribed by the Bankruptcy Code can offer significant relief that may not otherwise be available without a bankruptcy filing. Sales tax is just one example of the various circumstances that often lead to Chapter 11 bankruptcy.

Contact Chapter 11 attorney Lynn Wartchow for an initial Chapter 11 consultation to review tax and other business liabilities affecting a Chapter 11 bankruptcy proceeding. Office located in Edina, Minnesota.

Recognize the Circumstances that Often Lead to Chapter 11

The factors commonly precipitating a Chapter 11 business proceeding are numerous: lawsuits filed by unsecured creditors, reluctance of secured lenders to extend or continue financing terms, attachment of business assets including bank account levies, foreclosure or repossession of key assets used in business, adverse administrative actions such as license posting by the state, aggressive tax collection, a commercial eviction proceeding and the list goes on.

Businesses are often cyclical in their financial condition, and experience financial highs and lows the same as individuals. Not every ailment justifies the time and expense of a Chapter 11 business proceeding, and an experienced and principled Chapter 11 attorney can advise if that is the case for your business. Sometimes, however, a situation that warrants Chapter 11 is a “one-off” of sorts: an unexpected lawsuit or judgment brought against the business, an isolated but escalating event such as an eviction proceeding or sales tax audit, or a recurring temporary circumstance that the business just  can’t get out from under.  In situations such as these, the expense of a Chapter 11 may be justified since it provides both immediate relief and a permanent solution.

Chapter 11 opens the door to new avenues of relief that are not available outside of the context of bankruptcy. As a simple yet common example to many small businesses, the nonpayment of sales tax can effectively put a business out of business in as little as a few months. The Minnesota Department of Revenue, charged with collecting revenue to offset the State’s huge deficit, is necessarily aggressive in the collection of sales tax and provides extremely little, if any, breathing room for businesses that cannot immediately pay delinquent tax obligations. Unpaid sales tax quickly threatens any business. Outside of bankruptcy, unpaid sales tax can result in license posting and a revocation of sales tax permit that is tantamount to the death of operations, as well as the pursuit of personal liability against principals of the business. Inside Chapter 11, by contrast, unpaid sales or withholding taxes can be statutorily repaid over five years at low interest, and often personal collection is put on hold while the business reemerges under a confirmed Chapter 11 plan.

Keep reading for more information about Sales Tax Obligations and Chapter 11 Reorganization and Commercial Leases and Chapter 11 Reorganization: The Requirements and Timelines under the Bankruptcy Code.

Read some of the recent Chapter 11 success stories handled by Wartchow Law Office.

Lynn Wartchow is a Chapter 11 attorney located in Edina, MN. Contact Wartchow Law Office for an initial Chapter 11 consultation to review business liabilities and other circumstances affecting a Chapter 11 bankruptcy proceeding, and for guidance on options and solutions that Chapter 11 can provide to keep a business operating and improve future prospects. 

Intro to Chapter 11 Business Reorganization: The Process, Time and Fees Involved

Many initial calls regarding a potential Chapter 11 business reorganization seek just the basic information: Does my business have to go out of business if it files bankruptcy? Can reorganization help my business resolve a particular debt or situation (i.e., unpaid withholding or sales taxes, judgments, collection efforts, commercial eviction, lawsuits)?  What is Chapter 11 anyway? How much does Chapter 11 cost? How long does it take for a plan to be confirmed?

At its most basic principle, Chapter 11 reorganization is a way that a financially distressed business can obtain immediate and lasting relief so that it can keep operating and stay in business. As the name “reorganization” suggests, that financial relief comes in the form of reorganizing and restructuring debts and other liabilities. A confirmed Chapter 11 plan of reorganization can accomplish this in any number of ways, from restructuring financing terms to extend the payback period, reduce interest rate and bifurcate secured claims (i.e., principal reduction), to discharging or significantly reducing unsecured claims, to providing a five-year payback period for most tax liabilities, to halting lawsuits and administrative actions, to reinstating a suspended license and more. The favorable results that can be attained in a confirmed Chapter 11 plan of reorganization are open ended and limited only by the parties involved.

The Chapter 11 process starts by consulting an attorney as soon as the business
finds itself in financial dire straits. Time is of the essence and non-bankruptcy options such as bank/creditor workouts or other out-of-court arrangements may be explored if time permits. However, Chapter 11s are often filed after such efforts fail or reach a standstill. At that point, the business can file Chapter 11 to obtain immediate relief in the form of the automatic stay prescribed under the Bankruptcy Code.  At the moment of filing, the automatic stay puts an immediate moratorium on debt collection efforts, including the suspension of pending lawsuits, judgments, foreclosure, levies, etc. While the automatic stay will not permanently deprive all creditors from pursuing their legal remedies, it often is the curveball that has that result. The automatic stay provides the debtor with breathing room and time to consider new routes to improve business prospects. Moreover, Chapter 11 offers a new platform upon which to leverage legal possibilities that may not be available outside of Chapter 11 bankruptcy.

Once filed, multiple parties become necessarily involved in a Chapter 11 proceeding. Of course there is the Chapter 11 debtor and its attorney, and also the Office of the US Trustee—which is a federal office organized under the U.S. Department of Justice—which has the duty to monitor and participate in Chapter 11 proceedings as necessary to ensure the procedural process and certain mandatory reporting requirements are properly followed. It is also possible that a committee of the business’s creditors may be formed however this is somewhat less likely to happen in smaller cases. Additionally, a bankruptcy judge is assigned to the case who serves as the ultimate arbitrator over the Chapter 11 proceeding and all disputes, if any, that may arise between the debtor and other parties in interest.

During the course of a Chapter 11 proceeding, the debtor can expect to make several appearances before the judge and with the attorney for the Office of the US Trustee assigned to the case. The debtor can also expect to prepare and file detailed monthly financial reports of the business’s operations, and to participate in negotiations with key creditors. Chapter 11 requires the business to be an “open book” for the duration of the proceeding, and transparency in most areas of the business is critical to a successful Chapter 11.

The duration of a Chapter 11 proceeding can vary widely, with a simple uncontested
case lasting a few months or more while a large business in an embattled case having multiple secured creditors and contested actions taking years to complete. An experienced Chapter 11 attorney can review the business’s circumstances, advise of the potential pitfalls that could arise to complicate a Chapter 11 proceeding, and provide an estimated range of attorney fees and other costs involved in Chapter 11 proceedings.

Lynn Wartchow provides initial Chapter 11 consultations to review the business
liabilities and other circumstances affecting a possible Chapter 11 bankruptcy proceeding, and to advise on possible options and solutions that Chapter 11 can provide to keep a business operating and improve future prospects.

 

What makes a Chapter 11 Business Reorganization a “Work of Art”?

A Chapter 11 reorganization proceeding facilitates a business’s ability to actually stay in business. A successful Chapter 11 is a creative composition thoughtfully sculpted from the good will of a business, crafted by the Chapter 11 attorney into an effective masterpiece of productivity and often with the patronage of key creditors added as the finishing touch. While a work of legal art that revives a business into profitability and longevity is always the goal with Chapter 11 proceedings, it is not always the case. The statistics on successful Chapter 11 reorganizations are discouraging, with over half not making it to the point of a confirmed plan.

So what is it that differentiates a Chapter 11 statistic from a Chapter 11 success? How can you know if your business has what it takes to survive the bankruptcy process and reemerge as a profitable going concern? As a Chapter 11 attorney having represented various types of businesses in reorganization proceedings, I would say the essential element present in every successful reorganization is the business’s ability to survive “but-for” the events that created the downturned circumstances. Phrased differently, if the business has what it takes to survive this economy and pull positive cash flow if only certain issues were not part of the equation, then it may have what it takes to achieve a positive result in Chapter 11 reorganization.

First, identify the factors that are causing the business to ail. Most common ailments are provided varying levels of flexibility in Chapter 11: income and sales tax liabilities, lease problems and commercial eviction, a pending balloon payment on secured financing, unmanageable unsecured debts or monthly payments, judgments, even pending lawsuits and adverse administrative actions such as liquor license posting—all of these can be positively resolved in Chapter 11. However there are some issues that even the Rembrandt of bankruptcy attorneys cannot artfully compromise: a truly defunct business venture that cannot compete in any marketplace will probably not be resurrected even with the benefit of Chapter 11. Knowing what forms of relief are applicable under Chapter 11 for the different business conditions is the starting point from which a successful  reorganization proceeding can launch toward success. Achieving those goals during the course of the Chapter 11 proceeding and sanctifying the results in a confirmed plan of reorganization is the art form.

Ultimately, every business is dependent on a favorable market and no amount of artistry in Chapter 11 can create a market that does not exist. But if your business has a track record of good will and also the tools to move profitability into the future, Chapter 11 may be the silver lining in a dark cloud. Just like in the paintings of late-19th century realism that depicted the ferocity of nature, even the bleakest landscape has a glimmer of hope on the horizon.

Attorney Lynn Wartchow has represented Chapter 11 business reorganizations proceedings involving restaurants, bars, nightclubs and other businesses in Minneapolis since 2008.

When sales tax threatens a business: Chapter 11 may be the answer

When I became aware of a popular local restaurant and bar recently close its doors due to unpaid sales tax and subsequent state shutdown, I had to wonder why no one suggested that the owners file a Chapter 11 business reorganization. True, I cannot be sure that the owners did not consult an attorney and make the decision not to file Chapter 11, but I have my doubts. The establishment was a long-standing popular Minneapolis hotspot, overflowing with patrons bursting out the doors even on weeknights—how could they not be making a decent profit? The zoning of the neighborhood may be to blame, which dictates a mandatory portion of receipts must be from food rather than alcohol, or the sales tax and penalties spike. Here in Minnesota, if a business that sells alcohol is delinquent in paying its sales tax, it can expect to have its liquor license posted within a month. Once a liquor license is posted, the business is not allowed to purchase liquor from wholesalers and distributors until they pay the tax in full, thereby leaving the business with a dwindling supply of inventory to sell to the public while it tries to generate enough revenue to pay the tax bill. Unlike other types of creditors that may be more negotiable, the state’s taxing authority is an unyielding force of government that demands payment under the threat of immediate adverse action. With the Minnesota Department of Revenue, you have to pay to play, and if you want to run a bar, you better pay your sales tax on time each month.

With one not-so-obvious exception: Chapter 11 business reorganization. While this means a business must file for bankruptcy, bankruptcy doesn’t necessarily mean it will go out of business. Quite the opposite—Chapter 11 is a mechanism established under federal law that provides significant flexibility for businesses to reorganize any number of liabilities so long as they can achieve future cash flow to actually stay in business. First and foremost, from the moment the Chapter 11 is filed, the state cannot post the liquor license—this is why it’s so important to head off the posting ideally before it happens. As for resolving the unpaid sales tax bill, the Bankruptcy Code generously allows businesses five years to repay federal and state tax liabilities. A five-year tax repayment plan sure beats the one month notice of liquor license posting.

Of course, other debts can also be reorganized in Chapter 11. Unsecured debt may be reduced to a fraction and paid over time while secured debts and financing agreements may likewise be restructured over more time with principal and interest reduced, and any other number of issues are given more flexibility inside a Chapter 11 bankruptcy proceeding. It should go without saying that, just as with most everything in life, it’s best to explore the bankruptcy option as early as possible and get an idea of what Chapter 11 may look like under your business’s specific circumstances.

The best general advice for a restaurant or bar struggling under sales tax liability: Talk to an attorney that does Chapter 11, and ideally before things go from bad to worse. Even if “bankruptcy” has not been part of your vocabulary before, it could be the solution that keeps your doors open and gets your business back in the black. As for the local favorite restaurant and bar I mentioned earlier in this post, I wish we had met sooner and hope you reopen soon.

Keep reading for more information about Sales Tax Obligations and Chapter 11 Business Reorganization.

Attorney Lynn Wartchow has represented Chapter 11 business reorganizations proceedings involving restaurants, bars, nightclubs and other businesses in Minneapolis since 2008.