Case Study #1: The SBRA reduces total debt by $245,848, monthly payments by $6,760, saves a restaurant that is on the verge of closing and wipes out personal guarantees.

Let’s take a look at how the SBRA works in a situation where a married restaurant owner doing business as a corporation has personally guaranteed the business debt.

The owner has been a California resident for the last 20 years,  his personal assets are a house with $250,000 in equity.  $50,000 in a CD.   A retirement plan with $250,000.  Two car payments.  Both cars are worth less than what is owed.

Next, let’s look at the business debt.  The restaurant has a contract to purchase equipment.  Original contract: $150,000, 84 months at 12%. $100,000 owed with

57 months left on the contract.  Equipment only worth $20,000. 

Owner rents two commercial spaces in a high end mall.  Two separate leases.  Furniture and some furnishings are also leased. Bad condition. 

Total credit card and other unsecured debt: $100,000.  Interest rate average 15%.  The owner also has an SBA loan with a balance of $80,000.  Owner used the $80,000 45 days ago to pay American Express $80,000.  In trying to keep the restaurant afloat and the employees working, owner withheld but did not pay payroll taxes.  $20,000 owed. 

Owner’s monthly payments:

  1. Equipment purchase contract:  Monthly payment: $2,933. Interest rate: 12%. Current balance: $105,848. Remaining months: 57. Equipment value: $20,000.
  2. Space Lease 1: $2,500 a month. Space Lease 2: $2,500 a month.
  3. Furniture lease: $750 a month.
  4. Credit cards. Monthly payment: $1501. Interest rate: 15%. Current balance: $100,000. Remaining months: 144.
  5. SBA loan. Monthly payment: $1057. Interest rate 10%. Current balance: $80,000. Remaining months: 120.
  6. Payroll/trust fund taxes. IRS has only agreed to repayment at 8% interest over two years. Monthly payment: $905. Amount owed: $20,000.

Total monthly payments: $12,146.

Total debt: $305,848.

Prior to COVID, the restaurant brought in $18,700 per month to cover the expense categories noted above. To keep things simple, other expense categories are ignored, such as employee wages. Owner takes home $6556 which is enough to just cover house payment and other personal monthly expenses.

COVID hit.  Income down to $11,250 per month. Owner planning to shut down and across many a sleepless and terrifying night he is 1. wondering how he can tell his employees, and 2. how he’s going to satisfy the personal guarantees.  He figures everything is lost: house, savings, maybe even the retirement plan.  Then he attends one of our free webinars where  he learns about the SBRA and puts us to work on his case.

Now, let’s apply the rules under the SBRA.  And remember, these are rules, not wishes or starting points for negotiation.  They are rules. 

Owner’s new monthly payments:

  1. Equipment purchase contract.  Under the SBRA, amount owed on secured debt is reduced to the value of the equipment, interest rate at 6% and the payment term can be extended.  Applying these rules, Monthly payment: $387. 60 months.  $20,000 owed.
  2. Space Lease 1: Under the SBRA, the owner can choose to assume or reject a lease. Owner elects to keep lease one. Monthly payment $250. Space Lease 2: Owner elects to reject the second lease and surrenders the space back to the landlord. No further amounts owed. Furniture lease:  Owner elects to reject this lease. No further amounts owed.
  3. Credit cards and the SBA loan.  As discussed more fully later, the credit cards and the SBA would share in the $80,000 recovered from American Express which the owner pays back at $1,437 per month.  End result, credit cards, including American Express, and the SBA get 31 cents on the dollar.
  4. Payroll/trust fund taxes. Under the SBRA, owner has five years at 3% interest to repay the taxes. With IRS approval, this can be extended even longer. Monthly payment $360.

Total monthly payments excluding payment to the unsecured creditors: $3,247.

Total debt: $40,000 plus repayment of the amount recovered from American Express, $80,000 for a total of $120,000. 

Monthly savings on the debt maintenance: $12,146-$3,247= $8,899.

Total debt wiped out: $365,848-$120,000= $245,848.

The SBRA turned a dire situation, imminent business closure, and a personal financial meltdown into the business staying open and the owner earning the same take home income as before the pandemic. 

Next, let’s talk about the personal guarantees.

If you have lived in the state of California for the last two years you can use California’s exemption system to protect property and still wipe out debt. Protect means keep. And like California in general, California’s exemptions are very liberal. There are two exemption systems in California. Where there is a significant amount of equity in real property we use what are called the 704 exemptions. In this case study, the client has lived in California for 20 years and owns the following property:

  1. A home that is his and his wife’s personal residence with $250,000 in equity. $50,000 in a certificate of deposit. A 401(k) retirement plan worth $250,000. Two car payments. Both cars are worth less than the loans.  The owner also owns furniture, furnishings, clothing and miscellaneous jewelry.  Outside of the Corporation, the owner owns restaurant equipment and related equipment with a quick sale value of $15,000.

Effective January 1, 2021, the owner can exempt a minimum of $300,000 in equity in real property. Likewise, the entire $250,000 balance in the 401(k) retirement plan is exempt. There is no equity in the vehicles. Nothing to exempt there, obviously. Furniture, furnishings, clothing and miscellaneous jewelry are also automatically exempt. The restaurant equipment would be considered  “trade tools.” $8725 in trade tools can be exempted and since the owner in this case study is married, the amount can be doubled so the entire value, at quick sale pricing, of the restaurant equipment and related items is likewise exempt.

What is not automatically exempt is the $50,000 certificate of deposit. That’s where the planning comes in. The owner can convert the $50,000 nonexempt certificate of deposit to an exempt asset by cashing it in and paying down the home loan. The owner has a minimum $300,000 exemption which equals the current $250,000 in equity plus the $50,000 certificate of deposit.

With all assets now exempt, the owners can file a personal Chapter 7 bankruptcy and wipe out the personal guarantees.

Note, it is entirely possible that the business debt can be renegotiated without the need for the owners to file Chapter 7 bankruptcy. How? The threat of a personal bankruptcy to wipe out the personal guarantees gives the business owner leverage, considerable leverage in many cases, to bring the creditor to the bargaining table.  Foreseeable end result: neither side gets their “best case scenario”.  The creditor gets paid more through the restructuring plan than they would without the personal guarantees.  The business owner doesn’t get all the debt reduction they could without the personal guarantees but the owner does reduce debt to the level where post-COVID income is enough to become profitable again. 

That leaves only the $80,000 payment to American Express made 45 days before filing the case. Under the law, the $80,000 is considered a “preferential payment” because it was made within 90 days of filing the SBRA case.  If American Express doesn’t voluntarily return the money, we’d bring what is known as a “preference action” to get the money back.  And it would be back in the business owner’s bank account quickly.  Bankruptcy court isn’t your typical state civil court where things take years and the rules are anything but certain.    The money would be considered a corporate asset and would not be exempt but the owners could keep it as working capital so long as they agreed to repay a total, principal and interest included, of $80,000. Owner agrees to repay this over 57 months for a monthly payment of $1437.  The money would be set aside for the unsecured creditors.  For the sake of this discussion, let’s assume that the only unsecured claimants are the credit cards, SBA and, now, American Express.  Total: $260,000.  Amount repaid: $80,000, or 31 cents on the dollar.

The owner would be free to use a portion of the $80,000 to purchase new furniture and furnishings and to remodel the restaurant. Ideal? No. But having working capital in your bank account in exchange for a monthly payment of $1,437 (3% loan) is pretty darn close.  The balance of these debts are wiped out.

And the personal guarantees? If the owner  files the personal Chapter 7 bankruptcy, the owners keep everything, over $600,000 in assets, and the personal guarantees are wiped out. Or, as noted, the threat of the personal Chapter 7 bankruptcy can be used as leverage to bring the creditor to the bargaining table.

In sum, then, by combining an SBRA action with a personal chapter 7, under this scenario the final outcome would be as follows:

  1. Prefiling monthly debt payment of $12,146 reduced to $3247 plus the $1437 to repay the $80,000 for a savings of $12,146- $3,247 $-1,437= $7,462.
  2. Trust fund taxes stretched out over five years.
  3. Business income post-Covid of $11,250 $-3247 $-1437 equals $6566, the same as pre COVID.
  4. Total debt wiped out: $365,848-$120,000= $245,848. Permanently reduced.

Imagine the restaurant owner’s personal income from the business when the debt payments and amounts remain the same and restaurant income goes back up. We focus on how to use the SBRA to wipe out debt and increase future profits in another blog which we encourage you to read (on video, as well).  We also go into these and other strategies in our webinar presentations.

Please check our video library and blog for other topics that may be of interest. Also, to find out more, you may wish to attend one of our upcoming webinars. Check the website for details. If you would like to discuss your company’s particular situation, call or fill out the contact form and we will get back to you. 

Picture of Steven E. Cowen, Esq.

Steven E. Cowen, Esq.

Attorney Steven E. Cowen attended the University of San Diego School of Law, graduating at the top of his class, cum laude, in 1987. He was also a member of the law review. Mr. Cowen is a member of the State Bar of California and a member of the National Association of Consumer Bankruptcy Attorneys. He is fluent in English and Spanish. Steve has successfully handled over 2,000 bankruptcy cases in Southern California.

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