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Here’s the program.
Andrew Warner: Hey, everyone. I’m Andrew Warner. I’m the founder of Mixergy.com, home of the ambitious upstart, and coming to you from Washington D.C. This is the first live interview I’m doing from Washington D.C. Getting the office set up, getting the technology set up, getting ready to do more and more interviews for you guys from here.
So, a few weeks ago, I did an interview with the founder of SEOmoz about how he built his company to over $4 four million in sales. He revealed in that interview how, at one point in his life, he had about half a million dollars in debt. When he talked about how it affected his business and how he had to hide from creditors, I said, “Hold on.” All businesspeople have to deal with debt. I should get a lawyer on here to do an interview about how to deal with that and how to deal with debt and creditors and how to fight back.
Well, Russ DeMott heard me say that. And he offered to do an interview here on Mixergy and talk about some of the issues that were brought up and some of the issues that all businesspeople, as I said, are going to have to deal with. Russ is a bankruptcy lawyer in Charleston, South Carolina. Russ, welcome to Mixergy.
Russ: Thank you, Andrew. Thanks for having me.
Andrew: So, you are a bankruptcy lawyer, and we’ve gone back and forth via email. And I kept saying, “I don’t want to deal with bankruptcy here. I want to teach my audience how to fight back when they owe money and someone is chasing them down. How to get some breathing room so they can build their business and not have to be crushed by that debt.”
And you told me what?
Russ: Well, I label myself as a bankruptcy lawyer, but really what I like to think of myself as is a financial problems lawyer. And bankruptcy is just one tool that I can use to help a client through financial problems. The way I approach things is the client comes to me and tells me about what is going on. And it is like a construction project. You need to do a particular job and you have got to reach for the right tool. You don’t want to use a screwdriver if you need a hammer. And different tools work for different situations.
So, what I was trying to get across to you is that there is this idea that bankruptcy means just total meltdown. It’s the worst thing in the world. “I’ll never recover. And I am just going to die. I am going to be a failure. It’s all over. I’ll never recover.” And that is just not the case. There are different types of bankruptcies. And even if you do the type of bankruptcy which you are thinking about, which is a Chapter 7, which is a liquidation bankruptcy or sometimes called straight bankruptcy, it doesn’t mean that you are out of business for good.
So, what I was trying to get across is I try to get the facts and all the facts from the client and try to come up with a solution that works for them.
Andrew: OK.
Russ: And if you take . . . go ahead.
Andrew: Oh, I was going to say, I don’t want this to be a depressing hour for people, where we talk about how they can close down their business and liquidate and how they can go through the worst case scenario. Why don’t we talk about, then, some of the upside. If we are going to talk about bankruptcy at all, let’s talk about someone who maybe you worked with who went through bankruptcy and came out on top as a result of it.
Russ: Absolutely, and I think there is an upside to bankruptcy. For one, a lot of times what happens . . . what I am seeing a lot in my area is what I call real estate meltdown. People invest money in various real estate ventures. And all of a sudden, of course you know this being from California, that the market, all of a sudden, the property is worth half of what it was worth three or four years ago.
And for many people, that is their business. They invested in real estate. You can call it speculation or investment or whatever you want to call it. But, the upside there is they have got all of these upside down investments. They have personally guaranteed all of these obligations, usually mortgage notes, and they don’t want it to take them down personally. In other words, they don’t want to lose their own house and their own car and their own retirement funds and things like that.
So, the upside there would be you could file, in that case, a Chapter 7 bankruptcy, which would just say, “All right. I am surrendering these properties.” And I’ve got clients that they can pay on these properties for 20 or 30 years. They will never be even at zero. They are going to be upside down for the foreseeable future. You can rid yourself of these properties and then get a fresh start. And that really is what bankruptcy is about is a fresh start.
Andrew: And you know what? We are not going to talk only about bankruptcy in this interview.
Russ: Exactly.
Andrew: I just want to start off by talking about the worst case scenario and how somebody recovered from that. Because, no matter what, if you are listening to this interview, you are not just going to lay down in life. You are going to get back up and you are going to find a solution. And in fact, before you even get down, you are going to fight like a beast to make sure that you stay on top.
But give me an example of one person, you don’t have to give me his name, we don’t have to get into specifics. But I understand ideas better when they are attached to one simple example. So, maybe you can give me an example of one client that you have worked with who had to go through this, through Chapter 7 liquidation, as you say, who ended up doing well afterwards.
Russ: Well, I have filed, again, lately with the real estate problems, I have filed for realtors, for lawyers. And what you see a lot of entrepreneurs doing, and I think Rand Fishkin mentioned this, you use your own personal credit cards to fund the business.
Andrew: Yeah. I’ve done that.
Russ: And I’ve done this. You’ve probably done it. At one point, I put $30,000 to $40,000 on credit cards a few years ago. And thankfully, paid them off. But you use credit cards to fund the business. I have had numerous clients over the years do that. And they get to where maybe the business isn’t doing that well. You file bankruptcy. The business itself, many times, is incorporated or it is a limited liability company.
So, you almost never file for the business. The problem is, maybe the business at that time isn’t making enough money. So, if you can live on less money personally by filing a personal bankruptcy and getting rid of all those credit cards that you are personally liable for, then you can continue to try to grow the business and make it into something more profitable.
Andrew: Give me an example of one person. I like to hear one example, one person. That’s inspiring.
Russ: Are we talking about business?
Andrew: Yeah. Business. All I care about is business. I am going to get a divorce in half a year because all I care about is business. [laughs]
Russ: [laughs] I shouldn’t laugh. I am sorry to hear that.
Andrew: I’m kidding. She will probably give me another ten years before she does that.
Russ: I filed for a lawyer not so long ago. Business wasn’t profitable largely because of all these credit cards and using it to fund the business. A profit loss is income in and expense out. And for that particular person, if we could get rid of these personal obligations that, in that case, were huge, he could then live on what was left. So, again, the business didn’t die with that. He just got rid of these personal obligations for all these . . .
Andrew: I see, so you are saying, you can get rid of personal obligations, but still keep your business.
Russ: Yes. Let me explain how that works.
Andrew: Please. Yup.
Russ: If I file a bankruptcy for John Smith, and John has a business of some sort. Say it is a limited liability company or a corporation, it really doesn’t matter. You almost never file for the entity itself. What you do is, on the bankruptcy schedules, you simply list his interest in that business. He may be a sole member of the LLC, or he may be a 50 percent shareholder of the corporation.
Then you value that membership interest. And the way you value the membership interest is assets minus liabilities. It is just a balance sheet. And in many cases, the business really isn’t necessarily worth anything. The business has got debt of its own. The liabilities exceed the assets, especially with service type people, like realtors, doctors, chiropractors, attorneys, those types of people. Consultants.
There is just not any hard assets to the business itself. So, the bankruptcy trustee, whose job it is to find assets, there is really nothing there that is of any value. In other words, if you have got a business, and I say I want to buy Andrew Warner Inc. and you have got $100,000 of debt and $50,000 of assets, I don’t want to buy that. I am just buying something that is upside down. So, as far as on a personal level, if you can get rid of these obligations, you many times can make the business successful.
There is also, what I think you are primarily thinking of, Chapter 11 bankruptcy, where the companies go through that and reorganize, just like GM or United Airlines. You get rid of obligations that are making it impossible for you to make a profit — in fact, usually what would make it impossible for you to stay in business — and then emerge.
What I deal with is mainly consumers with small businesses. That’s what I deal with in my practice.
Andrew: OK. Let’s go over quickly all the different chapters in this book. Chapter 7 is what?
Russ: Chapter 7 is called liquidation. I don’t like that term. I refrain from using it a lot because the clients get terrified, and they think that means that their house is going to be sold, their belongings are going to be sold, their car is going to be sold. They are not going to be left with anything. What it is, is a liquidation of non-exempt assets. And by exempt assets, in every state, there are statutes that say that certain amounts of various properties are protected. In other words, so much in home equity, so much in equity in a motor vehicle, so much in cash, retirement funds, household goods and so on.
So, what is liquidated, there is probably only a liquidation in one percent, maybe 1 out of 100 Chapter 7 cases. Maybe less. Most of the stuff, most people, like what you say, have been dragged into this kicking and screaming. They have tried to work everything out.
Andrew: And in a moment, we are going to talk about how to kick and scream through it.
Russ: OK. And they have gone through that and there is just not a lot left. There is sort of what I call a middle class amount of stuff left. They have got maybe a little home equity, if they are lucky, these days. They have got maybe a little equity in their cars. Retirement accounts are pretty much, and I am making a broad statement, unreachable by creditors.
Andrew: OK. I want to whip through these quickly. So, what you are saying is, it is liquidation, but it is not liquidation of everything. There are some things that are exempt.
Russ: Exactly.
Andrew: Including retirement. What else is there? Chapter 11 you talked about?
Russ: Chapter 11 is typically used for businesses. It is a business reorganization. It can be used for individuals as well. When you see individuals in Chapter 11, it is usually for those that exceed the debt limits of Chapter 13. Typically, individuals, when they reorganize, they will use Chapter 13 to reorganize.
Andrew: What does it mean to reorganize?
Russ: Well, to pay at least some of what you owe back. It may be a penny on the dollar. It may 50 cents on the dollar. It varies from case to case. And we can switch, and I can segue into Chapter 13. Chapter 13 has been around since the 1930’s. And what it allows you to do, if you have regular income — that may be from a job or a business or it could be Social Security or something like that — is to pay your creditors back at least some of what you owe them.
The big issue in bankruptcy is, does the system, so to speak, will the system allow you to do a Chapter 7? There is no repayment in Chapter 7. So, you just file and basically the unsecured debts are just gone. In fact, all of your debts, really, are gone, except non-dischargeable debts, or difficult to discharge. Like student loans are difficult to discharge, fraud, some taxes. But basically, making a broad statement, in Chapter 7, you file, there is no repayment, the debts are wiped out.
In Chapter 13, and I will give you an example. It is easier to do an example. Say a family comes to me — mom and dad, and they have got two kids. Let’s say they are making, their household income is around $95,000 a year. I would have to put that couple in a Chapter 13. They would not be eligible for Chapter 7 because they make enough to pay their creditors back something.
So, in addition, sometimes you have to do Chapter 13. You are not really going to be allowed to do Chapter 7. And in other instances, there are certain things you can do in Chapter 13 you can’t do in Chapter 7.
Andrew: OK. All right. One last question, and then let’s move on past this. Lenny Ramirez, who is outside of the U.S., is asking what book are these chapters of? Where does the name chapter come from?
Russ: It is chapters of the bankruptcy code. The bankruptcy code is Title 11 of the U.S. Code. And under Title 11, there are sub-parts called chapters.
Andrew: OK. All right. So let’s go back to the beginning of a business. What can we do in the early stages to protect ourselves?
Russ: Well, I mentioned entities. When I say that, I’m talking about limited liability companies, limited partnerships, corporations. Limited liability means all of those entities have limited liabilities for the owners. And what that means is, unless you personally, in other words, I set up a business.
We talked about Andrew Warner, Incorporated. And, in your email, I think you mentioned a copier. If you go and you sign a copier lease and you sign it as Andrew Warner Inc. by Andrew Warner, President, and it is very clear that you are signing in a representative capacity, then Andrew Warner has no personal liability for that debt.
The problem with that . . . can you hear me?
Andrew: I can, yeah.
Russ: Oh. OK. I got a screensaver on or something. The problem with that is most businesses, they are going to look at it and say, “Well, this is just Andrew Warner. I don’t know anything about him. I don’t know how creditworthy his company is. I don’t know how long it has been around. We are going to have him personally guarantee that.”
And I think what you did, what you said in your email, is you said, “Wait a second. Show me where I signed. Show me where I personally guaranteed this.” And they couldn’t come up with anything. So, you were not personally liable. Andrew Warner Inc. might have been liable in our example. But Andrew Warner Inc. may or may not have anything. It may just be a consulting firm with really no assets.
So, the limited liability is the benefit of setting up a company or a corporation. This can also be handy. There are really two types of creditors. What we were just talking about are what I call voluntary creditors. That is, people who say, “I want to extend credit to this corporation or limited liability company.” Then there are what I call involuntary creditors. Those would be tort creditors. People that slipped and fell or you had an employee and sent him on a delivery to go get a new hard drive because your computer crashed and he runs a red light and smashes into somebody and does a bunch of damage. Limited liability would protect you, and there are exceptions, but would protect you from liability in that instance.
And one thing I need to make clear, you are always liable for your own personal negligence. I was teaching a class at a local university and trying to explain this to students. Let’s say a group of doctors form a corporation. They are still liable for their own malpractice. Same for lawyers, accountants, so on and so forth.
So, the main protection would be negligence of those that are under you or where you just don’t have to personally guarantee things.
Andrew: All right. We have got a lot in here. Let me break this down before we continue. First thing you are saying is incorporate or get an LLC because that is going to give you protection, right?
Russ: It is going to help.
Andrew: It is not 100 percent protection, but it is going to help.
Russ: Exactly. In our example, I talked about the car wreck. A good plaintiff’s lawyer is going to say, “Well, you weren’t the one driving the car.” If you were driving the car, again, you are always liable for your own negligence. It doesn’t matter whether you were driving a company car or not. But, in that instance, the crafty plaintiff’s lawyer could say, “Well, you weren’t driving the car, but you didn’t check this guy. He had a couple of convictions for drunk driving. He had his license revoked. He almost hit somebody last month, and you let him drive. Therefore, you are negligent because you let him continue to drive.”
Andrew: OK. So it doesn’t give you complete protection. Some lawyer could always come after me instead of my company.
Russ: Yeah.
Andrew: But it gives me some protection. What kind of protection does it give me to incorporate or to get an LLC?
Russ: Well, there are also some tax advantages and things like that.
Andrew: Let’s not talk about the tax advantages. I want to keep this very simple for this conversation. So, what kind of protection do I get?
Russ: It would protect you against two types of creditors. Number one, if you are loaned money, like in our copier lease discussion, if you don’t guarantee that, if you are not signing as an individual, you are just signing as a representative of the company, there is protection there. So, protection against voluntary creditors.
And then there is also some protection against, like I said in my example, what I call tort creditors, where there is a slip and fall. And let’s talk about that in an example. Let’s say I am back in Michigan where I used to practice, and there is some ice and somebody slips and hits their head and loses 30 IQ points. I am the owner of the building. I suppose they could argue that I should have shoveled. But if I have that building in an LLC, the claim is going to be against the owner of the LLC. OK?
Andrew: Not against the company, but against the owner of the company?
Russ: No, the claim would be against the company.
Andrew: Oh, OK.
Russ: In other words, individually, maybe I own that building. In fact, I do. I own DeMott Properties. OK. So, if DeMott Properties owns that building, the only entity or person that is going to get sued is DeMott Properties, LLC.
Andrew: OK.
Russ: And I may have five other buildings. I don’t, but let’s say I do. And I’ve got DeMott Properties two, three, four, five. They are not involved in this mishap, because only DeMott Properties own that individual property. OK? Whereas if I owned the property alone, just Russ DeMott owns it, they can come after me for all my assets.
Andrew: OK.
Russ: So, there is some protection there.
Andrew: I want to make this as clear as possible. I understand that in the law that there are lots of different shades of gray. But, if we start going off on every different possibility, we are going to leave people confused, and we are not going to help them enough. So, I think what we should do is just be as clear as possible, but tell people that there are going to be exceptions and they should be aware that nothing we say is going to be absolute.
So, what we are saying is, bottom line is you are going to get some, not 100 percent, but you are going to get a lot of protection if you get an LLC or a company. Number two, I think you said, and tell me if you disagree with anything I think you have said, if there are shades, we can let that go, if there are shades of gray. But, if I am wrong, stop me and let’s make sure that it is clear.
Next thing we should talk about is when you sign agreements, make sure that in the agreements you are representing yourself as a representative of the company.
Russ: Absolutely.
Andrew: So, you are signing as the CEO of the company or as the managing member of the limited liability company, of the LLC. Not as you as an individual. Which is why a lot of contracts will have a line for your name and for your title and company name. True?
Russ: Absolutely.
Andrew: OK. And the copier story that you were talking about, let me tell people that story, and then we can come back to this. The story was I needed to get a copier into the office. And as soon as you go and buy something, even if you have money, what they do is they try to get you into a lease. They want you in a lease because they want to get the payments, they want to get the interest that goes along with it. Am I right about that, Russ?
Russ: Right. Right.
Andrew: OK. And so I signed the agreement. And then when we sold the assets of the business and it was time for me to go travel, I said, “Any debt that we have, instead of paying it off, since I am going to go travel anyway, I should use that as leverage to negotiate the debt down.” I called up the company that leased me the copier, and I said, “All right. Let’s negotiate. Let’s make a deal.”
The guy says, “Oh, no. We are not making any kind of deal.” I said, “Wait. Everyone else is making a deal with me. Let’s make a deal right here. I will pay off half of what I owe you on the copier, send the copier back to you, and we can move on with our lives.” The guy says, “No. We don’t make any deals at all.”
So, I looked back at the contract and I realized, hey, I signed it as the company. He has no hold on me personally. If he wants to go sue the company, let him go sue the company. We will deal with it at that point. But, as long as it is not me personally, I could be Mr. Superman and take a risk. So, I said, “Look. I am not going to pay you anything now. And I am going to keep the copier, unless you want to make a deal.” Didn’t want to make a deal. I still have that copier somewhere. I am paying storage on that freaking copier. I wish I could get rid of it. If anyone in New York wants a copier, let me know. Next time I am there, I will wheel it over to you.
But bottom line is, because it was not me personally, because I had a company that signed for it, I had a lot more negotiating power with them. And that is what you are talking about when you are telling that story.
Russ: Absolutely.
Andrew: OK.
Russ: And let me leave you with one thing. As far as we are talking about people running stop signs, slipping on ice. The number one protection for that is you get plenty of insurance. That is the number one protection. All of this other stuff, the insurance is the backstop there. So, obviously, I don’t want to leave the discussion without saying that. That is not so much to do with business formation, just practicality. Get insurance, so that if you have something go wrong, you are covered.
Andrew: If I form a company, rent an office, and somebody slips and falls in the office, can’t I say, “Hey, you can sue the company, but you can’t come after me.” Worst case, I will close down the company. There are no assets in the business. I keep it all in my personal bank account.
Russ: Well, that is true. Whoever slipped and fell, if it is Andrew Warner Properties, LLC, that is who they can sue. Now, again, I don’t want to get into shades of gray. Not absolute, let’s just leave it like that.
Andrew: OK.
Russ: Creative lawyers can get around that, and that is why you always have insurance. But that’s the idea.
Andrew: OK. All right. So, you get a lot of protection as a company, but insurance is going to give you even more protection.
Russ: Yes.
Andrew: OK. What about this? An entrepreneur wants to start a company. Decides he is not going to go through the rounds of funding and figuring out who to ask for investment money from. He is going to do what I did. He is going to do what it sounds like you did. Take money out on their credit cards and then go out and launch their business.
Company doesn’t do well. What’s the worst case scenario? What happens?
Russ: Well, that’s a great question. And that is why I think bankruptcy is, you know, it has been described as a safety net. We don’t have, for those of us old enough to remember the Soviet Union and the Eastern Bloc, you know, we don’t have guaranteed jobs and guaranteed apartments and things like that. And we have a capitalist economy. It encourages people to go out and take risks.
And the Bankruptcy Code changed in 2005. And the general idea behind those changes was to make it so it was more difficult for consumers to file Chapter 7 bankruptcy as opposed to Chapter 13 bankruptcy. To put that as simply as I can, the system said, because it had been lobbied by the credit card industry for eight years, with millions of dollars, it said, “All right. We want people to pay something back on their debts in a Chapter 13 rather than just wiping out the debts in a Chapter 7.”
The important exception to that, there are two ways that the system shoves you over into Chapter 13 and says you are not allowed to do Chapter 7. One is a thing called the means test, which basically allocates how much you get to spend on various things — so much on housing and so much on food and so much on cars and so on and so forth.
And the other is called the totality of circumstances test, which just means based on looking at your budget, it looks like it would be abusive for you to be able to do a Chapter 7. So, those are two things that you are going to be put through.
Now, here’s the huge exception, and I think this is important for people that are in business. If the debts that you have are primarily business debts, those testing mechanisms don’t apply to your case. In other words, if you ran up this debt, if you incurred . . . for example, if you buy a house to live in, you would incur that debt for personal, family, or household purposes. That is a consumer debt.
Andrew: Yup.
Russ: If on the other hand, I buy a house as an investment property, that’s a business debt. So, the Bankruptcy Code says if most of your debts, if your debt is primarily business debt, so it was incurred for some business purpose, these testing mechanisms to test whether you are abusing Chapter 7 don’t apply.
What’s that mean? It means if you go out and you start a company and you borrow a bunch of money, you may have an equity line on your home because of it. You may take out credit cards and you may put it into the business. You may go get a specific business loan. If, God forbid, we hope it doesn’t happen, but it does. We all know that. If the business fails, ultimately you want to be able to protect your own assets.
I don’t want to lose my car, my house. I don’t want to have to go through Chapter 13 because it would typically have to be five years. And five years is a long time to be paying a Chapter 13 bankruptcy trustee. The law says if the debt is primarily business debt, you can go ahead and go Chapter 7.
Now, you still have this issue of assets. And if you’ve got a lot of assets, and they are over and above the assets, the amounts that you get to keep, you are going to have to surrender those to the trustee. And I will give you an example. I recently filed for a woman who had a business. She had about, let’s say, $100,000 of non-exempt assets. In other words, if you think of a glass, you get to put so much in a glass. Once you pour it and it goes to the top, it starts to spill out over the top. Well, that is non-exempt assets. She couldn’t hold all of the assets, so to speak, couldn’t protect them all.
But she got to do a Chapter 7 bankruptcy, and it still was a good deal, because she put in approximately $100,000 into the estate and discharged, I think, if my memory is correct, $1.5 million of debt. So, we would all like to keep everything and pay nothing and walk away from the debt when we have financial problems. But sometimes you have to pay in. And, again, the system is set up so it doesn’t take the shirt off your back, but it is not going to let you keep $100,000 in a bank account. It’s not going to let you keep a paid for Cadillac or a paid for BMW or something like that.
And I will give you some South Carolina examples of just how much you get to keep.
Andrew: OK.
Russ: If you would like me to do that.
Andrew: OK.
Russ: I need to stress, this is different in different states. Some states have their own exemptions, like South Carolina. And, in other states, they go under the federal exemptions, which are contained in the Bankruptcy Code. The Bankruptcy Code says the states get to choose. So, in some states, for example, where I used to practice, in Michigan, you could pick Michigan exemptions or you could pick the exemptions in the Bankruptcy Code, whatever was more advantageous for your particular case.
In South Carolina, you just get the South Carolina exemptions. In South Carolina, each debtor in home equity can protect a little over $53,000 of equity. You get about $5,300 in car equity. I want to break this down. Equity is the value less any mortgages or other liens on a property.
So, in other words, if a house is worth $200,000 and I owe $150,000, I’ve got $50,000 of equity. I am not going to have any problem. If you have a husband and a wife filing, you double these amounts. So you get around $106,000, almost $107,000 in equity in South Carolina. You get about $5,300 in cash. IRAs are protected, 401Ks are protected.
Andrew: That means I get to keep all of this, even if we have to liquidate?
Russ: Absolutely. That’s what you get.
Andrew: And it means this. It means that I can liquidate my credit card debt, too. Right?
Russ: Absolutely.
Andrew: So, basically what you are telling me is, and tell me if I am wrong to be thinking this way, but I have got a Superman complex. That is why I am an entrepreneur. Tell me if I am going nuts here. I figure, borrow money on my credit card. Launch my business. Worst case, I file for Chapter 7, as you are saying. I don’t have to owe anything on my credit cards, because all of that credit card debt was used to build up my business. I get to keep equity in my car. I get to keep some cash. I get to keep, I think you said, equity in the home.
Russ: Right.
Andrew: Bottom line, I don’t lose everything. I get to save some things and then go rebuild myself with the next business.
Russ: Right. Bottom line is this. If you are incurring debt for consumer purposes, you are taking cruises, you are eating out too much, you are living beyond your means, you are buying some outrageously expensive car that is going to get repossessed, and so on, that is a whole lot more problematic than borrowing money for business purposes. And the Bankruptcy Code has been this way for at least since 1978. This was not changed by the recent changes to the Bankruptcy Code in 2005.
It basically says if you have got primarily consumer debt, well, we are going to run you through the ringer, so to speak. We are going to put you through this testing process. But, if you have got primarily business debt, we don’t look at that as being as bad, because America is the Mecca of capitalism. And the idea is, we are going to encourage people to start businesses and employ people and stimulate the economy. So, that is the philosophy behind it.
Andrew: OK. And what about this? A lot of credit card agreements say that you can’t use the credit cards for business purposes. If you do it anyway, what kind of power do they have over you as a result? What kind of obligations do you have as a result?
Russ: Well, I suppose they could call a default if they found out you were doing it. I’ve never heard of that happening.
Andrew: OK.
Russ: I have never heard of that happening. For one, they just don’t know why you are using it, really. And, ultimately, with the credit cards, the issue there you are going to have is you are going to have to substantiate how the credit card was used. And I have had some clients come in and they say, “Well, most of this was business, but some of it wasn’t. And it is all sort of mixed in.” And that leads me to another point. When you are in business, keep business business and keep personal personal.
I have a credit card I use. I only use it for business. I don’t use it for personal. And you don’t want to mix things up. It creates all sorts of problems accounting-wise, tax-wise. And then if you fail, you want to be able to say, “I used this card for business. This is all it was ever used for. Look, it is on my QuickBooks or my whatever that I am using.” And you can substantiate that.
Andrew: I see. OK. And it allows you to keep the protection of a company, of a corporation or a limited liability company, of an LLC.
Russ: Well, what it allows you to do is you run up all this debt to start your company. You are personally liable for it. If business gets bad and business fails, it lets you just say, “All right. Well, I am going to shut this company down.” It probably doesn’t have much in it anyway, in many instances. And I can get out of this. At least personally, I am not going to get sucked into this and end up doing Chapter 13 for five years.’
Andrew: OK.
Russ: So, that’s what it allows you to do.
Andrew: What is the difference in protection between a corporation, an LLC, a partnership?
Russ: In terms of a corporation and an LLC, both have what is called, what we talked about earlier, limited liability. So, there is really no different protection between a limited liability company and a corporation. With corporations, you have to observe what are called corporate formalities. Have your annual meetings and do annual resolutions and things like that.
If you don’t, the argument can be made that the corporation is just a sham, and the creditors can do what is called pierce the corporate veil and say, “Well, you formed Andrew Warner Inc., but you never had an annual meeting. You never had a corporate bank account. You just ran it all on your own account.” And pierce that corporate veil.”
In our copier lease case, now they are not going to go into this over a copier lease. But if we pretend it is something really interesting, maybe you owe $100,000, or $150,000, they may depose you and ask for these records. If you can’t substantiate those things, go after you individually.
Andrew: I see. Because it is not really a company. You just pretended that you were a company. You went through company incorporation. You paid them a few hundred bucks. You’ve got the paperwork, but you never really ran your business as a corporation.
Russ: Exactly.
Andrew: I see.
Russ: Exactly.
Andrew: OK. And what about partnership? What are the dangers there?
Russ: Well, nobody is really using partnerships anymore. Now, they are using limited partnerships. But, in terms of just partnerships, I don’t know anybody forming or using partnerships anymore, and here is why.
Andrew: Mm-hmm.
Russ: If you and I go into partnership. Let’s say we are doctors. Let’s pick something where we can really do some serious damage to people. And we’re horrible doctors. Or let’s say you are a horrible doctor, and you go do surgery and you take out the good kidney instead of the diseased kidney. If we are partners, my own personal assets are at stake in a partnership, because you are my partner. So, nobody is using partnerships anymore, other than limited partnerships. And that has got that limited liability quality as well. But I haven’t seen a partnership in the longest time. They have just gone the way of the dodo bird, really in the United States, at least.
Andrew: You know where it happens? It happens when people come up with an idea over drinks. They decide that they are going to go execute it. They are executing and they are busy figuring out the business. And they don’t have enough time to figure out how they are going to structure the company itself.
What are the risks there? That they maybe go a year or even six months and don’t form that corporation and don’t get themselves that protection? Can they get into any trouble there?
Russ: They could. I think the biggest danger is disputes between the members or the shareholders. “I thought you were going to do this.” “Oh, no. I thought you were going to do it.” And if they break up, there is no buyout agreement. You know, a buyout agreement is sort of like a prenuptial type thing.
Andrew: Mm-hmm.
Russ: There is nothing agreed to. It is just best, even among honest people, to just put everything in writing as to who is going to get what, who is going to do what, who is going to make various contributions. One member or shareholder might be the worker bee, primarily. The other might be the money person. So, it is just best to put it in writing.
Andrew: Is there a danger that you and I come up with an idea for the next hot Internet company. We don’t have a chance yet to form the company. But I decide, “Hey, we are going in the right direction here. While Russ is busy coding it up, I am going to go and rent office space for us.” And I get us on the hook for maybe $150,000 a year in rent. Is there a risk that you then personally are liable for that, because all we have is a partnership?
Russ: There could be. I mean, they would have to show that we held ourselves out as partners. In other words, if we met with a landlord, and we said, “Look, we started this company. He is my partner. I am going to do this and he is going to do that,” then there is a problem. It is called partnership by estoppel. Meaning you may have not drawn anything up, but you told him we were partners. So that is a problem.
So, the lesson there is, don’t ever use the word partner. Just erase it from your vocabulary. Don’t refer to the other owner as a partner. People do it. I’ve done it before with law. I say law partner, or whatever. But it is best to say the other member of the company or the other shareholder. Other owner, even. Bu, just don’t say partner.
Andrew: OK. All right. Let’s talk about how to fight back a little bit. So, you are in debt. The company didn’t do as well as you expected. Revenues are lower than you thought. You still have all this debt, and you still have to make all these payments. You are starting to fall behind. Maybe what you do is for a little bit you borrow on your credit cards or you borrow from a friend and you pay off. Or you borrow from another company and you pay off some of the debt temporarily. Or make some of the payments, I should say, temporarily.
But, meanwhile, you have all this debt and it is looming and you have to address it. What do you do in that situation?
Russ: Well, like so much of what I do, everything depends on the facts. But I keep thinking of Rand Fishkin’s interview. I think he said he put, I can’t remember, I think it was half a million dollars on credit cards. Just ran up the credit cards.
Andrew: I think it was more than credit cards to get to a half a million dollars. But there was a lot of credit card debt.
Russ: There was a lot of credit cards and unsecured debt, at any rate. He got to the point where he defaulted on those obligations. Just couldn’t pay them anymore, and yet had enough cash to settle with them. And that is a viable strategy for a lot of people. There are really two problems with it. You got to have the cash. And a lot of people I deal with, they don’t have any cash, because by the time they come and see me, it is all spent. It’s gone. Maybe all that is left is cash in 401K or IRA. A lot of times, people don’t have the cash.
The other issue you have there is a tax issue because the discharge of indebtedness is a taxable event. There is a big exception, and the main exception is for insolvency. In other words, insolvency just means I have more debts than I have assets.
Andrew: OK.
Russ: If that is the case and the debt is discharged, there is an exception. But what I do in those circumstances, you have really got to get to a good CPA for him to evaluate that. And I don’t think Rand got into how that all played out to that level, but it made sense for him because bankruptcy would have been a bad idea for him. He had a company that was worth something. If he put it in bankruptcy, there would be a reputation issue that would cause problems. And then the company itself, maybe it could have been sold for a decent amount of money. So, that could have been a problem.
But, if you have the right situation, where there is some cash, maybe 10, 20, 30 percent of what is owed, it is a viable alternative. And I explore it with my clients.
Andrew: What’s the alternative? What happens if you have a percentage of what is owed, what do you say that you do?
Russ: Well, the first thing that you need to do . . .
Andrew: Yup.
Russ: This is my own special term, I call it fermentation. It reminds me of the old Paul Masson commercials. “I sell no wine before it’s time.” If you call the credit card company, and you have been current, let’s say you just made the August payment on your credit card. And this goes for bank loans, business loans, it doesn’t matter what it is.
And you say, “I’m having trouble. I don’t think I can pay you next month.” You are going to get into this circuitous conversation where they say, “Well, you made last month’s payment.” And you say, “But business is down.” And they say, “But you made last month’s payment.” And you may as well be talking to a tree at that point.
If on the other hand, you haven’t made last month’s or the month before or the month before that, maybe you haven’t made payments in four, five, six months or a year, that debt has fermented and you’ve gotten somebody’s attention. You really need to get to the loss mitigation side where they say, “All right. This guy has defaulted. He is not making payments. We’ve been sending him letters. We’ve been calling him. We are not going to get anywhere.” They ship it over to the loss mitigation department and now they are interested.
Now you have got their interest, because they know that if you could have made the payments, you would have made the payments. It is sort of like the proof is in the pudding. Once you get to that point, you can say, “All right. I am going to pay you a certain amount of this in full satisfaction of the debt.” You don’t have to use a lawyer to do that.
What I tell my clients is you can do it on your own or you can use me. The advantage to using me is I write a letter on my law firm letterhead. If they Google me, they will immediately figure out I am a bankruptcy lawyer. So when I start talking about, “Hey, they are thinking about filing bankruptcy.” They know I can do it.
But you don’t have to use a lawyer. And, again, there is also the tax issue that has got to be analyzed very carefully.
Andrew: OK. So what you are saying is you are going to come at your creditors from a better negotiating standpoint if you wait until you haven’t made a few payments.
Russ: Absolutely.
Andrew: And then you can come in and negotiate a lower amount.
Russ: Absolutely.
Andrew: So if I have three or four month’s worth of payments left in my bank account, I am better off not making payments for the next three or four months, just sitting on that money, and then coming back to them three or four months later after having missed a bunch of payments and saying, “This is all the money I have. Let’s negotiate. I’ll give you this. You wipe out all my debt.”
Russ: Absolutely.
Andrew: OK. And I see how it would be a lot more powerful to come from you and your letterhead and your office than to come from me.
Russ: That’s true. And the other thing I need to stress is, if you do settle, for one, I said this before, but I will say it again. It bears repeating. See a CPA before you do this. Get some advice on taxes. You don’t want to find out that, “Okay. I wiped out $100,000 of debt. Now I owe $20,000 to $30,000 to the government. Then I can’t pay that.” And then you really have a problem, because tax debts are hard to deal with.
Andrew: I see. Because, at that point, the government is going to see you as having gained whatever it is that you have wiped out.
Russ: Absolutely.
Andrew: They are going to say that you just got that benefit. You have to pay us taxes on what you gained.
Russ: Right. Let’s say you are solvent and you owe me $100,000. And if I say, “All right. I am going to take $20,000 for that $100,000.” The $80,000 that I say is discharged, I am going to issue you a 1099-C. Now, small creditors won’t do this a lot of times. But certain creditors are mandated to do this — banks, credit unions, big creditors, or government agencies. They are mandated to do that.
So, they send that to the IRS, and it is just like any other 1099. “All right. Well, there is $80,000 dollars that Andrew Warner just made.” And you have got to pay tax on it, or you have got to prove that you were insolvent or had some other exception.
The other thing I don’t want to forget to mention is to make sure your deal is in writing. You need something from them very clearly stating that if you give them this money, the debt is satisfied in full.
Andrew: OK.
Russ: A lot of the times, you are going to be dealing with people, debt buyers, debt collectors. They may be two or three down the road from the original creditor, and it is sort of the slimy underbelly of the lending community. You need to make sure that you are covered and protected.
Andrew: What if all you have is, say, 10 percent of what you owe? Do you think you can negotiate that, in your experience?
Russ: You know, years ago I used to think you had to have half. And, because of the economic problems we’ve had, it’s gotten much lower. And now, 20 to 30 percent, many times, can do it. And if all you have is 10 percent, it can’t hurt. You can just say, “This is what you are going to get. You either take it or you don’t.” And just see what they do. And they may say, “No. We aren’t going to take it now.” And then come back six months from now and say, “Hey. You made that offer. Do you still have it?”
Especially if they really can’t get anything from you. If they have got a financial statement from you, and they know you’ve got a bunch of assets, that is not going to work. But if they don’t know what they are going to get, they just don’t have any idea what you have. Or you have pretty much established that, “I just don’t have anything. I’ve got this old car. It’s worth five grand. I bought my house,” and I’ll pick on people from Las Vegas a little bit, “I bought a house in Las Vegas back in 2005 or 2006. It was worth $600,000. Now it’s worth $300,000. I don’t have anything.” They get more and more interested as time goes on.
Andrew: I see. Let me say this, too. I am not looking for myself or for anybody to get away with not paying their debt. I want us all to pay our debts. The problem is that I want us to be able to take risks and know that it is not the end of the world if things don’t work out.
And I also want us to be at least as armed as the people who we owe money to. I find that the companies who I do business with, who I sign leases for, who I borrow from, they know more about the whole process than I do, because that is all they do. They know more about the process, because they are the ones who are writing the contract that I am going to be signing. So, I want to be as aware of my rights and my powers as I can be, because I know that they are as least as aware they can be because this is their business. So I am not looking to get away with anything. I am not looking to take advantage. I just want to make sure that we are armed.
Russ: Absolutely, and I am talking about these strategies. I am not trying to say to anybody listening to this that, “Oh, it is a great thing to just not pay your debt back.” I am all for people paying their debt back. What I am talking about are people that come to me that can’t pay their debt back. Or they are in a circumstance where they have got, I keep going back to the real estate meltdown, they have got properties they could pay and pay and pay and pay for 20 or 30 years and not even be to break even. To where doing that is just not a viable option.
If you can pay your debts, sure, pay your debts, absolutely. I would think it would be morally reprehensible to be able to pay . . . say you’ve got $30,000 to $40,000 in credit card debt and you can pay it off. To just say, “Well, you know what? I’ve got a good job. I’ve got a good income. I am just going to stop paying on these things, and then I am going to play this game.” That is not what I am suggesting at all. I am talking about people that just really can’t pay their debt. There is really no light at the end of the tunnel if they continue to do what they have been doing. It is just not a viable solution.
Andrew: In your experience, what are the big mistakes that entrepreneurs make that lead them into this situation?
Russ: I see not hiring the right support staff. Especially, I don’t know why I think of contractors. Not hiring somebody to take care of the books and the business end while you go do the part of the business you are good at, whatever that is. And then, the business end of it, the accounting and the bill paying, and the budgeting, and all these things, falls by the wayside and it turns out to be a big mess. And the invoices don’t go out. Bank statements aren’t balanced.
I think that what you want to try to do is surround yourself with good people who know how to do accounting or bookkeeping or payroll or whatever. And free yourself up to do what you need to do, that you are good at, to grow the business and to network and to maintain business relationships and contacts and those types of things.
Andrew: I see. So, you are saying that because they are so busy building their business, they are not as aware of their debt and their financial situation as they should be. And that is where they get caught up. That is where they get caught up in debt that just crushes them.
Russ: Exactly. I think the key is you need to find qualified people to help you. Good accountants, maybe good lawyers. Good people on staff so you really do what you are good at.
Andrew: What else are they doing?
Russ: And I know, for example . . .
Andrew: I’m sorry.
Russ: Pardon me?
Andrew: What is another mistake?
Russ: Well, probably too much speculation. Growing too fast. And this is sort of hindsight is 20/20 now that we are in this meltdown, but assuming that things will never change. That it was that way this year, so it is going to be that way next year. Change seems to happen much more quickly now than it ever did. And I just think that you need to keep your finger on the pulse of what is going on and not grow too quickly and not assume too much.
The lawyer that I clerked for back in law school about 20 years ago, Bob Anderson, out of Columbia, said to me, “Young man, the most difficult decision you will have to make is how much staff to have.” And I don’t know how you really teach those things. Except if you expand too quickly, you have problems with those expenses. And then, if the business slows down, you have got real problems.
Andrew: You know what? I had a situation like that. I thought that I was Superman, as I said earlier, which is why I went into business. I get into business. We are doing thousands a month, which was huge for me. And then we got to the hundreds of thousands of dollars, and then quickly, like that, we got into the millions of dollars a month. I said, “I am exactly what I thought I was. I could build anything here.”
I said, “I am going to build a beautiful office to accommodate my future growth. I am going to sign up more people to make sure that we never slow down and that we can keep coming up with new ideas.” And then, boom. There was a crisis that had nothing to do with me. I was still working as hard as ever. There was a crisis in the economy. Specifically, the dot com boom wiped out many of my customers. And I went from millions to, I don’t know, hundreds of thousands.
And suddenly, the whole income statement changes overnight. And you can’t blame yourself. Well, actually, I should have blamed myself. I should have known that there was a risk that the economy would go under. That even if I was going to do as well as I could, even if I was going to grow as an entrepreneur and keep fighting to get more customers, the economy may not be cooperative, or something else could happen.
Russ: Exactly. Exactly.
Andrew: Yeah.
Russ: I think the best thing you can do is to try to be somewhat defensive. The problem that happened lately that I see . . . and I am seeing the worst of it, so I might not be the best person to ask about this. But when you are in business, you think, okay, my revenues could be off 20 percent, 30 percent, something like that. Maybe even half. And I have got clients where they are off 90 percent or they are just gone.
And I don’t know what those people could have really done in real estate or construction or whatever. But, if you are in something that is not that volatile, I just think you have got to be somewhat defensive. You have got to get to where you take your expenses and you say, “All right. If things got bad, could I shed some things quickly?”
Some things are easy to shed. Some things aren’t. For example, office leases are very hard to shed. You know, you are stuck. If you have a problem, you open a new office, and you sign a five-year lease and you need to shut that office down after one year of leasing, you have got four more unless the landlord finds somebody else and does what is called mitigates the damages, gets another tenant in there. But you have got all of these liabilities.
So, if you can stay flexible so you can quickly adjust your expenses for a downturn in the economy, then that is obviously a great idea.
Andrew: Let’s add a disclaimer here. You are the lawyer. What kind of disclaimer can we add to this to make sure that Andrew doesn’t get sued?
Russ: [laughs]
Andrew: Do we say, “Consult a lawyer.”
Russ: Nothing contained herein shall be considered legal advice.
Andrew: All right, let’s do that. Nothing contained herein shall be considered legal advice. Please consult your lawyer before making any decisions.
Russ: That’s right. Consult your lawyer. Consult your tax advisor, and I’m licensed in two states.
Andrew: Hire Russ.
Russ: South Carolina and Michigan. That’s it.
Andrew: [laughs] You know what? I did this interview with a guy, Tim Sykes, twice. This is a guy who comes up with stock tips. And he is like Mr. Big Shot. “My stock tips are the best. You have to follow my rules,” and so on. Every email that I get from him, on the bottom, after all this big rant, on the bottom it says, “Just for entertainment purposes. Don’t follow anything that I say.”
Russ: [laughs]
Andrew: All right. You’ve got to say what you’ve got to say for legal purposes.
Russ: Right.
Andrew: This is Mixergy. Actually, I can’t say for entertainment purposes, because a) I am not entertaining, and b) even the design of this thing is horrible. For once, though, now that I am in a new office here, I’ve got a light over my head, so people can actually see me. But we got that disclaimer in there. Now that we do, let’s find out about you. So, how long have you been a lawyer?
Russ: I have been licensed 17 years. I spent the first two years clerking for a circuit judge in Michigan, which is where you work with a judge, do research, and sit in on trials and things like that. And then since . . .
Andrew: Has it always been bankruptcy? Sorry.
Russ: Pardon me? Oh, I’ve done other things as well. I’ve done other things as well. I’ve done bankruptcy work, like I said, I worked for an attorney by the name of Bob Anderson, who is a bankruptcy trustee in Columbia, South Carolina. I did that in law school. And then, with the two years of my clerkship, there was no bankruptcy work, because it was just a state court judge, a state court in Michigan. But since 1995, I have done bankruptcy work. I have done other things as well. But now, I am pretty much just focused on bankruptcy work.
Andrew: How depressing is it to deal with people’s bankruptcy? You see them in the worst moments. I’ve talked to some entrepreneurs when they have gotten deep in debt. I get depressed after a phone call.
Russ: Well, I don’t think it is depressing at all, and it is not just because I get paid. But I like to help people. I like to fix their problems.
Andrew: Mm-hmm.
Russ: And, when I get people that come to me . . . I had a guy in a couple of days ago. He almost had a heart attack, had a quadruple bypass. All stressed out, can’t sleep, worried. And I think we are going to be able to fix his problems. And he is 70 years old. And I said, “You’ve got so many more years left of life. You need to focus on quality of life, not . . .”
People come in and they beat themselves up. There is a lot of woulda, coulda, shoulda. And, I like it because I can stop people from getting divorced, because they are fighting over their debts and various things. I can make it go away. I encourage them to then, if the financial problems were caused by lack of budgeting and financial irresponsibility, to get help for that.
But, you can alleviate the cause of their marital problems, the cause of their not being able to sleep. All those things. So, I think it is a happy practice. It might sound just totally perverse to people. But when people come in and we work through their problems, and we file bankruptcy or we settle with creditors, or we do whatever, and then once it is all over with, they are so relieved and so happy and so overjoyed.
And so, I think it is a very happy practice. I did plenty of divorce work before and that is a horrible practice. Nobody is happy. It is just trying to make it less bad, but it will be bad. So, I like my bankruptcy practice and I think it is a great practice.
Andrew: You know what? I had a friend who went through bankruptcy and before then it was just clouding every part of her life. It was constantly on her mind. And it was constantly worrying her about everything she was interacting with today and everything that she could possibly interact with in the future. Once she had gotten through the bankruptcy, I could see that the weight had been lifted off her shoulders. She was able to experience life again. She knew what she could do to build up her credit again. She got one of those credit cards that you put some cash in the bank to get.
Russ: Right.
Andrew: And she built up her credit. You know what? She was a much better person for it. Her life was much better for it.
Russ: Right. And people will ask me, people are obsessed with their credit score. “What is it going to do with my credit score?” Well, with most of the people, their credit score is trashed anyway. And what bankruptcy is going to do, even if it is not bad yet, it is going to be bad. When you go to get a loan, especially a mortgage loan, the thing that they really look at is called the debt-to-income ratio. What is your income and what is your debt? And if it is over about 38 percent, let’s say, of total debt, you are limited to what you can spend.
Bankruptcy gets rid of that. You have got a bunch of credit card debt and things, it eliminates that. So, I use a service that runs the credit report right before I file the bankruptcy for the clients, and we get all the information from the credit report, as well as what the client gives me. But it predicts what will the credit score be a year after bankruptcy.
It usually goes up 130 points right after the first year. If you are two or three years beyond bankruptcy, you are going to be able to get a mortgage again. And I am not talking about a, what I call a (________) finance mortgage. I am talking about a regular, low rate, five to six percent mortgage, FHA mortgage.
So, you really do rehabilitate. It is going to be on your credit report for ten years, just like any bad credit. But you are going to rehabilitate quickly. It is not going to be the end of the world.
Andrew: All right. How do people find you? I know that in addition to having this practice, you are also a blogger. Where can they read your work?
Russ: I started the Charleston Bankruptcy blog about a little over a year ago. I started blogging and had no clue of what I was doing. Maybe somebody will read my blog now and say, “He still has no clue what he is doing.” But the blog can be found at SCBankruptcyAttorney.com/blog. I also am a contributing author to Bankruptcy Law Network, which is just BankruptcyLawNetwork.com. And I like to educate people and to try to write about financial issues so that they are interesting and understandable. And hopefully I have done some of that today.
Andrew: Well, thank you. You have, and I am glad that I met you. And thanks for responding to that request in the interview with Rand Fishkin. I was wondering if anybody would hear it and if anyone in the audience was a lawyer. I am glad you were there.
Russ: Well, I am an SEOmoz Pro member and I am very proud of that. And I love Whiteboard Friday and I really enjoy reading that.
Andrew: What have you gotten out of being a member of SEOmoz?
Russ: Pardon me?
Andrew: What have you gotten out of being a member of SEOmoz?
Russ: Well, I don’t know. You’d have to look at my website and see if I am doing it the right way. I seem to do well in the search rankings. When I started this a little over a year ago, I knew absolutely nothing. I used WordPress. I didn’t know how to run that. I really didn’t know how to do anything.
And, hopefully, I have learned some things about good quality back links and various things like that, and putting out good content and using good keywords in content. For whatever reason, I just find it a challenge and I find it interesting. And I really enjoy SEOmoz. And someone will probably look at my website and say, “Well, you are doing this wrong and that wrong.” And maybe I am. I have made all sorts of mistakes. And hopefully I am learning.
Andrew: You know what? Good on them. If they want to come back and give you advice and tell you what you are doing wrong and what you could do differently, let them do it. I love it when they do that.
Russ: That sounds great. I would appreciate that.
Andrew: Yeah. Check out Russ’ site. If you have any feedback for him on the site, let him know. If you want to contact him, his contact information is right on the site and you can connect with him. Thank you for doing this interview.
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