Having practiced bankruptcy law in the Central District of Illinois for over 46 years, and being a Chapter 7 bankruptcy trustee since 1995, a few observations and suggestions might be in order for any attorney contemplating retirement and supplementing one’s retirement income with a business venture.
No one actually enters into a business with the intent of having it go bankrupt or of having to file a personal bankruptcy because of co-signed or personally guaranteed debt. However, it is becoming terrifyingly more common to see situations where an attorney retires from a successful legal practice or career, and then finds that playing golf, fishing, sailing, skiing or even traveling does not make good use of his/her business and other skills acquired from their years of practicing law.
This restlessness can become compounded if the retiring attorney is still physically and mentally healthy. It even becomes more tempting if he/she is approached by a child, relative or former client to get into an “exciting” and “potentially profitable” business venture with them.
You can rest assured that any such business venture undertaken will require the personal guaranty of the retiring attorney for any credit line obtained by the business. Also, you can safely bet that the attorney will, in all likelihood, do due diligence of the finances of an existing business, or scrutinize a business plan of a startup business utilizing not only his/her legal skills and experience, but also the skills and advice of accountants, business or transactional attorneys, bankers and even insurance agents. Rarely, if ever, will such a scenario include the services of an experienced bankruptcy attorney.
Although great amounts of time and money are spent on income tax and estate planning, it is highly unlikely that any thought is given to what is sometimes referred to as “bankruptcy planning.” At one time, it was even thought to be collusive to do any type of bankruptcy planning with a bankruptcy attorney; however, if no fraud, hidden assets or false statements are being planned or recommended, it should be perfectly alright to discuss, preferably before getting into a financial bind, as to what personal assets are protected against claims of creditors and/or bankruptcy trustees.
The Bankruptcy Code
On October 1, 1979, the present Bankruptcy Code became effective. Over the following years it was considered by some as greatly weighted in favor of debtors, and that it encouraged their abuse of the bankruptcy system with multiple filings and liberal court interpretations making it more remedial than what some considered was intended by Congress.
Title 11 of the United States Code is the bankruptcy section and, originally Section 522 of Title 11 gave, for its time, liberal exemptions to individual debtors in bankruptcy. As a result, many states, including Illinois, opted out of the federal exemptions in favor of the State’s statutory exemptions. This occurred in Illinois in the very early 1980s, because it was permitted by Congress when it enacted the Bankruptcy Code.
Thus, the exemption provisions of Section 522 of Title 11 has very little, if any, direct effect in Illinois.
After many complaints and examples of abuse given by credit card companies, banks and other creditors, Congress drastically amended the Bankruptcy Code, effective October 17, 2005, in an effort to lessen its abuse by debtors and their attorneys.
While these changes did limit the so-called “business as usual” bankruptcy filings by debtors, they did not eliminate the right to file bankruptcy. There are several changes that were intended to lessen these conceived abuses, which are beyond the scope of this discussion. Suffice it to say that personal bankruptcy filings have gradually increased since late 2005 to the point where they are now approaching the number of filings, at least in the Central District of Illinois, that existed before the amendments became effective.
As with every individual bankruptcy filing, debtors are permitted to claim certain amounts of their unencumbered assets as exempt from the claims of creditors and bankruptcy trustees. These exemptions can also extend to substantial equity in a debtor’s homestead, vehicle, and certain encumbered personal property used primarily for personal (and not business) use.
As stated earlier, Illinois, since the early 1980s, has allowed an individual debtor, even one in bankruptcy, to use only its exemption statutes.
On January 1, 2006, Illinois doubled its allowed exemptions for individual debtors. These exemptions apply not only to bankruptcy debtors, but to judgment debtors outside of bankruptcy as well.
These allowed exemptions are found in 735 ILCS 5/12-901 with respect to a debtor’s homestead, 735 ILCS 5/12-1001 with respect to personal property, and 735 ILCS 5/12-1006 with respect to retirement plans, as well as 215 ILCS 5/238 with respect to cash values and proceeds of life insurance, endowments and annuity contracts payable to a spouse and/or dependent(s).
Certain commonly used exemptions in Illinois are herein summarized as follows:
A. Up to $15,000 per debtor, but no more than $30,000, in the debtor’s homestead, which means up to $30,000 for a husband and wife who are joint owners, per the deed, of their home (735 ILCS 5/12-901). Pursuant to 735 ILCS 5/12-902, a surviving or deserted spouse of a jointly owned homestead would be entitled to up to a $30,000 exemption. Of course, if a joint owner is not a judgment debtor, or does not join in a bankruptcy filing, his/her equity in the homestead is not affected;
B. With respect to personal property used for personal, rather than business use, the following commonly used individual exemptions are highlighted pursuant to 735 ILCS 5/12-1001:
1. Up to $2,400 in value in any one motor vehicle;
2. Up to $1,500 in value in tools of debtor’s trade or business, including professional books;
3. All social security, unemployment, public assistance and veteran’s benefits;
4. All maintenance and support;
5. Up to $15,000 in personal injury awards;
6. Life insurance proceeds payable on the death of an individual of whom the debtor was a dependent, to the extent reasonably necessary for the support of the debtor or of a dependent of the debtor;
7. Up to $4,000 in value of all other personal property owned by the debtor, including, but not limited to, furniture, bank accounts, stocks, mutual funds which are not an IRA or a 401(k), income tax refunds, divorce property settlements, and inheritances which were vested either before the bankruptcy filing or within 180 days after the bankruptcy filing.
C. In addition, 735 ILCS 5/12-1006 exempts all retirement plans of an individual debtor, including voluntary plans such as an IRA or a 401(k) as long as they were established in good faith;
D. The last two paragraphs of this personal property exemption should be read carefully, because it infers that if non-exempt property is converted to exempt property under Section 5/12-1001 or in fraud of creditors, that property will not be considered exempt, and that exempt property acquired within six months of the filing of a bankruptcy should be presumed to have been acquired in contemplation of bankruptcy; and
E. 215 ILCS 5/238 exempts all death benefits and cash values of life insurance and endowment policies and annuity contracts payable to a spouse of the insured and/or to a dependant of the insured.
Finally, it should be noted that tenancy by the entirety was re-established in Illinois during the early 1990s, and it is an excellent means of insulating a debtor and his/her spouse’s homestead if a creditor is attempting to collect against a debtor’s homestead.
Obviously, if both spouses are obligated on a particular debt, or if they both file a bankruptcy, the tenancy by the entirety will not offer much protection for their home, except as provided by the above described homestead exemption.
Tenants by the entirety can only be created at this time in favor of a husband and a wife and only with respect to their one and only homestead, and it is suggested that the deed creating this type of tenancy specifically refers to the grantees as husband and wife, as tenants by the entirety, and not as joint tenants and not as tenants in common. It is further suggested that this wording should be used whether the deed is from a “straw man” or from the husband and wife conveying in each of his and her own right and as spouse of the other to themselves as tenants by the entirety. It would, of course, be very premature to speculate what standing, if any, the recognition of civil unions in Illinois will have with respect to creating tenants by entirety on and after the effective date of this new law.
Having said all of this, and by way of caution, it is suggested that 735 ILCS 5/12-112 be reviewed before setting up a tenancy by the entirety because it allows a piercing of the tenancy by the entirety if it was created to avoid debts existing at the time of setting it up.
Also, the Illinois Fraudulent Transfer Act (740 ILCS 160/1 through 160/12) should be studied because there appears to be a four year statute of limitations created for bringing actions to void any conveyance determined to be fraudulent pursuant to Sections 160/5 and 160/6 of this Act.
In addition, Section 548 of the Bankruptcy Code (11 U.S.C. 548) has a look back of two years with respect to transfers made prior to bankruptcy which were either fraudulent or without adequate consideration.
Consequently, any transfers into a tenancy by the entirety would be subject to scrutiny by creditors and a bankruptcy trustee if it were made within four years before the bankruptcy or within four years after an obligation was incurred.
Protection of assets
Having given the above statutory outline of certain exemptions allowed individual debtors in Illinois, either in or outside of bankruptcy, this discussion will now focus on what can be done to preserve assets of a retiring individual contemplating investing and/or participating in an existing or a startup business.
It is highly recommended that the following be done as soon as possible so as to start the clock on the four-year look back on transfers:
A. If married and if the marital home is not in tenancy by the entirety, transfer it into a tenancy by the entirety, particularly if only one of the owners is to be involved in the business (this is also recommended even if both spouses are involved in the business);
B. Check all vehicle titles to make sure the ones owned free and clear or in which there is substantial equity are put into joint ownership so as to maximize the $2,400 vehicle exemption per owner, or, if one debtor owns several vehicles in his/her sole name, transfer the title to one of the vehicles to the other person;
C. Review all whole life insurance policies, endowments and annuity contracts to make sure a spouse and/or dependent is/are named beneficiaries, even if the spouse is subject to being a co-debtor in a bankruptcy. There is Bankruptcy Court authority in the Peoria Division of the Central District which allows a debtor to change beneficiaries to a spouse and/or dependent even within the two year and four year look back periods.
D. Make timely 401(k) and/or IRA contributions keeping in mind that 2010 contributions, for example, can be made on or before April 15, 2011, and that 2011 contributions can also be made anytime during 2011, and until April 16, 2012;
E. If a homestead is sold but a new home has not been purchased, segregate the net sale proceeds until a final decision has been made with respect to purchasing a new homestead, because 735 ILCS 5/12-906 allows up to $15,000 per owner to remain exempt for one year after the proceeds are received, and if that amount is reinvested in a homestead during that year, this $15,000 exemption will carry into the new homestead; and
F. If a spouse is not going to be a principal or an active participant in the business, do not encourage him/her to co-sign or guarantee any debt of that business even if a lender requires it. In that case, a different lender should be sought or a decision should be made to avoid this business venture entirely.
While owning or investing in a new business is still the American dream, it can easily turn into a worst nightmare situation if, in addition to the usual due diligence expended, assets are not property protected. The protection of those assets should preferably start before financial difficulties arise so that maximum allowed exemptions are not challenged.
Obviously, what has been presented in the above discussion simply scratches the surface of this complex area of the law. It is not meant to be a substitute for sound business or bankruptcy advice, which, as we all should know, comes after presenting and discussing in detail all of the intricacies of a particular venture with an appropriate professional adviser. On the other hand, this discussion is meant to raise some cautionary red flags which should be carefully considered and weighed before entering into a new business after retiring from one’s law practice. ■