1

Creditor ProofingAnd Organizational Structure

For Entrepreneurs

CREDITOR PROOFINGAnd Organizational Structure

For Entrepreneurs

CREDITOR PROOFINGAnd Organizational Structure

For Entrepreneurs

Professor Bruce M. Firestone

• Bankruptcy trustees, supposed to give someone in trouble impartial advice,

• Influenced by fact that if you decide to go bankrupt, that’s a new customer for them

• Banks and financial institutions are unlikely to be your friend in need 

• Call your loan immediately—so they can be first in line to grab your assets

• Really no such thing as ‘Creditor Proofing

• Putting money in secret overseas, numbered bank accounts, protected by bank non-disclosure laws in neutral countries like Switzerland or ‘pirate’ havens in the Caribbean—bad idea

• Neal Stephenson, Cryptonimocon, describes data havens

• Nothing is private or secret any longer

• Ken MacMillan, old fashioned guy

• Thought best way to creditor proof yourself was to not have any creditors

• Paid his bills on time

• Lived within his means

• Saved money every month

• Paid cash for his home and only purchased what he could afford

• When Ken passed away, estate attracted no death duties or terminal tax liability because he kept all of his money in cash

• No deemed disposition of stocks, RRSPs, property (other than his primary residence, which is tax free in Canada anyway)

• Canada Revenue Agency (CRA, equivalent of IRS in US) didn’t take away half of his estate

• There were no lawyers and accountants involved to take away other half

• Father-in-law did not think much of me

• Built real estate empire and then a NHL hockey franchise with huge land assembly

• Largely with debt

• He was not impressed

Late Harold Shenkman, Founder of Shenkman Corporation, large real

estate holding company in Ottawa once told me that:

“…the way I kept a good relationship with my Bank (the Royal Bank

of Canada) for over 40 years, Bruce, is that they always owed me money.” 

CCC Cash Conversion Cycle

• Billy asked me what I was going to do when I got into business in 1982

• Told him I was going to build office buildings

• Billy said he was going into parking lots

• At the time, parking in downtown Ottawa was about $25/month

• Office rents in western suburbs were ~ $18 per square foot triple net

• By 1987, parking rates were around $80/month while office rents down to 6 bucks

• In 2000, went to my Bank to see mutual funds were doing

• Gave them $100,000 in cash in 1995 to invest in their Bank mutual funds

• Supposed to receive a monthly statement– never got a single one

• In greatest bull market since 19th century RR bubble, they turned $100k into $92k  

• Bank’s mutual funds were among 10% worst-performing mutual funds in Canada

• Managed to lose compounded average of 2.5% per annum for 5 years

• Monkey throwing darts at list of Canadian mutual funds would have done better

How to Get in Trouble?

• you do not pay off your credit card balances every month;• you receive multiple applications for other credit cards in the mail and you complete these and get those cards too;• you miss payments;• your bank lines are maxed out;• you bounce a few cheques by mistake;• you can’t keep track of all the payments you have to make;

How to Get in Trouble?

• creditors start calling your house;• your spouse goes out to buy an appliance on OAC (On Approved Credit) and she is rejected because your credit rating (measured by your Beacon score) has fallen below 650 or 600;• your bank calls your personal loans;• you can’t get another mortgage on your house;

How to Get in Trouble?

• your bank wants you to change your Line of Credit into a term loan so you pay it off and then they won’t renew it;• you need to go to private lenders for loans at much higher than prime lending rates.;• you can’t get any new financing at all.

Causes?

• drinking/drugs/gambling;

• job loss/divorce/illness;

• failed biz model/entry of new competitor;

• inadequate sales;

• receivables age– major client goes bankrupt;

• insurance claim disallowed (Bora Laskin);

• fail to control costs;

• loss of hope…

Refi your personal residence?

• drive-by appraisal;

• FMV, fair market value;

• LTV, loan to value ratio;

• QSV, quick sale value;

• 48 hour refi;

• or leg breaker loans.

• Human beings cannot live without hope

• Three days to recover

• First, to be angry at the world

• Second, to feel sorry for yourself

• Third, get some exercise and get on with rest of your life!

• Personal Bankruptcy Option

• US execs proud to tell stories of companies in financial difficulties turned around by taking them into Chapter 11

• Not same as personal bankruptcy

• many things you can not do: teach, police officer, security clearance, get credit card, get cell phone, visit some countries, be Director or Officer of publicly traded company, be an Accountant, buy on credit, get mortgage...

• Get complete discharge from bankruptcy after a few years or even months and your record wiped clean?

• Total bunk—data havens 

• Personal bankruptcy, you end up paying three times!

• First, you pay court appointed Bankruptcy Trustee to manage your affairs (you have new boss)

• Second, not discharged from some of your responsibilities (like, alimony) or Judge may decide you have good earning potential/put future earnings in pot for your creditors

• Thirdly, you’ll pay higher costs for everything– no OAC for you!

Sweden Unpaid debts remain after bankruptcy for individuals People who are deeply in debt can obtain a debt

arrangement procedure (Swedish: skuldsanering) On application, they obtain a payment plan under which

they pay for five years, and then remaining debts are cancelled

Debts that are derived from being subjected to a ban on business operations (issued by court, commonly for tax fraud and/or fraudulent business practices) are exempted from this and like before this process was introduced in 2006 will remain lifelong Most common reasons for personal insolvency in Sweden are illness, unemployment, divorce or company bankruptcy, not reckless spending

• How to Get out of Creditor Hell?

• If you drink too much, stop!

• Terry Matthews takes 7 to 12 years to build great business/hard work and focus required

• So it’ll take you and me longer!

• Lower your costs

• Fortune 100 corporation  CEO could not control his costs– collecting grand masters

Control Costs?• replace Rogers cable with Netflix ($120 v $8/mth)• replace home hone with Magic Jack ($40 v $1.75/mth)• replace tied bank mortgage insurance with life insurance ($105 v $28/mth)

Control Costs?

• people I thought I could trust • my local bank • got $196,000 home mortgage January 2011 • bank automatically added Loss of Life Protection/Health Crisis Prevention/Disability Protection

Control Costs?

• $105.66 per month

• increases payments to bank by more than 11%

• mortgage payment $937.99 per month• cancel after first charge

Control Costs?

simple life insurance for $200,000 worth of coverage): $11.43 (her) + $16.83$ (me) = $28.26/month get more protection for quarter of cost how come it’s more?

Control Costs?

bank’s insurance only covers outstanding principal heaven forbid anything happens but if it did on third anniversary, outstanding balance not $196,000 but $179,000

Control Costs?

policy paying four times more for pays out $179,000 less expensive life insurance always pays out $200,000only get worse over time

Control Costs?• reducing the number of phone lines you have,• having a home office instead of a plush downtown office,• doing our own filing instead of hiring a clerk,• answering your own phones,• sending your kids to public school instead of private school,

Control Costs?

• taking a nice GoTravelDirect.com holiday to an all expenses inclusive resort in the DR for $899 a person including airfare instead of staying at the Kahala Mandarin Oriental Hotel in Waikiki,• visiting a qualified, trusted Mortgage Broker and renegotiating your home mortgage interest rate,• visiting a qualified, trusted Mortgage Broker and increasing your home mortgage in order to pay off high interest rate credit card balances,

Control Costs?• freezing your credit cards,• selling your home and downsizing,• turning off lights in your home,• lowering the thermostat,• getting rid of premium cable services,• getting rid of cable,

Control Costs?• reducing the number of dinners out,• brown bagging your lunch,• planning your day to become more efficient with your vehicles,• buying gas when it’s cheap,• maintaining your vehicles so they last longer—doing preventive things like remembering to change the oil once in a while,• doing minor house repairs and routine maintenance yourself…

Raise Revenues?

• Can I ask my boss for a raise?• Should I look for a higher paying job?• Is there anything else I can sell?• Should my spouse take a job outside the home?• Can I start a business that will make us more money?

(Rod Bryden, whenevercashflow suffers, goes out and buys another business!

Called accretive deal making, eg Disney’s acquisition of the

Mighty Ducks of Anaheim)

Raise Revenues?• Should I get a second job?• Can I add to our income by doing some consulting?• Can I make more money by stopping some of the things I am doing and concentrating on the best opportunities? (My Dad called this ‘supporting the winners and dumping the losers’.)

• Whatever you do, don’t ignore your creditors

• They hate that

• Will definitely report you to credit bureau

• Kill your credit rating

• Be polite, tell them what steps you are taking to pay them (even if you are late) and then live up to what you said you would do

• Terrace Investments Ltd policy of not kicking tenants out when they had financial problem

• Not suing them either• Lower rent by agreement during tough times and get it back

during better times

“If a man should steal my watch, I shall fight him for it. But if a man should sue me for it, I shall take it off and give it him, glad to have gotten away so cheaply.”

• If you are honest with people, most of them will cut you some slack

• Error of omission versus commission

“It is the definition of insanity to repeat the same things over and over again and expect a different result,” Anon.

• What to do if You or Your Company is Petitioned into Bankruptcy?

• Fight it, especially if it’s personal bankruptcy

• If vindictive creditor just wants to hurt you, they may try to petition you into bankruptcy

• You don’t have to accept that

• Meeting face to face with your most difficult creditors is generally a good idea—they see that you are not such a bad person after all

• Lawyers don’t want to settle—you do

• Is it any surprise that NHL experienced a year-long lockout when NHL and NHLPA were both led by lawyers? Gary Bettman and Bob Goodenow 

• If you or your company do go bankrupt—tell the truth

• The smart truth

• Coke’s soda pop dispensing machine that increased prices when temp increased…

• In our society when things go wrong, we always want to find someone to blame

• And that someone is you

• Call the Trustee the next day and arrange for him to send you a

list of questions that he needs help with

• Take the initiative

• Offer to help

• However, never answer their questions off the top of your head

• They have done this dozens, maybe hundreds of times and they

know how to think around corners. You have done this (hopefully)

never. Therefore, it is a very unequal playing field and likely to

result in a very unequal result

• Remind yourself that they are not your friends

• Remind yourself that they may be trying to trap you into saying

things that incriminate you even though you have done nothing

wrong

• Answer their questions on paper first. Then sit on your answers for

at least 24 hours

• Read them again. See if they still make sense

• If you can’t handle it yourself, get a lawyer

• Don’t get bullied or rushed into premature answers. Tell them

you’re trying as hard as you can to get all the info they need

• Start by giving them something innocuous to show that you are

cooperating and this will buy you some time

• Remember what happened to Patty Hearst—she not only got

captured by the Symbionese Liberation Army, she was brainwashed

into becoming a gang member. This is known as the Stockholm

Syndrome, which means that any of us can be forced to do things

we would normally abhor if we are under sufficient duress

• If people keep telling you, you are a bad person, you may eventually come to agree with them even if you did nothing wrong. (This entire essay is based on the fact that you are a trustworthy person trying to get ahead honestly in the world but, like everyone else on the planet, you make mistakes of omission)

• This is what Crown Attorneys (District Attorneys in the US) count on in a cross-examination—that they can brow beat and rush you into damaging admissions. Even experienced, professional witnesses feel intense stress during these types of crosses

• You would be surprised what people will admit to—even things they did not do just to get them to stop

• You never let people like this put words into your mouth. Don’t repeat bait words like: “Isn’t it true Mr. Smith that you paid bribes to City officials to get your permits released?” You don’t answer: “I never paid bribes” because the next question will be: “Well, Mr. Smith, if you don’t like the word ‘bribe’, what word would you use?” You can see where this might take you. The smart answer is: “We have records and invoices from the City for all of the costs for our building permits.” The word ‘bribe’ never passes your lips

• Remember the ‘pen is a long arm from the grave’. Never write anything down that you would not feel comfortable seeing on the FRONT page of your local newspaper

• This goes for email too

• Especially for email

•Sweden has a system for credit score

•This system aims to find people with bad payment attitude

•It has only two levels, good and bad

•Anyone who does not pay a requested debt payment on time, and also not after a reminder, will have their case forwarded to the Swedish Enforcement Administration (Swedish: Kronofogdemyndigheten), a national authority which collects debts

•The very appearance of a company as a debtor in this authority, will render a mark among private credit bureaus - however, this does not apply to a private person

•This mark is called Betalningsanmärkning (non-payment record) and can according to the law be stored for three years for a private person and five years for a company

•This kind of non-payment record will make it very difficult to get a loan, a rental apartment, a telephone subscription or a job with cash handling

•If one gets an injunction to pay by the Enforcement Administration, it is possible to object to it

•Then the one requesting the payment must show correctness in district court

•Failure to object is seen as admitting the debt

•If the debtor loses the court trial, costs for the trial are added to the debt

•Taxes and authority fees must always be paid on request unless payment has already been made

•Every person with a Swedish national identification number must register a valid address, even if living abroad, since sent letters are considered to have arrived

•For example, the Swedish astronaut Christer Fuglesang has a Betalningsanmärkning since he forgot to pay the Stockholm congestion tax, and had an old invalid address registered, since he lives in the USA

•Letters with payment requests did not reach him on time

•Canada and US use Beacon Scores

•CRA and IRS can get judgments against you ex parte and w/o notice

•Atrocious

•Belief is you are guilty before being proven innocent

• With judgment against you, they now have power to ruin your credit rating

• To send bailiff in without notice

• To garnishee your wages

• To seize any property you have and much more…

• Credit rating torpedoed?

• You’re sunk

• No OAC

• Credit bureaus are hugely powerful

• Keep track of all credit cards, mortgages, Bank debt…

• Even number of requests made on your credit rating lowers Beacon Score

• Absolute right to demand from each credit bureau, free copy of your credit report

• Check it!

• SMEE owner had his credit score cratered when Bank held certified cheque and bounced all his payments

• The Proper Role of Debt

• Recommend to students buy their own home, condo, townhouse, as soon as they can

• To do that, most need mortgage

• Mortgage can be a form of useful debt

• How many can save $700 a month? None

• How many can afford $700 a month in rent? All

• So why not buy a home?

• Part of every month’s blended mortgage payment pays off principal

• Over time --> mortgage-free home

• Forced savings

• Home equity is world no. 1 source of startup capital

• Wealth effect—imputed rent

Way to understand imputed rent is as follows:

1. You own a home free and clear2. You decide to move out and rent your home out for $2,000 per month.3. But you need to live somewhere, so you rent a comparable home for $2,000 per month.4. Your former principal residence (now a rental property) is producing income for you and let’s just assume you net $24k a year (i.e., your costs are zero).5. However, you are in the 50% marginal tax bracket, so you have to send CRA half of this amount—you are left with $12k after tax.6. But you are paying rent of $24k a year to your Landlord so you are out $12,000 in CASH.7. Therefore, you are $12,000 better off staying in your principal residence. This is a very real effect* if somewhat hard to grasp.

• Not all debt is bad

• But buying NHL hockey team with debt is probably bad idea

• Good debt is secured debt so that, if for some reason you can’t make your payments, when you sell the underlying asset, the debt goes away

• Good debt is that it is secured by an asset whose value is likely to exceed the unamortized portion of your debt throughout its term (i.e., probably not car loan)

• Bad debt unsecured personal debt where only recourse is to you–credit card debt and student loans, for example

• Note: can be upside down on equity in your home in hurry if market crashes as it did in parts of the US in 2008/09 when home prices collapsed in Florida, Arizona and California by as much as 50%

• Good debt may also be debt that creates return on investment

• How to Reduce Your Risks and Protect Your Family?

• Don’t protect your family by hiding your assets on Pirate Island

• Don’t be financial engineer

• Never buy an asset to lose money so you save taxes!

• “Be proud to pay your taxes in a great country like Canada, but don’t pay more than you have to.” 

• Free to arrange your affairs in a way that is efficient and effective, as long as it meets GAAP (Generally Accepted Accounting Principles)

• Keep your affairs simple

• LLC—Limited Liability Company.

• Apart from a few institutions that are ‘other directed’ (like the Holy Roman Catholic Church, The Emperor of Japan or the House of Windsor), longest lived organizations on planet are incorporated companies

• Vanuatu where Company A can own all shares of Company B and vice versa

• Advantages • Luxembourg holding company (Soparfi) is legally tax exempt from all

local taxes including corporation tax, capital gains tax and withholding tax

• A Luxembourg financial assets holding company (SPF) is legally tax exempt from all local taxes including corporation tax, capital gains tax and withholding tax. This vehicle is often used to manage a family privately owned investment portfolio

• A Luxembourg Intellectual Property and Royalty Collection Company only suffers corporation tax of 6% and enjoys zero withholding tax from distribution payments to non-residents, which is an advantage to Luxembourg company incorporation.

• A Luxembourg Investment Funds Company is legally tax exempt from all local taxes including corporation tax, capital gains tax and withholding tax

• The European Union Parent Subsidiary Directive eliminated withholding taxes on dividends paid between European countries

• The sale of shares in a Luxembourg company is legally tax exempt from capital gains tax

• A Luxembourg holding company is legally tax exempt on dividend income and capital gains on sale of shares in a subsidiary company

• For Luxembourg company incorporation, a non-resident trading branch of a foreign company is legally tax exempt from all local taxes including corporation tax, capital gains tax and withholding tax

• There are no withholding taxes on interests, royalties or technical service fees paid to non-resident companies, which benefits Luxembourg company formation

• A Luxembourg private equity firm (SICAR) is legally tax exempt for all income from bonds and equities. The SICAR law provides a full withholding tax exemption on dividends distributed to its shareholders

• Disadvantages• Luxembourg is considered a 'tax haven' by EU member states. Its

membership of the European Union will continue to force the country to abandon legal tax exemptions on holding companies

• There is valid concern about Luxembourg’s banking secrecy laws, agreeing to OECD standards on exchange of customer information since 2009, which could be disadvantageous for Luxembourg company incorporation

• A Luxembourg commercial trading company suffers company taxation at 30%. Consequently, entrepreneurs often choose to only use tax exempt holding companies when investing in Luxembourg

• Since July 2011, interest payments to EU residents suffer a 35% withholding tax. Withholding tax exemption is granted after taxpayers disclose their Luxembourg investments in their home country

• LLC limits some but not all of your personal liability

• In Ontario, Directors and Officers may be held personally liable for environmental contamination or non-fulfillment of statutory obligations like remitting HST (Harmonized Sales Taxes), PST, PAT, income source deductions 

• In order to avoid such personal liability, Directors must show they have been duly diligent

• Incorporate personal holding company (PHC)

• Put your assets in there except for principal residence

• In Canada you can sell your principal residence tax free, so it should not go into PHC

• Principal residence should go into spouse’s name—spouse with lowest risk profile

• In Ontario, if you get divorced, half of everything you own goes to your partner and vice versa

• Don’t pledge your house to secure loans if you can avoid it

• Try to pay off your mortgage as soon as you can

• Creditors (in Canada) can get at your RRSPs, so make sure you max out your spouse’s before your own

• Some types of insurance-based products (e.g., seg funds) are creditor proof in Canada

• Individual Pension Plan (IPP) is defined benefit registered pension plan that a company contributes to on behalf of owner manager/employee

• Contributions are tax deductible to company and non taxable to owner/manager

• plan must be registered with Canada Revenue Agency and is fully creditor protected since it is bona fide pension plan

• You own small percentage of your PHC

• Spouse and kids own majority

• If you get in trouble, PHC may not go down drain with you

• If you own only a nominal shareholding in PHC, upon your passing, taxes on deemed disposition of your assets will be minimal

• Companies can live forever, you won’t

• If you have home office for your PHC, some of costs of running your home may be tax deductible

• Inter-corporate dividends between two Canadian companies may be tax-free

• So you can find efficient ways to get money into PHC and out of PHC into hands of yourself and your family

• You or your spouse or both might become consultants to your PHC

• Your PHC might be a consultant to your clients or other companies

• Often first step toward full-on entrepreneurship is to turn yourself into consultant instead of employee

• Your PHC owns shares in your op co and in your real estate co

• Your op co rents from your real estate co at FMV

• Move profits to real estate co and up from their via inter-corporate dividends

• Capital dividend account create opportunity to dividend out, tax free to shareholders of PHC including you, your spouse, your kids

• Diversify!

• Buy a home (townhome or condo) as your principal residence and pay off your mortgage

• Buy some residential rental property with 5% down

• Buy some commercial rental property with 25% down

• Buy some land with 50% down

• Diversify!

• Set up a PHC

• Have an operating company, a PB4L

• Have an iron reserve

• Have some financial assets

• Manage your assets and manage yourself!

@ProfBruce