Business Bankruptcy

Your business is in trouble: How do you determine if bankruptcy is helpful for your situation?

What should you do when it becomes obvious that your business should wind down?   For the entrepreneur, winding down an insolvent company is a challenge at best: paying the debts to creditors while minimizing the damage to the founders and employees. Some of the questions that a business owner should consider are:

• Is the business a corporation, partnership or sole proprietorship?
• Should the business be reorganized or liquidated?
• Does management have the time to put towards a reorganization or a liquidation?
• Is the business one that the owners could easily start again?

First, is the business a corporation, a partnership, or a sole proprietorship?

• Corporations, limited liability companies and partnerships are legal entities separate from their shareholders or partners.  They can file Chapter 7 or Chapter 11 bankruptcy in their own right.
• In a partnership's Chapter 7 case, the trustee can sue the general partners of the partnership if the partnership's assets are insufficient to pay all claims for the amount by which the partnership assets fall short of partnership debts.   11 U.S.C.  723.
• Partners may be facing a suit by a well funded trustee suing for the benefit of all creditors of the partnership.
• Sole proprietorships are just an extension of the owner:  they can't file bankruptcy alone: the proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor.

Should the business be reorganized or liquidated?

To answer this question, you have to know what has caused the problems the business now faces and what are the prospects for change:

• Reorganization can't create a market; increase gross revenue, or make up for a poor fit between the skills available and the skills required to run the business. 
• Reorganization could free up cash from servicing the old debt to permit current operations;  permit rejection of leases or contracts that are no longer advantageous (an expensive facility lease or improvident equipment purchase); or prevent the loss of vital assets or cash to creditor collection actions.

In between Chapter 7 liquidation  and reorganization, a  liquidating Chapter 13 or Chapter 11 could provide a breathing space for the owners to sell the business  as a going concern or or its assets in something other than a fire sale.  

The resulting proceeds could pay taxes or unpaid salaries; sale of the business could provide ongoing jobs for the work force under new ownership.  The bankruptcy could then be converted to Chapter 7 or dismissed if bankruptcy protection is no longer needed.  The court will probably condition dismissal of the case on payment to creditors of the sale proceeds. 

Does management have the time to put towards a reorganization or a liquidation?

Bankruptcy reorganization in Chapter 11 requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system, interface with counsel, and negotiate with creditors.  It is usually expensive as well.

A reorganization can drain an already stressed organization of management's time to participate in bankruptcy proceedings and money since the legal fees are significant.  

Is the business one that the owners could easily start again?

Businesses that require little capital, have few assets, or are really just extensions of the owner's skills are ones that it may not pay to reorganize.  The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity.  

Chapter 7 Options

A Chapter 7, whether for the individual or a corporation, may be the best choice when 

• the business has no future, 
• it has no substantial assets or qualities that cannot be reproduced after bankruptcy,  or 
• the debts are so overwhelming that restructuring them is not feasible.

Individuals can get a discharge of the dischargeable debts and a chance to start over. 

Corporations do not receive discharges, but a Chapter 7 can provide an orderly liquidation under the direction of the trustee and at no expense to the shareholders.  Creditors are assured that they will be paid to the extent of the assets available and the priority of their claim.  Former management is also assured that the assets that are available go (after the expenses of the Chapter 7) to pay taxes for which the individuals may be liable. 

Since corporations do not receive a discharge, when does it make sense to file bankruptcy as opposed to simply closing the doors, liquidating the assets, and allowing the state to terminate the corporate existence?

• When a creditor is poised to lien or levy on assets that could be used to pay debts for which the shareholders or officers are personally liable or leases or other obligations that are personally guaranteed.
• When the services of a Chapter 7 trustee are desirable to preside over the liquidation of assets and the winding up of the business, freeing the corporation's officers to seek employment, etc.
• When filing bankruptcy may discourage creditor suits which have a tendency to name the officers and shareholders personally, irregardless of whether they are legally liable for the debt.

There is no clear or absolute answer to whether a failed business should file a Chapter 7, which is a liquidation proceeding.  It depends on the value and nature of the assets; the attitudes of creditors; and the availability of management to oversee the process.

Companies can go out of business without filing bankruptcy:  they liquidate their assets and cease operations.  Creditors have a right to recover their claims from the assets of the corporation.  If there are no assets, the corporation cannot be further harmed by lawsuits that try to collect from the corporation.  

The danger to management in this approach is the tendency of some creditors to sue the officers as well as the corporation to collect the debt.  While the claim against the individuals may be invalid, the individual sued has to appear and defend in the lawsuit, or a judgment will be entered against him.  In some situations, the individuals may be found liable.

Positive aspects of corporate chapter 7's:

• The Chapter 7 becomes responsible for liquidating assets, returning equipment, and dealing with creditors, freeing management to turn to other endeavors
• Trustee has powers under Bankruptcy Code to sell leases despite anti assignment provisions and to avoid levies and writs of attachment, recovering value for creditors that isn't possible outside of bankruptcy
• Filing bankruptcy seems to reduce the instance of creditors naming management as well as the business in collection actions
• The automatic stay prevents aggressive creditors from diverting cash that could be used to pay taxes, employees, and guaranteed debts or recovering property needed for wind up

If you are a business owner and are contemplating bankruptcy please contact our office at 404-885-6650 so that we can assist you in properly assessing your financial situation. Please complete our Business Intake Form before scheduling an appointment.