To Close or Not

Is Bankruptcy Necessary?

Small businesses fail for various reasons, including many beyond the owner’s immediate control. It’s a reality of entrepreneurship, not every new business will succeed, and sometimes even long-standing companies hit hard times. The 2020 Coronavirus crisis has impacted small businesses more than almost any time in US history.

If you have decided your small business will not survive the Coronavirus crisis, we can help give you legal options to close or restructure the business.

Bankruptcy is an option when debt overwhelms a business, but is it the right one? Even when it is the best choice, there are different types of bankruptcy filings, each with its own advantages and disadvantages.

First, you have to determine if your small business is set up as a separate legal entity. This means you have a limited liability company (llc), corporation, or a partnership. It is critical if you are self-employed or using a trade name to talk to an attorney about your options. Understanding the basics can help reduce some of the fears and misconceptions that surround the word bankruptcy. Sitting down with an attorney to review options will help you understand your choices

If you do have a separate legal entity, then you have to consider your goals for yourself and the business. If you simply wish to shut down the business, you can often accomplish that without the cost and legal fees associated with a bankruptcy, and many times, there are benefits to not filing bankruptcy.

In evaluating whether bankruptcy is worthwhile for a separate legal entity, it is important to know what debts of the business entity the owner may owe personally. These would be debts that the business owner personally guaranteed, such as bank loans or leases. Most credit cards for a business are issued under the owners’ personal social security number and contain a personal guarantee. Also, if the business owes certain types of taxes (employee taxes, sales taxes, and certain others) those liabilities can pierce the corporate veil and carry liability over to the company owner's individually.

If you are personally responsible through guarantees for much of your business’ debt, then you need to understand a business bankruptcy does not eliminate your personal liability. We find that most of the time the owner needs to file a personal bankruptcy and let the business simply be closed without filing bankruptcy.

Bankruptcy Options

LLCs, Corporations, and Other Business Entities

Chapter 7

Chapter 7 is a type of liquidation that can be used when you want to shut down the business completely. It is important to note that a corporate or business entity does NOT get a discharge of debts in a Chapter 7 like an individual does. In my opinion, there are generally two reasons a business files a Chapter 7.

First, the court can help disburse or sell off the assets of the business in an orderly fashion. If the business has valuable assets not pledged to a large creditor, the bankruptcy trustee will sell those assets and pay creditors. But, beware, the trustee will often sell assets at a low price and the court system 100% controls the sale and how the funds are paid to creditors. The owner of the corporation has little or no say in how the assets are valued, to whom they are sold, and how the proceeds are handled. Given this, Chapter 7 is often not the best solution for a business. It can often be more beneficial for the business owners to close and liquidate the business assets themselves, rather than file a business Chapter 7.

Second, a Chapter 7 can be an extremely effective mechanism for notifying creditors that the corporation (or LLC, etc.) has no more assets. Years ago there was a large medical clinic owned by a group of physicians in Salem. The medical clinic sold all of its assets (equipment, etc.) to another company, but the LLC still owed millions of dollars to a long list of creditors. Filing a Chapter 7 for the LLC was an effective way for the physicians who owned the LLC to notify all the creditors that there was no more money. Also, because a bankruptcy involves the court system reviewing all financial transactions over the past couple of years, the creditors could be assured that the liquidation of assets and payments made to creditors before the case was filed were proper. However, we only really recommend this if there is a substantial amount of outstanding debt and the financial records of the company are in good shape. Otherwise, the cost may not justify the filing or the consequences. It really depends on the size of the business and the list of creditors.

The New Chapter 11 for Small Businesses

If your business is a separate legal entity and you have hit a temporary issue but can see light at the end of the tunnel, a Chapter 11 business bankruptcy can allow you to restructure debts and continue operating. A Chapter 11 allows a business entity to restructure debts over time. There are brand-new special provisions for small Chapter 11's which simplify and streamline the proceedings, with the goal of helping lower costs for small business Chapter 11 debtors.

A Chapter 11 allows your company to restructure debts over time, and often to pay back debts at pennies on the dollar. But, be forewarned, the cost of a small Chapter 11 is still more expensive than consumer bankruptcies and there are more regulations. However, if you need time for your business to get back on its feet, Chapter 11 can help provide that time.

Do’s and Don’ts

Important Considerations if Business is Troubled

DO immediately stop paying back all shareholder loans. This means if the company owes you money, you must put other creditors before the owners.
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DO try to keep up to date on payroll expenses and all payroll taxes.
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DO make sure to file all required federal and state taxes and get all filings (even if you cannot pay the taxes) up to date. Make sure you have copies of all companies records duplicated or stored where they will not be locked out by a landlord.
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DO talk to an attorney or qualified professional about your options.
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DON’T agree to provide personal guarantees to any lenders in exchange for extra time on debt extensions, or add co-signers to loans (especially spouses).

DON’T dispose of any business records.
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DON’T decide to take money out of the business for business owners or family members, instead of paying business creditors.
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DON’T transfer business assets to your personal name.

DON’T try to fix past mistakes on your own by immediately pledging collateral or signing new loan documents.

Conclusion

Giles & Lambert PC is glad to consult with you on whether a bankruptcy is a good option or if you need legal counsel to help close down a business. We provide a free 30 minute consultation to cover the basics, with any time beyond that available at a discounted hourly rate for the initial consultation. Contact us and we will provide a free memorandum giving you a broad overview of the options before you talk to us in person. Please remember this is intended to be a very general guide and does not provide specific legal advice for your situation.

If you wish to have a consultation on closing a business, we will ask you to complete a short intake form first so we can evaluate which attorney you should see, and provide you an estimate of how long we think a consultation will be, and if there will be any fees.