How does the business operate? What does it produce or provide? What are the biggest problems threatening the business? Who are the business’ clients, vendors, suppliers, and lenders, and—perhaps most importantly—what is the business owner’s ideal outcome? Does the owner want to continue operating the business with less debt, or would the owner prefer liquidating or selling whatever is sellable?
These are some of the most important questions that need to be asked at the outset of a case. Answering these questions is essential to determining whether the business creates sufficient revenue to operate successfully going forward, and whether some of the debt and financial issues can be removed or restructured.
Gathering Important Documents And Information
When determining whether to pursue the bankruptcy process, the best sources of information will come from the accountant (or QuickBooks, or other bookkeeping departments). The most important items include profit and loss or income statements and balance sheets. If a statement of cash flows can be created, it should be included with the income statements or balance sheets in order to develop a full financial picture.
It will be important to have a list of the company’s debts divided into secured debts (e.g., loans for the purchase of a property, equipment, or inventory used in the operation of the business) and unsecured debts (i.e., debts from creditors that don’t have a security interest in any of the goods sold by the business, like suppliers or vendors). There should also be documentation of any other debts, such as leases or contracts that are executory and in the midst of being performed by the debtor entity and the party on the other side of the contract.
Together, this information will generate a complete financial picture of the business, which will allow for an evaluation of how the debts may be restructured, and what contracts may be beneficial or detrimental (and therefore whether to accept or reject those contracts as part of the bankruptcy process).
Once the decision to pursue bankruptcy has been made, there is the option of a prepackaged bankruptcy. This involves putting together a proposed plan for the business and how the business owner would like to see the bankruptcy move forward. If creditors are unified enough in their views as to how things should be handled, the business owner may be able to propose, draft, and negotiate a plan with those creditors, and file the bankruptcy with that plan attached. Once filed, the bankruptcy plan could be approved in a matter of days or weeks instead of months.
Don’t Squander Retirement Savings
The business owner should not entwine themselves individually with the business any more than they must for normal operation of the business. A corporation, LLC, or partnership has a separate life, liability, and obligation from its owners, and this should be maintained as much as possible prior to bankruptcy. For example, almost any type of business loan from a commercial lender will require some personal security, such as a personal guarantee, a second mortgage on a home, or a mortgage on some other piece of property; in the normal bankable areas of the United States, this is almost unavoidable. On the other hand, personal retirement assets (e.g., dollars that are in an IRA or 401(k)), belong to the business owner—not the business. Even in a personal bankruptcy, those are not assets that can be taken or used to pay creditors.
All too often, business owners try to heroically save their business by infusing it with money from their IRA and 401(k), but they absolutely should not do this. Business owners should keep their ability to retire and care for themselves and their loved ones separate from the business entity.
If it comes to the point where the only way to operate is through those funds, then the business owner has already waited too long to speak with their accountant and an attorney. However, even if a business owner has reached this point, they should talk to those professionals to determine whether bankruptcy for the business could help save the business and their retirement funds, which are otherwise not going to be entwined in that business’ debt.
The Business Owner’s Personal Assets
If the business owner does not entangle their personal assets in the business, nothing will happen to those personal assets during the business bankruptcy, because the debtor is the business entity and not the individual. Most commercial loans will include a personal guaranty, but if there is no personal guaranty, then the bankruptcy will not affect the individual at all.
If the business owner has entered personal loans and personal guaranties for the operation of the business, then in addition to the business reorganization, thought must be given to how to deal with the individual.
Typically, the automatic stay that begins when the bankruptcy petition for the business is filed will not stay actions by a creditor against the business owners and against any owner’s personal assets or debts. Under limited circumstances, such as a bankruptcy plan that involves fully repaying the creditors, the court could be asked to enjoin the creditors from pursuing debts against the individual.
Absent some extraordinary circumstances, the presence of personal debt or a personal guaranty that is associated with the business will need to be addressed with a lawyer. Separate bankruptcies for those debts or other avenues of resolution may be available.
To Pay Back Creditors, Or To Not Pay Back Creditors
Should a business owner pay back certain creditors before bankruptcy? The answer is that it depends. Creditors who are essential to the operation of the business should be paid to some extent before bankruptcy, so long as the normal course of business with those creditors will remain unchanged. For example, if the business owner usually pays a creditor on a 30-day and net-30 basis, and continues to do so, then there will not be a problem continuing to do so.
However, if the business owner starts making payments to one creditor, thereby favoring that creditor over all the others, then that business will be making what amounts to preference payments. In the bankruptcy world, preference payments can cause trouble, in that the trustee who is appointed in the bankruptcy could recoup those preference payments into the bankruptcy estate to help repay the creditors. Since the business is usually its own trustee in a business bankruptcy (a “debtor in possession”), it is less likely that a preference payment would be an issue, but it is possible that creditors could raise claims about such preference payments.
Giving Notice To Creditors
When it comes to large, secured lenders and important suppliers, giving them a heads up about an impending bankruptcy is an absolute must. Likely, these creditors will already be frustrated with the business due to ongoing payment and cash issues. If, on top of that frustration, the business owner files for bankruptcy without giving those creditors prior notice, and the first notice they receive is the bankruptcy filing, those creditors may become frustrated to the point that they are not willing to work with that business going forward, which is the last thing a business owner would want.
Ideally, a business owner should tell large, secured lenders and suppliers that the business has done everything it can to address the financial issues, but must consider bankruptcy to survive. The business should add that the business wants to do everything it can to ensure that the lender or supplier will continue working with the business. The lender or supplier might respond by offering a solution, such as making some payments to the creditor, and then waiting until after the preference period to file for bankruptcy. Without notifying these creditors in advance, the creditors could take action in state or federal court to try to collect the debts owed by the business. However, those collection actions would be stayed when the bankruptcy is filed anyway.
There is no harm in communicating with large, secured lenders and suppliers, but there are some fairly significant downsides to not telling those creditors about the intent to file for bankruptcy. If the business owner has chosen not to alert the creditors of an impending bankruptcy, then notices of the bankruptcy will be sent to the creditors via regular mail after bankruptcy has been filed. It typically takes three to four days for those notices to be received by creditors, but it could take a week or more due to the impacts of COVID-19 on mail service.
For more information on Pre-Bankruptcy Steps And Considerations, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (205) 506-3354 today.