Bankruptcy Is Tough and Costly And Might Be Your Only Option

(Bloomberg Businessweek) -- Nearly three months in, it's apparent the novel coronavirus will leave many victims in its wake — including thousands of small companies, despite decisions in many states to open up for business. Health officials warn that these efforts will lead to a surge in new illnesses that in fact will only prolong the shutdown, and polls show that most Americans oppose the abrupt return to normal. In the end, it is consumer sentiment, as much as government decrees, that will restart the economy. Acting and thinking strategically—cutting cash payments and also gaming out future expenses and options for generating the sales to cover them—will certainly help you beat the odds, but even that might not be enough.

So it's natural, if regrettable, that you might be thinking about how you'll have to wind down your business if its debts become overwhelming and it becomes insolvent. Many people imagine bankruptcy is the ultimate end for such a company, but bankruptcy is a legal status that an insolvent company or its creditors can voluntarily choose to pursue. In fact, bankruptcy is a process mediated by a federal court, to resolve a debtor's obligations to creditors, either by reorganizing and shedding some debt, or by selling assets to pay back creditors. Bankruptcy generally makes resolving those obligations easier, and offers some protections for debtors who would otherwise find themselves at the mercy of those they owe. For example, as soon as a company files for bankruptcy, the court issues an automatic stay blocking most creditors from attempting to collect their debts.

In bankruptcy, creditors collectively negotiate with the debtor, as a committee, and the terms they reach are generally binding on every similar creditor. Typically, creditors who have collateral that secure the debt ("secured creditors") will form one committee and unsecured creditors, who have no collateral, will form another. "Bankruptcy gives you concessions from creditors they don't otherwise have to make," according to Rob Charles, a bankruptcy lawyer with offices in Tucson and Las Vegas. Outside of bankruptcy, "every negotiation is its own play. You end up paying some kind of holdout tax. It's, 'I have the key to the lifeboat.' "

But filing for bankruptcy in U.S. court takes time and money that most insolvent small firms simply don't have. As a result, few file. And perhaps most firms shouldn't — especially those that are unlikely to turn profit, even after reorganizing. "Anything you can do in bankruptcy court, you can also do outside of bankruptcy court, depending on the cooperation of the creditors," says Gerry Sherman, a turnaround consultant in Boston. 

Here's what to consider if winding down the business seems like the only way you can go.

When the company has no real assets — if, say, it purchased inventory with trade credit, and either leased its furnishings and equipment or financed them with a secured loan, there's no real point in going to court, says Charles. Secured creditors will take back their collateral, lessors will retrieve their property, and unsecured creditors will come away empty-handed—though if creditors have extracted a personal guarantee from the owner, they'll likely try to recoup their losses. (Beware: don't let your landlord  confiscate whatever property you do have.)

If your business owns assets, then the decision becomes a bit more complicated. A court-supervised process, under Chapter 7 of the U.S. bankruptcy code, has its advantages, particularly when creditors have lost patience and are readying for battle. In most parts of the country, he says, a small Chapter 7 case can be concluded for under $15,000.

Besides the time and money spent, bankruptcy can be an invasive procedure. “The trustee has powers to recover things like preferential payments to certain creditors in the 90 days prior to filing, and can look back four years at transactions to determine whether they were fraudulent or not,” says Michael Goldberg, a bankruptcy lawyer in Boston. “When you file a bankruptcy you open the door to all that.”

In most cases, says Goldberg, you might be better off trying to liquidate your assets without going to court, using remedies found in state law. For example, in an assignment for the benefit of creditors, the business' assets are transferred (or assigned) to a neutral third party, which sells them and develops a framework for turning the proceeds over to the creditors. 

Hire a bankruptcy lawyer or a turnaround consultant to handle the sale of your business. Besides bringing expertise and calculating the value of the troubled company, turnaround experts bring a fresh perspective and, perhaps more importantly, a new counter-party for your creditors to negotiate with. "Part of my job for a client is often to establish credibility with creditors," says Sherman. "I want the creditors, when I tell them the best I can do for them is get them 40 cents on the dollar, to believe me." Also, if you can resolve matters amicably with your creditors, they may forgo attempting to collect on whatever personal guarantees they may have.

Is the company better off in someone else's hands? Oftentimes, the problem with a struggling company isn't the business — it's the owner. In these cases, the best solution may be to sell the company — or its assets, which is fundamentally the same thing. This can be done in bankruptcy or outside of it, with a turnaround consultant or a business broker. You may be able to get a higher price out of court, but you might find a larger market of value-minded buyers in court. “There are some people who argue that bankruptcy has become a much more efficient marketplace for selling a troubled business,” says Goldberg. “It's a public forum – some people shop there.”

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