How Small Businesses Can Soften the Blow of Bankruptcy

Some dos and don’ts for those teetering on the brink

If despite your best efforts, the company you’ve built and run is teetering on the precipice, don’t give up completely. There are still things you can do to soften the blows, and steps you definitely should avoid.
 

DO talk to your creditors. If you’re struggling, let them know. Be straightforward, proactive, and realistic. “If you are a person with integrity, and that’s a known fact, good will makes a huge difference,” says Gerry Sherman, a Boston-based turnaround consultant. It might make the difference, for example, between a creditor that pursues a personal guarantee or fights a reorganization plan and one that doesn’t.
 

DO give priority to your most important creditors. Usually these include secured creditors, who have a right to collateral backing the debt, and those who’ve extracted a personal guarantee. But they might also include those essential to keeping the business going, such as vendors supplying inventory. Bear in mind that if you file for bankruptcy, creditors may have to return so-called preferential payments you’ve made to them within the previous 90 days. Preferential payments are those that give a creditor more than it would get if the debtor's assets were liquidated under a Chatper 7 filing.

If you lend your company money, DO take collateral against the loan. Business experts often warn against drawing on personal assets to give a failing business a cash infusion. But if you’re going to do it, says Rob Charles, a bankruptcy lawyer practicing in Las Vegas and Tucson, Ariz., structure the transaction as a secured loan—using, say, receivables, to back the debt. That way, repayment won't be considered a preferential payment that could be clawed back in bankruptcy, Charles says. For insider transactions, the recovery period for preferential payments is one year prior to filing.

DON'T attempt to shield your assets with below-market transactions. These sorts of deals, whether between an owner and a business or among affiliated companies, raise a red flag for bankruptcy trustees, who can look back four years for fraudulent transactions, according to Michael Goldberg, a bankruptcy lawyer in Boston. "You have a lot of people who are not sophisticated say, ‘I better put my house in my wife's name,’” Goldberg says. “But it's a terrible optic, and it ends up putting on a target on the transferrer's back—and maybe the transferee's back.”

DON'T borrow from tax kitties. A business owner can be considered a “responsible party” who is personally liable for the taxes the company collects (such as sales taxes) and withholds from employee wages, including income and employment taxes. For example, responsible parties who fail to pay these withheld taxes (called “trust-fund taxes” because they're held in trust for the government) can face an additional penalties—including one equal to the unpaid federal taxes. Moreover, says Charles, “it’s a real impediment to reorganization. I would never start down that road" of diverting tax funds to keep your business afloat. But, he cautions, “If you’ve started down that road, getting back off that road as quickly as you can is a good thing.”

DO talk to a bankruptcy lawyer. Most bankruptcy lawyers will hold an initial consultation with you for free or at a very low cost, says Charles, “because you need to know if you have a viable bankruptcy. And they need to know if they have a viable client.” Before retaining counsel, check with your state bar to see if it has undertaken any disciplinary actions against the lawyer and whether the lawyer carries malpractice insurance.