Ganje Law Office

Archive for August, 2009

More and more recently, small and middle-sized businesses find themselves in financially stressed operating conditions.  In this economy many businesses will find themselves in a position where the business is currently encountering a weak cash flow, a downturn in orders, or sales figures fall short of projections.

An important issue for these businesses is not how quickly this economic downturn is noticed, but how the business reacts.  While many businesses faced with financial troubles think they have few options, and will all but immediately come to the conclusion that a bankruptcy filing is the only alternative, this is not the case.  A common reaction to financial troubles is to ‘over-react’.  Overacting leads to ‘we’re going to have to shut down the operation’, ‘we’re going to have to lay off two-thirds of our staff’ or ‘we’re going to have to file for bankruptcy.’  But this is not necessarily the case.  There are non- bankruptcy alternatives that may be available.  Some of these non-bankruptcy alternatives, such as a business workout, or turnarounds may afford a business a more rapid and more affordable way of achieving a legal and successful financial reorganization. A workout may also afford the business owners significantly more control over the restructuring than the more invasive government-oversight that occurs with a Chapter 11 case filing.

Excessive lay-offs, which is sometimes one of the ‘over-reactions’ business owners resort to when the operation becomes financially stressed, can prove problematic to long term operations.  Also many businesses will turn to focusing on only one client, or making inappropriate budget cuts that in a best case scenario often only lead to a slower closing of the doors.  When a business faces an economically challenging time cost cuts should be made but it is important to first create a new business plan to fit the current economic circumstances.

The first part of the planning process is to carefully weigh the positives and negatives of both bankruptcy and non-bankruptcy alternatives.  The company’s staff and professional advisors should take a step back and put the business’ cash flow, sales and service projections, and financial data on the table.  It is now that the business should retain the best possible accounting and law team to analyze the problem.  It is essential to not enter this process with a do it yourself attitude. Do not rely on staff reports as to where the problem lays.  We all are myopic in how we view our own business, our own practice, our own client base – we do not have a broad enough self vision.

Understanding the tax consequences as well as the financial problems the business faces should be at the forefront before determining whether to initiate bankruptcy proceedings. A critical outside party and outside the box analysis of the company’s strengths and weaknesses are needed to develop a game plan. Bankruptcy is surgery and before a business considers surgery the owners should always consider a remedy of antibiotics or physical therapy.

A business workout or turnaround is a non-judicial, non-bankruptcy method of  restructuring or reorganizing a business to overcome a particular financial challenge. The workout partly relies on informal negotiation and communication with the business’ creditors and staff to redirect the company’s cash flow, go forward with weaker projections, and establish a plan to service their creditors.  It is crucial that a business act in a timely fashion to their economic downturn.  In some rare occurrences small to medium-sized businesses have waited too long to apply the non-bankruptcy alternatives, leading to a judge-signed order for all equipment to be seized.  Most businesses are well before that stage in litigation or collection, as it were. Most businesses will have some sense and understanding of the level of their problem.

It is important to note that while most small and mid-sized businesses that are financially stressed lack significant cash flow, most still would have enough cash flow available to service the modest needs of an accountant, a lawyer or a law firm for their initial retainer fee or short-term advice and consult.  The workout process is not a long-term commitment, debt, or contract and that the accounting firm and lawyer working with the business would know within one to two weeks what challenges the company faces.  Most businesses in a financially stressed situation still have cash flow, and they still have the available funds to pay creditors and it is, generally, from those funds that the business would pay the workout team.  It is not a large investment to get into the workout mode, and most likely a good workout team will be able to diagnose the cash flow issues and determine who the principal creditors are with a two-hour face to face time with their client.

The process of the business workout is one of practicality that does not require a lot of investment in professionals to get the method up and running.  The process is not advocated often and is one that is not taught in business school, talked about at Chambers of Commerce, or
read about in publications such as Newsweek or Business Week.

One of the major disadvantages to proceeding with a bankruptcy is that it is a very public process. All of the business owner’s finances, investments, creditors, and contracts are recorded and available for public viewing. Once a business files for bankruptcy a competitor could access information such as the filing business’ debt load, customer list, inventory suppliers, financial institutions, line of credit and what interest rates they are charged.  All that is valuable information and competitors could use that to their advantage.  Yet another negative aspect to consider is that a bankruptcy filed business is monitored and managed by the court and trustee system. Bankruptcy allows the intervention of a bureaucracy that is requiring the company to produce financial reports justifying its budget. In other words, having a government partner you didn’t know you already had.  The government partner is the bureaucracy called the trustee and the trustee has certain powers to oversee, to require budgets, and to object if the business is going to invest in the wrong kind of action.  That is a draw back because you do not have the latitude or the flexibility a business needs to survive, in some ways.

A bankruptcy reorganization case does not create a new market for the business, increase gross revenue, or create a better skill set for the management team. To reiterate, bankruptcy should never be the first choice for a company, but there are several advantages of bankruptcy.  One of the advantages is the ability to free up cash from servicing old debt to give current operations the breathing room to move forward. A couple other advantages would be the flexibility concerning leases or other contracts that may no longer be advantageous to the business
operation and having the protection of the courts if a creditor decides to file suit.

From a business perspective, corporations, limited liability companies and partnerships are separate legal entities from their owners, shareholders and partners and have the ability to file a business liquidation option Chapter 7 or a reorganization option Chapter 11 in the name of the business entity.

Filing of bankruptcy has many different impacts on the business depending on the formation of the business entity.  Filing a Chapter 7 could prove to be more problematic for a business partnership. The liquidation option exposes individual partners to a possible liability not
withstanding the bankruptcy filing.  A sole proprietorship is seen as just an extension of individual. An individually owned business is not permitted to file a bankruptcy case under the business name. The individual business owner would be required to file their bankruptcy case under their name since, in actuality, the assets and liabilities of the proprietorship are really just one form of the assets of the individual.

With a Chapter 11, a business is protected for 120 days. The bankruptcy filing allows the business four months to rewrite its business plan of reorganization. After the allotted time expires, the business needs the permission of the bankruptcy court to extend the time in which to
write its own business plan.  There is no particular chronology or any statutory time protections built into workouts because workouts or turnarounds are non-judicial.  The amount of time a business will have to be successful will depend on how soon you discover the problem and how soon the business begins negotiations with the larger creditors that could give the business the most financial stress or legal problems while the business is in a workout.  An additional option for the individual business owner is the min-reorganization Chapter 13.

A main advantage of the workout is that it is a private process. The public has no knowledge, participation, or observation of the process and a workout or turn around has no bureaucratic overseers. It is a private negotiation process between the business and its various creditors.  The business is dealing directly with each creditor and coming to some compromise or resolution and going about their business as it were with no judicial or bureaucratic intervention.

The business has more control of what the settlement arrangements are, there are less people participating in the resolution of the case, and there are less people participating in how the business restructures and recasts the finances.

Stephen Costello’s visitors typically “walk out feeling better” after they’ve talked with him, which is a little surprising because Costello is a bankruptcy attorney. He’s the only attorney, in fact, at Costello & Costello P.C., Carpentersville.

“The business owner knows more (about bankruptcy), and the stress begins to lift,” Costello explains. “It’s my job to explain what would happen. It’s the business owner’s decision” as to whether bankruptcy is the right choice.

That’s not a choice most entrepreneurs ever expect to make, but the companion facts that small businesses account for “a lot” of the increased activity at Costello’s practice and that Chicago bankruptcy attorney Peter Berk, of the Law Office of Peter L. Berk, says business “was up 40 percent last year and is up over that so far this year” indicate that more businesses are at least exploring the bankruptcy option.

Bankruptcy can be complicated. To help, but with the caveat that every situation really is different, here is some basic small business bankruptcy information based on conversations with Berk and Costello:

• Business owners looking at bankruptcy generally have two options: Chapter 7, which refers to the chapter of the bankruptcy law that provides for liquidation of a business, or Chapter 11, which allows a business to keep operating while it reorganizes.

• Viability can be an issue. “You’ve got to be big enough to do a Chapter 11, and the business has to be viable,” Berk says. “There has to be enough revenue coming in to satisfy creditors” in a reorganization.

Costello adds that Chapter 11 often is “too expensive for very small businesses.” Figure a “$15,000-$20,000 retainer to get the case filed,” he says. A Chapter 7 filing is likely to cost about $5,000.

• One problem is that “businesses tend to wait until things get pretty dire” before seeking help, says Berk. “It’s often an emergency situation where a creditor has gotten a judgment or the owner sees that the business will default.” In that context, a dose of realism can help. “Everyone is optimistic that things will turn around,” Costello says. “They usually don’t.”

• The corporate veil that is one reason many entrepreneurs incorporate their businesses may offer some protection in a bankruptcy. “If there are no personal guarantees, then corporate officers generally are not liable” for a business’ debts, Berk says.

• It is possible to essentially liquidate your business today and start a new one tomorrow–although, Costello warns, there “always is a suspicion among creditors that you’ve squirreled enough assets away” to fund the new business.

“The legality matters,” Costello says. “Stealing assets (from the bankrupt business) and bringing them into a new one is something I won’t tolerate. Neither will the courts.”

Questions, comments to Jim Kendall, JKendall@ 121MarketingResources.com. © 2009 121 Marketing Resources, Inc.