A man was lamenting his financial distress to his closest friend. “My business has been so bad in this economy,” he said, “that I’m afraid I may have to file bankruptcy.”
“I have an alternative,” his friend said. “I’ve invented a pill that will slow your metabolism so much, you will appear dead. Here’s what we’ll do. First, you send purchase orders to every vendor you know, having no intention of paying them. Then you liquidate the inventory they send you as fast as you can, and send the money to Argentina. Then you write a suicide note, saying how despondent you are about your financial problems, and then take the pill. I’ll run you a nice funeral, ship your body to Argentina where we’ll split up the money, and we’ll live out the rest of our days in luxury.”
The man thought about the idea for a few days and finally decided that he had no other alternative, so he ordered and liquidated the merchandise, wrote the suicide note, and took the pill. His metabolism slowed to the point that everyone thought he was dead. His friend organized calling hours, and, as is usual, most of the mourners were also his vendors. A long line formed at the open casket. As each person tearfully reached the casket, people lamented, “Oh Charlie, if only I had known how depressed you were, I wouldn’t have pushed you so hard for payment, I would have given you more time, I would have increased your credit limit, etc., etc.”
At the end of the line there was one man who was not sad. He was furious. When he got to the front of the line, he growled, “You scumbag. You took the coward’s way out, and you left me with such a large receivable that I can’t collect. I have to file Chapter 11 bankruptcy. I know you’re dead, but to show my hatred and disdain, I’m going to take this knife and plunge it into your black heart.”
With that, Charlie sat up in the casket and said, “You, I’ll pay!”
There are many better alternatives for debtors and creditors than Charlie’s and his vendors. LNL is recognized in the commercial legal world as handling matters for debtors, creditors and lenders. Depending on the problem, these cases may require significant sophistication. They may also be relatively uncomplicated. Some of the things which we consider at the first meeting with financially distressed clients (after clearing conflicts) are:
- What is the form of business organization (an individual with regular income may file a Chapter 13 which a corporation or LLC may not)?
- How much does the debtor owe?
- What is the make-up of the debts? Is there a dominant creditor or numerous creditors, none of who is owed more than 1/3 of the unsecured debt?
- Are there unpaid income tax obligations? When were they incurred? Have all tax returns been filed? Should we consider a short tax year election?
- Are any of the corporate debts “trust fund debts” (e.g. sales taxes or withholding taxes) which carry personal liability that cannot be discharged in bankruptcy.
- What is the going concern value of the assets? What is their liquidation value?
- Is there a secured creditor with a collateral interest in everything the debtor owns? Is it angry at the debtor?
- Are there financing sourced potentially available to propose a work-out?
- Are there personal guarantors with substantial assets who will be placed at risk if the business fails?
- Does an individual debtor have an expectancy of inheritance? Does the family member’s estate plan protect our client from the claims of her/his creditors?
- Are there tax implications to a sale of the assets of the business, the forgiveness of debt, etc.?
- What brought the business to financial distress? Is it a non-recurring problem or a systemic one?
- How much would the debtor pay for the business if it was debt free? (The answer to this question may well determine which direction to go).
These are just some of the issues we consider with any client who has serious financial problems. We have many weapons in our arsenal. By far the best is an out-of-court work-out. This may be either a reworking of the balance sheet and moving forward, or a liquidation of assets. Being able to accomplish this requires trust between the debtor and his/her major secured lender, as well as an agreement on the valuation of the assets as a going concern vs. a liquidation.
There are various forms of bankruptcy protection (Chapter 7, Chapter 11, and Chapter 13 are by far the most common for the lawyer and client to consider). Cost varies greatly, with Chapter 11 being by far the most costly.
While bankruptcy is a Federal remedy, receivership is a somewhat comparable state court remedy. There are many differences, and they must be considered on a case-by-case basis.
“Case-by-case” is the key phrase. Each situation must be analyzed on its own, and a joint decision made with the client. As one of my doctor friends tells his cancer patients, “There are no good alternatives. Only less bad ones.” Each client, with the assistance of her/his counsel, must make a decision which fits with her/his situation. It is the role of the lawyer to present alternatives with risks, rewards and costs of each. The well-informed client will make a decision best for her/him.
There are similar considerations for secured and unsecured creditors, “key vendors,” etc. Consideration of their rights is beyond the scope of this article, but our firm represents many banks, suppliers of goods and services, asset based lenders, and many more.
Please don’t regard these comments as legal advice, but only an outline of issues to consider. For an in-person meeting, please call your attorney at LNL.