We represent lots of small business owners in Nebraska bankruptcy cases. Starting a new business is an expensive learning experience. There is an old saying that it takes seven years to grow a business. If you can survive seven years with doing things wrong–seven years of correcting your assumptions of how the business should advertise, hire, manage, purchase, spend money–then the light switches on and the business starts to succeed.
So you now reach a point where you have “figured out” the business, but the company is saddled with so much debt that it can’t move forward. You have reduced payroll, slashed wasted advertising, learned how to properly bid jobs, and focused on the core elements of running a successful business, but the old debt keep sucking all the cash flow and it needs to go away. Bankruptcy appears to be the best option, but are you ready to file?
WHO FILES THE BANKRUPTCY: THE OWNER OR THE COMPANY?
- Personal Guaranty. In most cases, it is the business owner that files the bankruptcy and not the company. Why? The usual answer is that you have signed a Personal Guaranty of the business debt. Almost every bank loan to the company requires a personal guarantee, so even if the company were to file bankruptcy the bank would have the right to sue the owner for the debt.
- Company Debts signed Personally. A common mistake made when signing for company debts is the failure to properly notify the other party that you are signing on behalf of the company and not signing for the debt personally. For example, if you sign a contract for Joe’s Plumbing but just sign the contract as “Joe Smith” the debt is probably a personal debt. To take the advantage of the Limited Liability benefit of being incorporated, you must clearly put the other party on notice that you are signing in a corporate capacity and not in a personal capacity. The contract should be signed as: Joe’s Plumbing, INC. by Joe Smith, President. See the difference? The first signature was vague as to who was signing for the debt, but the second example is not vague. It clearly states that you are signing as a corporate officer of an identified corporate entity, not personally. Most business owners do not take the time to sign company contracts correctly, so they become personally liable for the debt.
- Corporations do not receive bankruptcy discharges. Corporations do not receive a discharge of debt in Chapter 7 cases. The purpose of Chapter 7 for corporations is to have a court-appointed trustee liquidate the company’s property in an organized fashion. So, if you are closing a company and want to sell off the assets to pay back the debts but certain aggressive creditors are seizing the assets and will sell them for far less than they are worth, chapter 7 may make sense. But if you intend on still operating the business filing chapter 7 is about the worst decision you can make. The debts survive the corporate bankruptcy and while the case is pending you cannot operate the business without the bankruptcy trustee’s permission.
- Preference Payments & Fraudulent Conveyances. A chapter 7 trustee has the power to undue transfers made to an “insider” within a year of filing bankruptcy. Owners of the company are considered to be insiders. So, the Trustee will scrutinize any payment made to the owner within a year of bankruptcy and may demand that you repay the money to the company. Also, the trustee has the power to undue any transfer of company assets made within four years of the bankruptcy if the company did not get equivalent value in the trade. For example, if you transferred a company vehicle into your personal name in the past four years to keep it out of the reach of creditors, the bankruptcy trustee may be able to make you return the vehicle or pay back its value.
IS IT TIME TO INCORPORATE AGAIN?
If the company has become saturated with debt it may be time to organize a new corporation so that new revenue and property may be held by a new company. If you don’t have one, now is the time to establish a relationship with a smart corporate attorney to create a new entity and to get counsel on how to keep the new company free of the problems of the old toxic company. This is not the time to skimp on legal fees or to use an online incorporation service. You need good counsel. You need a business coach. You need someone who has seen every mistake a business can make and who can help you avoid those pitfalls. Hire the best corporation attorney you can find. It is the best money you will ever spend.
BE CAREFUL WHEN TRANSFERRING ASSETS FROM THE OLD COMPANY TO THE NEW COMPANY.
If you transfer title to all the old company’s assets to the new company rashly, creditors may argue that the old company’s debts should attach to the new company. This is why it is critical to hire an experienced corporate attorney. The dudes at Legal Zoom will not be there when problems arise and the new company is under attack. You are not going to figure out this issue by yourself–there are too many rules. Hire the experienced counsel.
Image courtesy of Flickr and reynermedia.