It has never been more dangerous for business owners to file Chapter 7 bankruptcy in Nebraska.
New rules now require that business owners prepare special valuation reports to provide more information about the assets of their business. Chapter 7 Trustees have the power to sell unprotected assets, and they are demanding special reports showing the annual revenue of the business and the value of the business inventory, equipment, real estate and accounts receivable.
Companies with significant revenue and assets will be put under the microscope, even if the net value of those companies is negative.
In short, the trustees want to know the scope and size of the business. How many employees and contractors are employed? What is the the gross monthly revenue? Are there any liens on the company assets? If the company liquidated all its property, how much cash would exist?
These new business reports will help the trustees to identify possible targets. Companies with significant revenue and assets will be put under the microscope, even if the net value of those companies is negative.
REPORTING THE VALUE OF A BUSINESS INTEREST ON BANKRUPTCY SCHEDULES:
What is the value of a business? In most cases, the value a debtor’s business is based on a balance sheet approach. If the debts of a company exceed the assets, the company is normally valued at zero. Conversely, if the assets exceed the liabilities the company is valued at the net difference. In most cases a debtor’s business corporation has debts greatly exceeding company assets and the ownership interest is zero. The general feeling is that a company with a negative net worth is protected in Chapter 7, but that concept may not always be true.
NEW CONCEPTS IN BUSINESS VALUATION:
Assume a debtor owns a small business corporation with $50,000 of assets and $100,000 of liabilities. Traditional thinking is that the company ownership is safe in Chapter 7 since the company has a negative net worth.
But net value concepts may be lacking. Nebraska law only protects up to a maximum of $5,000 of stock ownership. You would think that stock in a company with a negative net worth is therefore protected, but that is not how stock is valued. The price of stock ownership is based on what an investor is willing to pay for its ownership, not necessarily what the net value of a company is. In fact, many companies listed on the New York Stock Exchange sell for prices greatly exceeding the stock’s net value per share price.
Value to Competitors:
Assume the above company is based in a smaller community with only one other significant business competitor. How much would the competitor be willing to pay to own the debtor’s stock? More than the $5,000 protected exemption limit? Chances are a competitor would be willing to buy the company’s stock to take over ownership of its main competitor and its customer list. Clearly the company stock is worth more to that investor than just the mere net asset value.
Value to Liquidators:
Assume the $50,000 of business assets above are free of liens. The company is still insolvent since total debts exceed total assets, but the assets can be sold to generate cash since no lien is present. What would an investor pay to own stock in a company that could be liquidated for $50,000 in cash? Yes, that cash would have to be applied to the $100,000 of company debt, but administrative expenses–wages of corporate officers in particular–are paid before general creditors. So the new owner could pay a generous executive salary greatly exceeding the stock purchase price to handle the task of closing down the company. In addition, perhaps the new owner could negotiate with creditors to pay them, say, 25 cents on the dollar for their debt, thus generating a positive $25,000 net asset value for the company.
Value of Company Name, Customer Lists, Customer Contracts & Phone Numbers:
Although a company may have a negative net asset value, there is an independent value to the company’s name, customer list, customer contracts and telephone numbers. Any company that has been existence for a long period of time develops a reputation in the community and probably has a long customer list. The company may have value beyond the auction value of its assets.
Piercing the Corporate Veil in Reverse:
The legal concept of a corporation is that it has a separate legal identity from its owner. But creditors may disregard the corporate form and pursue its owner for a debt if the formalities of operating as a company are not followed. Were corporate tax returns filed and paid? Did the company conduct annual stockholder and board of director meetings to elect new officers? Does the company use a separate taxpayer identification number? Are company assets and funds comingled with the debtor’s personal funds? In short, was the company really operated as a company? If not, there are cases in Nebraska courts where the company fiction is disregarded and creditors were able to reach the assets of the company.
The takeaway here is that Chapter 7 Trustees are looking intently for companies with hidden value and net asset value is not the only measure of a company’s worth. Debtors who own a substantial business may be well advised to consider the safer options of Chapter 13 or Chapter 11 bankruptcy to protect their business operations in Nebraska.
Image courtesy of Flickr and Kevin Dooley.