COVID-19 is a wrecking ball destroying small Nebraska businesses, but at some point the medical crisis will end and the debt crisis will take off.
So far the damage has been mitigated by programs such as the Paycheck Protection Plan, but business revenues have dropped dramatically and consumer spending is not likely to return any time soon. Emergency funds have been depleted, worker layoffs have been instituted, but fixed expenses for rent and loan payments remain.
At some point a business just needs to start over. Assuming the core business model is valid and revenues will return when the health crisis ends, how does the owner address the overwhelming debt?
Is it better to file a Chapter 11 and restructure the debt or should one abandon the insolvent entity and incorporate a new debt-free company?
It is my general preference to abandon the old company and to start fresh with a newly incorporated entity. Why? Because resurrecting a debt-ridden company in Chapter 11 is darn expensive and, in most cases, unsuccessful. So one must question why they want to keep the old entity alive.
Why can’t an owner just incorporate new company? The cost of incorporating a new company is relatively cheap, but filing Chapter 11 is a massive and expensive process fraught with complexity and litigation. Only a very small percentage of companies emerge from Chapter 11 with a discharge of their debt. Most cases fail and are dismissed, leaving the owner worse off than when they started.
So, it is important to evaluate the facts that tend to support or not support filing Chapter 11 instead of just walking away from the old company and starting a new debt-free company to resume business affairs.
Factors favoring restructuring the existing company in a Nebraska Chapter 11 Case:
- Assets owned by the company. Some companies own very special assets that cannot be abandoned. Assets that produce current and future revenue. For example, if a company owns McDonalds franchise rights, you wouldn’t want to abandon that property right. In cases where a company owns a special property right that is hard to duplicate or transfer, it may be wiser to restructure the existing company than to start up a new company.
- Leasehold Rights. When it comes to real estate, it’s all about location, location, location. A restaurant or store with a long-term lease in a high demand area of town may need to protect that leasehold right in Chapter 11.
- Accounts Receivables. Even though new revenue may have dropped in recent months, a company may have substantial receivables that will be paid out over a long period of time. Receivables owed to the existing company cannot be transferred or collected by a newly incorporated company without fair consideration being paid to the former. So it might make sense to file Chapter 11 to protect and preserve the cash flow provided by unpaid receivables to finance current operations and employee salaries.
- Equipment. A business that has a lot of industrial equipment and machinery may not be able to function or provide new services without that equipment. Unless a new company can acquire replacement equipment quickly, it may be best to file Chapter 11 to protect the equipment that generates revenue.
- Unfinished Work and New Contracts. Perhaps a business is in the middle of a large contract and payment depends on completing the project. Perhaps a business has signed several new contracts with work to commence in the near future. Abandoning the old company may not be the best option in these situations.
Factors favoring abandoning the old company and incorporating a new one.
- You are the company and the company is you. Customers of a popular hair stylist are likely to follow them no matter where they are located, and such a business has few hard assets or receivables. It makes little sense for such a business to file chapter 11.
- The company has few receivables. Restaurants and hair stylists and car washes have few receivables. Future cash flow is not dependent on collecting unpaid accounts but rather is based on new work in the future.
- The company has few fixed assets. Consider a drywall installer. Business assets consist of a few hand and power tools and perhaps a work van. It is not much of a burden to replace those assets, and it makes little sense to pay substantial bank loans even if they are secured to the business equipment. It is far less complicated and expensive to start a new corporation and to buy replacement equipment.
- The company needs to downsize and relocate. Reducing overhead and paring back leasehold square footage to more manageable levels is the order of the day. Consumer spending is likely to stay at lower levels for years to come. Do you really need all that warehouse space? Is a cheaper venue available? Will employees start working from home? When current leasehold commitments are excessive, abandoning the old company may make greater sense.
Personal guarantees and liability of the owner.
Regardless of whether the business files Chapter 11 or simply opts to form a new corporation, the business owner may face a personal debt crisis for company debts due to loan guarantees. Most bank loans and lease agreements require a Personal Guarantee from the owner, so in addition to a restructure of the company’s debt, the individual owner may need to look at bankruptcy options as well. A bankruptcy filed for the business corporation does not relieve the personal liability of the owner for loan or lease guarantees.
For help, contact a qualified Nebraska Chapter 11 attorney.
Image courtesy of Flickr and Haldane Martin