Corporate Bankruptcy or Business Wind-down? Pros and Cons of Chapter 7

CO-AUTHORS: Katie Imler and Salene KraemerLet’s face it, all businesses face challenges. Especially when the economy is not a booming bull, financial challenges are in abundance. You are not alone. So what do you do when your company has financial troubles staring you down? What do you do when going to work every day puts you and your family deeper in debt instead of adding money to your bank account? At some point, the best business decision you can make may be the decision to no longer do business.What do you do?  Well, there are a few options:  1) Sell the business to a competitor, strategic business, or key employee; 2) File for Chapter 7 bankruptcy; 3) Wind-down the company yourself. We want to talk about the latter two options. Before taking action, both avenues have advantages and disadvantages that must be weighed.Avenue 7. Filing for Chapter 7 Bankruptcy means that a Bankruptcy Trustee employed by Office of the United States Trustee of the Department of Justice, steps into the shoes of the company and has the burden of winding-down the business.  In doing so, the Trustee is in control of distributing the business assets according to the Bankruptcy Code.Perks of Chapter 7:

• Upon filing a petition for Chapter 7, an automatic stay is imposed preventing lawsuits and writs of execution against business assets –think of it as MC Hammer’s “Can’t Touch This.” This preserves the vital business assets and provides peace of mind that the business will not have to defend against future legal actions arising from pre-petition debts
• The Bankruptcy Court assumes the burden of notifying all creditors of the bankruptcy (sending the “funeral notice”, if you will).  Having this objective third party serve as a buffer between the business owner and the unpaid creditor provides a sense of relief to the business owner
• Debtor benefits from expertise of an experienced Bankruptcy Trustee
• Debt forgiveness is not taxable

Downsides of Chapter 7:

• Business management has no control in the winding-down
• Trustee will scrutinize the pre-petition financial and operational affairs of the Debtor
• Instead of finding a strategic buyer who may pay more for business assets, a trustee may liquidate business assets for pennies on the dollar, called a “fire sale”
• Trustee may abandon certain assets letting creditors with an interest in them duke it out
• Since the Trustee assumes the place of the debtor, he or she also assumes all of the debtor’s legal claims. The debtor, therefore, may be without standing to pursue a future lawsuit arising out of pre-petition transactions, unless otherwise agreed
• Furthermore, filing for bankruptcy creates a public record and may pick up media attention, depending upon your business
• Time and monetary costs are also associated with Chapter 7.  In addition to attorney’s fees, the filing fee alone is $306 and the Debtor will have to pay Trustee’s fees if there are assets for the Trustee to liquidate. Plus, the Trustee’s fees come off the top of liquidation proceeds before any distributions to creditors are made.

The Wind-Down Alternative.  If you are a do-it-yourself personality, then the Wind-down approach may be the approach for you. In this scenario, you control the winding-down process of the company and pay off the debts. However, this do-it-yourself project may require a thick skin and much cooperation from your creditors and lessors.Perks of Non-Bankruptcy Wind-down:

• Winding-Down the business yourself avoids the legal and bankruptcy fees
• Business owner retains control and does not expose dirty laundry to the public
• Business avoids scrutiny by the Trustee
• Higher likelihood that you, the business owner with the industry know-how, will find a better buyer in the market who is willing to pay more for business assets

Downsides of Non-Bankruptcy Wind-down:

• Creditors may initiate an involuntary Chapter 7 bankruptcy petition against your business
• Business must comply with state laws for dissolving which are usually more demanding than the Bankruptcy Code and take longer to execute. If liquidation is done incorrectly, the business can be exposed to lawsuits for dishonoring creditors’ legal rights
• Business owner personally deals with all of the creditors and is responsible for all issues that arise.
• Debt forgiveness is taxable outside of bankruptcy

Now, do you file for Chapter 7 or Wind-down? In some cases, a hybrid approach may be best. Go as far as feasible in the liquidation process on your own, and then turn it over to a Trustee or a bankruptcy  lawyer to finish the job.  Weigh which option suits your needs the most, reflecting upon your unique business, the nature and amount of the debt that your business still owes, and your personal capabilities.  And, as always, it is best to first consult with your attorney.