Avoid a Plunge into Bankruptcy

Although many businesses look forward to putting 2021 in their rearview mirrors, some economists suggest 2022 could be even worse, with inflation and supply chain delays causing a slowdown or perhaps even a recession. 

Many struggling businesses try to navigate their financial difficulties alone, yet that can put them at greater risk. Making smart decisions now, including implementing the following tips, can slow — and possibly even prevent — a plunge into bankruptcy.

Get the full picture. It’s important to understand the legal and tax consequences of a company’s past and future actions, as well as those stemming from current inaction. Attorneys, accountants and consultants can provide information and analysis needed to make informed decisions.

Understand all obligations. Reading and comprehending documents governing the business’s obligations is critical; failure to thoroughly do both can result in severe consequences. Because most people do not have the expertise or experience to review and understand concepts such as subrogation, joint and several liability or non-recourse carve-outs, consulting an attorney to review and evaluate key documents helps them get a better grasp on their options. 

Cultivate relationships with customers, vendors and creditors. A good relationship can mean the difference between lender cooperation and a battle to the financial death in which the creditor is determined to crush the debtor no matter what the cost. Maintaining periodic contact and keeping the lines of communication open is vital. If that becomes difficult, an attorney can protect the business without needlessly antagonizing opposing parties.

Focus on the business. Some businesses try to postpone the day of reckoning by refinancing debt when they should instead concentrate on generating income and minimizing expenses. The business cannot take care of itself; focusing on strategies for business development and marketing is much more effective than struggling with problems better left to attorneys and accountants. 

Beware of third parties with adverse agendas. Creditor representatives, commission salespeople and unlicensed up-front fee consultants often have a conflict of interest or lack substantial experience and qualifications to help businesses successfully resolve financial difficulties. 

Even if these agencies are successful in obtaining a loan workout agreement, the agreements are usually very one-sided (in favor of the lender), poorly written and empower lenders even more. Frequently, loan workout agreements compel a business owner to reaffirm the debt, eliminating any chance of contesting it.

Such agreements are usually written by banks, which are aware the business will continue to have problems in the future and likely file bankruptcy at some point. This is exactly what banks want, since they get to keep all the money paid under the terms of the loan workout agreement, in addition to the collateral after the business files for bankruptcy. Thus, all the money that was paid under the terms of the loan workout agreement is lost.

Hold on to cash. One of the largest mistakes businesses make is waiting to file for bankruptcy until they don’t have anything left.

With outstanding debts, everyone will want a piece of the cash. Many creditors act like businesses have plenty of money to spare, failing to recognize that having spending money isn’t the same as having money tied up in a lease, payroll or daily expenditures. Businesses should pay the most urgent expenses first to keep the business running.

Another common mistake is using exempt assets that could have been saved to pay debts that could have been discharged. Such assets can often be preserved from creditor claims, especially with the help of an attorney.

Recognize when the cause is lost. After exploring all options, sometimes bankruptcy alternatives are the best way forward. The longer struggling businesses wait to get good legal advice, the fewer options they will have. There are new bankruptcy options that began shortly before the pandemic, including the use of a subchapter V form of Chapter 11 bankruptcy. Turning to competent and experienced counsel helps businesses make educated and informed decisions on their financial future, including how to minimize losses and maximize assets.

Preparing for the worst is painful, and many businesses will need to make some tough decisions in the months to come. However, pre-bankruptcy planning gives many of them hope for the best.   

D. Lamar Hawkins is an attorney with Guidant Law Firm. He is an eight-term chair of the Arizona Board of Legal Specialization’s Bankruptcy Law Advisory Commission and one of Arizona’s foremost experts on bankruptcy law, debt restructuring, loans and loan workouts.

Did You Know: According to S&P Global Market Intelligence, U.S. corporate bankruptcies reached their worst levels in 10 years during 2020. 630 public and private companies with assets or debts of at least $2 million declared bankruptcy, surpassing the number of filings in every year since 2010.