My Small Business is in Trouble. Do I Need a Chapter 11?

This economy has been very rough on many people, but especially harsh on the small business owner. Small businesses don’t have access to the same tools available to larger businesses (access to credit, sale of stock or other security) to weather a stormy economy. Additionally, a small business may be reliant on one core line of business (construction of a certain type of building for which demand dries up) than a larger, more diverse business entity. So what can a small business owner do when the debts are deeper than the money to pay them? Unfortunately, the answers are somewhat limited and can be disappointing.

File a Chapter 11 Bankruptcy. This is the classic business bankruptcy, of which you have undoubtedly seen many examples in the news (pick an airline, the Phoenix Coyotes hockey club, GM and Chrysler to name a few). In this scenario, the business uses the bankruptcy court to help effect a reorganization of the debts of a company, often eliminating a large portion of amounts owed to vendors, and restructuring secured loans (mortgages on land, e.g.) to make for a more affordable debt load. Indeed, the last few years have seen a significant increase in the number of small business Chapter 11 filings. However, a Chapter 11 remains out of reach for most small businesses for a number of reasons:

• Cost of filing. Attorneys for a Chapter 11 are very expensive, often with fees in excess of $50,000. Many small businesses simply cannot afford that kind of outlay for legal representation.
• One large creditor. If most of the debt of a business is owed to one creditor, that creditor essentially has the power to scuttle any plan they don’t agree with.
• The business is no longer viable. It is often hard to admit, but sometimes the business has simply run its course, and needs to end, not restructure.
• Difficulty in obtaining ongoing financing. The credit squeeze has not only affected existing loans, but sharply limited the availability of new financing, especially for distressed businesses.

Informally restructure debts. In the instance of significant debt owed to one or a few creditors, it may be possible, if the creditor is willing, to restructure the debts sufficiently to allow for continued operation. This may require forming a new business entity to continue operations, or some additional personal risk for the owners of the small business. Absolutely consult with legal counsel before attempting this option.

Dissolve the business. Each state has a procedure for the orderly ending of business operations and paying creditors. Following these procedures will keep the officers, directors and shareholders of a business insulated from liability for the debts of the company (barring any personal guaranties or fraud). This has been done for many years, and is the method by which most businesses end. Your business attorney can help lead you through the needed steps.

File a business Chapter 7. Most of the time, it is neither necessary nor desirable to use a Chapter 7 to end a business. The state dissolution procedure is the preferred method. But there are circumstances when it is best to turn the liquidation of business assets to an independent third party (the Bankruptcy Trustee). If there are disputes over what property is secured by a given lender, and in what order they will be entitled to receive sale proceeds, then a Chapter 7 may be beneficial. But most businesses should not be in a Chapter 7, for they have no assets to distribute to unsecured creditors.

Generally I find that when a business owner refers to a “business bankruptcy,” they are referring to taking care of the personal obligations of the business, not the business obligations proper. In this case, they may be suited for a personal bankruptcy, but one that is primarily business-related debt. The distinction is fine, but important.

Remember, entrepreneurialism and the failure of businesses is the American economic way. Bankruptcy and dissolution are the methods that back stop our system, ensuring that the next great business idea can be developed without ruining the lives of the people behind the businesses.

Don't Be Like Lenny; or How to Behave During Your Bankruptcy

This post is inspired by the ongoing bankruptcy of Lenny Dykstra. Mr. Dykstra was at one time a very famous baseball player, and at a later time an apparently successful businessman with a line of car washes. As has been the case with many businesses (and former athletes), the success was built on poor fundamentals, and when the economy went south, so went Mr. Dykstra's business and financial situations.

"Nails'" story really isn't all that different from many of the people I see in my office everyday, save that he was playing with bigger numbers when it all came crashing down. The real estate and construction markets are nearly vaporized, and lots of hard-working people and families have been affected adversely.

What separates Dykstra's case from others in a more important sense is his behavior during the case. Mr. Dykstra has repeatedly sold property without court approval, ruined property (letting his dogs mess all over a house that was to be sold), and otherwise worked to the opposite ends than the bankruptcy court desires. As such, the judge has taken over his case, and Mr. Dykstra has been reduced to making half-baked claims about his superior will being critical to the success of his case. Needless to say, his case is not going well.

Every one of my clients come to me from a different place. The events that led to their arrival in my office are as varied as they come: job loss, medical expenses, divorce, failed business, stupid in college. But all of them have a desire to re-grasp control of their financial selves, and bankruptcy is a tool they can use to help regain that control.

But you have to want it, and you have to admit you need the bankruptcy code as an ally to get you there. Being too proud and declaring that you don't need help while standing in front of the bankruptcy judge is not a successful combination. The "fault" behind your filing may not be your own, but humility in the face of the situation is a must.

Some of my clients attempt to beat themselves up for failing; I try to stop them. A chapter 7 case is not a time for recriminations, it is an opportunity to move forward again. To be successful, you do need to closely and critically examine the "whys," but not dwell on them.

Do you need to make changes after you file? I would bet the answer is yes. You could become an expert coupon clipper, change your eating habits from restaurant to kitchen, find a more fuel-efficient car, or even stop smoking to spend less. Obviously your relationship with credit will need to change - perhaps a program like Dave Ramsey will work for you.

But a bankruptcy filing is a moment in time, that you can use to greater good, or waste by crowing about yourself like Lenny Dykstra. Use the opportunity wisely.

(And it is never a good idea to make the judge mad at you. Never.)