Bob owns an independent bookstore, aptly named Bob’s Books. After many successful years, e-commerce has unfortunately taken its toll, and Bob cannot compete with the large e-tailers. In addition, the neighborhood around Bob’s Books has changed, and Bob did not see the foot traffic he once did, even before the COVID-19 pandemic. Now, with the pandemic, Bob’s Books must close permanently.
Although bankruptcy can help save a business, sometimes it cannot be saved and must close. However, there is more than one way to close a business, and the decisions that its owners make during these perilous times can have serious consequences.
Bob’s Books owes hundreds of thousands of dollars to its creditors. It owes money to its landlord for back rent and accelerated rent; money to publishing houses and other vendors; and it is involved in litigation with a customer who was injured in the store. However, even if bankruptcy could magically wipe away these debts, Bob’s Books simply cannot earn enough revenue to survive. What can Bob do?
First, Bob must understand that he has a legal duty to his creditors, a “fiduciary” duty, to exercise his business judgment in such a way as to preserve the value of his business’s assets for the benefit of creditors. Therefore, any decisions he makes now can be scrutinized later. Also, Bob can be held personally responsible for certain of the company’s debts, such as taxes and any obligations that he personally guaranteed. It is very important that he close the business in a responsible way. What are his options?
Chapter 7 Bankruptcy
Many people think of Chapter 7 bankruptcy, which is a liquidation, as the go-to option when a business must close. In a Chapter 7 corporate bankruptcy, a trustee is appointed who liquidates the company’s assets for the benefit of the creditors. However, there are repercussions to filing a corporate Chapter 7 bankruptcy. Oftentimes, there is added scrutiny of the business owner’s past activities. A trustee can, for example, perform a forensic review of a business’s finances, going back many years, which can sometimes lead to the trustee actually bringing claims against the business owner over past irregularities.
Assignment for the Benefit of Creditors
An Assignment for the Benefit of Creditors, called an “ABC,” is another option. An ABC is a state court procedure available in many states, where the company selects an “Assignee,” who acts like a bankruptcy trustee and liquidates the company’s assets for the benefit of creditors. An ABC is usually less contentious than a Chapter 7 corporate bankruptcy and can afford the Assignee greater flexibility in the way it liquidates assets. Most notably, an Assignee can sell certain assets back to the business owner; an option that is usually unavailable in a Chapter 7 corporate bankruptcy.
State Court Dissolution Procedures
Many states also have dissolution procedures available through their business corporation statutes. These procedures are similar to those of a Chapter 7 corporate bankruptcy and ABC proceedings but can be more difficult to work through, more time consuming, and less flexible. In general, the other procedures offer more efficient ways to close a business.
Out of Court Workout
Finally, a company may not need to file a formal liquidation proceeding at all. An “out of court workout” can take many forms. Sometimes, a business with very few creditors can simply return the premises to the landlord, notify its creditors, and close. Or, a business can negotiate with its creditors regarding payment, and come to an agreement on what the creditors will be paid, and then close. Formal bankruptcy or ABC proceedings can sometimes invite unwarranted attention (and expense) when the matters can be dealt with out of court.
Business owners saddled by debts have options, including bankruptcy, to try to address them. But, as we will see in our next article, going through a bankruptcy, or pursuing other options to close a business, may not necessarily clear the decks of all creditor claims; some may yet survive to plague the business owner. So, Bob still needs to think strategically about his post-liquidation future.