This blog is from a webinar that was presented by SunRay Construction Solutions, featuring Jordan L. Rappaport from Rappaport Osborne & Rappaport, PLLC. In this blog we will discuss how you can secure your right to be paid and to collect money especially if you are owed only a few thousand dollars.
There is oftentimes a misconception that bankruptcy is the end of the road, and that if a corporation files bankruptcy it is essentially failing or closing down. That is far from the truth in most cases. Many businesses reorganize and operate stronger and better than before. The US government and the US code allow bankruptcy and it would be unwise for a business owner to not look into all options when faced with financial difficulties.
Financial Issues Impacting your Business
Now we will talk about some common financial issues that impact a business.
a. Cash flow
Depending upon the type of business whether you are a contractor or pizza shop owner, you have to deal with cash flow. Cash flow is a relatively simple concept. You get money in and for expenses money goes out. Sometimes you may encounter something that will block or prevent cash flow from coming through wherein you know you have enough money to pay the expenses, but things got delayed, a project took longer, or business was off one month, but you know it will be better the next month.
For example, there is a company that owns a restaurant in South Florida and June was a particularly bad month for them because it rained every weekend. That affected their cash flow. So, when your cash flow is affected, you can see some the bills pile up. If it picks up the next month maybe you can meet those expenses.
But sometimes you encounter an insurmountable wall and you just need breathing room. You need something to protect you from the creditors who are coming after that month, for instance, a landlord.
b. Accounts receivable
Accounts receivable fall into the same category as cash flow, because you may be building up a tremendous amount of accounts receivable but unless you can collect those accounts, some of the bills may begin to pick up. Bankruptcy can stop those creditors from coming after the business, harassing you, and in some cases, offsetting those debts against an existing bank account.
A perfect example is where you have a line of credit with a financial institution and as part of the agreement with the financial institution, if you miss your payment, they can automatically debit your corporate account. That may pose a problem because that takes the control our of your hands, and they may take the money at an inopportune time.
You may find yourself balancing checks. That should be huge red flag that you may need to consult with a professional because it creates a downward spiral.
A more immediate and obvious concern is eviction. Numerous businesses have sad that during COVID, when the mandates were out there and people were not leaving their houses, landlords were giving them extra time to pay their rent or even forgiving a few months. But now that the mandates are gone and people are going out, they want that money back.
And if the business does not have the ability to pay, they will file an eviction proceeding. Now evictions are extremely dangerous to an ongoing operating business, especially for a restaurant or a retail establishment. It is also important to know that if in fact you get an eviction notice, you cannot wait until the last minute.
Eviction proceedings are extremely fast and extremely aggressive. If a Writ of Possession is issued, that means that it dispossesses you of possession of your establishment, and bankruptcy in that case will not help.
If the word eviction every comes up or you ever get a notice of default and a 10-day notice, that should probably be the largest red flag.
The last thing is a construction lawsuit. Sometimes a business is operating perfectly and you either have an old client or customer, or someone slips and falls and files a lawsuit against your company. Sometimes the cost of defending the lawsuit is just as great as what people are alleging, and especially if there are various construction lawsuits, bankruptcy may be an option. Once again, you should speak with a bankruptcy professional to establish whether it is more economical to reorganize your business and deal with those construction lawsuit cases.
A perfect example is a contractor who was being sued by a number of subcontractors (more than three). The cost of defending the lawsuits even if they won was so astronomical that they reorganized a business and offered the credits pennies and a dollar. It is a viable option, and it is something worth looking into.
Reorganization vs. Liquidation
Now when we talk about a bankruptcy of business, there are essentially two types – reorganization and liquidation. The terminology is a Chapter 11 which is a reorganization and Chapter 7 which is a liquidation. Each of these are clearly different.
a. Continuing to operate business
A Chapter 11 is where you continue to operate the business and these are traditionally more expensive types of cases. But if the business is viable and is facing one or two obstacles, then depending on the amount of debt and the amount that can be saved, it may be worth looking into.
For example, there was a distributor of auto parts and they had more than $4 million in debt. They reorganized the business to keep it operating. It never closed down even during the pandemic, and they were able to save over $3.5 million.
It is definitely a wise decision to reorganize, and the business is much stronger, and has much better financials now. They didn’t lose any employees, they actually hired additional employees. It was a great success but it took a lot of work and it was worth it.
b. Closing down business
There are other businesses where the business is no longer viable for a variety of reasons but there is still inventory and assets. A Chapter 7 liquidation or even a Chapter 11 liquidation may benefit the owner of that company in that when assets are liquidated, they can go towards paying personal lines of credit where the business is co-obligor or by paying sales tax or other tax that the business has not paid, in which the owner is personally liable for.
Liquidation advantages vs. Closing the door
It is important to understand that there are a lot of debt that businesses incur wherein the principal is jointly liable on. Sales tax and payroll tax are the most obvious. Companies sometimes file for bankruptcy solely to help the principal protect themselves either from sales tax issues or payroll tax issues. In some cases, for sales tax owed to the state, if not dealt with immediately can become criminal.
You cannot just close the doors and walk away, there be a more strategic way to address that.
Real Estate Reorganizations
There are a lot of single-asset LLCs or single-asset real estate cases. Someone may have created a corporation and invested in one piece of property or multiple pieces of property. An individual may buy a small rental building of maybe ten units and they know there is equity in there. Maybe they will put in a lot of money to fix it up. But they just need more time to sell.
a. Imposition of automatic stay
If you are trying to foreclose there might be a sale date set and there is equity in the property, they just need that time. People who invest in single-family homes fall into the same predicament. They own a piece of real estate, there is equity there, but they just need a little more time.
In that case, filing bankruptcy is extremely useful in that immediately upon the filing of bankruptcy. An automatic stay is created which stops the foreclose in its tracks. There are no ifs, ands, or buts. Once the foreclosure is stopped, and the company is in a bankruptcy, they in many cases will be able to propose a plan which has enough time to either auction off the property or just allow them additional time to market and sell the property.
b. Adequate protection considerations
The key there though, is that this additional time comes with a small price tag in that you have to pay the creditor what is called ‘adequate protection.’ What does that mean? The perfect example is let us assume you are behind $60,000 to your lender, but your monthly mortgage payment is $5,000. Well, if you are put in bankruptcy, you do not have to come up with the $60,000 all at once.
That is the reason you are filing bankruptcy but you will have to pay on a going forward basis. That is the $5,000 a month. That may make perfect sense. You dug yourself a small hole but you know there is equity above what is owed the lender and they are pushing you forward by applying pressure with a foreclosure action. You file bankruptcy and you pay them what is called the adequate protection.
During this time, you can market and sell the property while you are the protection of bankruptcy and when the property sells, the lender gets paid in full and whatever profit there is will go into your pocket. That is the reason you are filing bankruptcy. Without filing bankruptcy, that foreclosure will go through and all the equity will disappear.
c. Ability to sell free and clear of lien under 11 USC §363
The one additional benefit sometimes in the filing, say a Chapter 11 bankruptcy is that you can sell a piece of property free and clear of liens under 11 USC §363. What does that mean? That means if you have a piece of property that is worth $4 million, but there is $6 million of debt on it, how are you going to sell it?
You cannot pay $6 million on a $4 million asset. But in bankruptcy, you can arrange the sale so that it does get sold for let us say, $5 million, and then you can use the bankruptcy to deal with the other $1 million worth of debt. The benefit of this, is by selling it for $5 million, over a planned sale and marketing over time, versus a fire sale, you will get more value.
So, in that instance with a 363 sale, you are minimizing your loss. It is better to have to deal with a $1 million debt than a $3 million debt. The 363 sales are used quite extensively in multi-million-dollar bankruptcies whenever a real estate project goes underwater. We have seen hotels being fixed up and repaired wherein the debt on the hotel could be tens of millions of dollars more than the property is worth because of a variety of conditions.
That property is then sold through what is called a 363 sale in a a bankruptcy. It is a very powerful feature of bankruptcy. It is used in multi-million-dollar and sometimes multi-billion-dollar real estate transactions, and there are significant benefits if you know what to look for. So just because you have a project that is completely underwater, it does not mean that there is not a way to maximize the value of the asset versus throwing up your hands and letting it go through on a fire sale value.
Now we will talk about funding companies and mom and pop stores.
a. Prevent them from attaching working capital
Small businesses like pizza joints and small retail places can be awash in funding money. That means that everyone’s business gets inundated with offers for quick cash for the business. Like $60,000 within 48 hours. There are a lot of companies out there, even hard money lenders, and what they do is, they will lend you the money.
But before they lend you the money, they want to make sure there is a large stream of income going through let us say, a credit card machine. So picture a pizza joint wherein the business processes $20,000 a month through their credit card system. The funding company says they will give you a quick $50,000, but that you have to pay them back through your credit card system and they will get paid first.
b. How funding companies work and how to ‘stop the bleeding’
What that means when they get paid first is when that money through your credit card processor, they take that money right off the top. You do not have a choice on whether or not you are going to pay them. They are going to get paid first before anyone. That is the condition they are going to give you for loaning their money.
Many businesses, instead of making a $3,000, $4,000, or $5,000 a month payment, they are making those payments per week. It is coming straight out of their gross income. So, if want to skip a payment in one month they cannot, and these funding companies step to the front of all other debts. And sometimes they take so much of your gross income that you are unable to pay any other expenses.
In those cases, bankruptcy is extremely useful. Many times, there are no assets by which the funding company can secure their debts. This means that if a bankruptcy is filed, they have to stop attaching your credit card receivables. They fall into an unsecured category. That is a tremendous advantage in bankruptcy.
We have seen businesses fail because of those funding companies. If you are a small business and you have a lot of those type of debt, you should run (don’t walk), to find a bankruptcy professional because they will be able to help you save a tremendous amount of money and potentially reorganize and save your business.
You need to stop the bleeding. These funding companies will bleed you dry and you need to be aware that this easy money comes with many strings attached.
Let us assume you have a business, you have a lot of venders and you just had a streak of bad luck or bad business, you are not getting paid receivables, and you have a lot of unsecured debt. Well bankruptcy will stop any collection efforts from all that unsecured debt, allow you to reorganize, and potentially pay pennies on the dollar.
Now it is important to understand that a lot of small businesses are financed by their owner’s credit cards. It is very common to see a couple who run a business in the mall, like a small boutique. When they are asked what the business is, they say $100,000. But when you look at the actual paperwork, the credit cards are not in the name of the company, they are in the names of individuals – the owners.
The first thing they say is of course, that it is business debt and they want to get rid of it through a business bankruptcy. That is not how it works. Unsecured debt is in the name of the principal, then filing a bankruptcy for the corporation will not help it. A potential personal bankruptcy or at least seeing who is a co-obligor on that debt needs to be looked at.
So it is important to understand that while bankruptcy can allow a corporation to get rid of those debts and reorganize those debts. You will even see restaurants with a couple thousand dollars' worth of unsecured debt, be able to get rid of it through a reorganization.
If any owner or principal of the company or a member of the LLC is also liable or a co-obligor, then you need to expand what you are looking at and consider a personal bankruptcy too. That is not the focus of this article but it is important to understand that.
a. Grouping all such debts together
But businesses can get rid of a substantial amount of unsecured debt. Unsecured debt all gets grouped together and, in many cases especially through what is called the new Sub-chapter 5, you may be able to push through a plan where you are paying pennies on a dollar.
b. Percentage payouts
You may even get five or six percent sometimes. You may be able to push through without the credits even having a vote. So it is definitely something important to look at.
Examples of Various Types of Businesses
Now we will talk about the examples of a few different types of businesses.
a. Small restaurant
We mentioned a few times above, about small restaurants. Small restaurants like mom-and-pop restaurants form the backbone of most cities’ collection of restaurants. Most restaurants are owned by individuals, they are not chains or big corporations. They are just people who want to start a small restaurant and invest a lot of money. They even use their own assets like their life savings in it.
Because some restaurants are seasonal and because of COVID, a lot of these restaurants are hurting right now. It has been all over the news and everyone is aware that sometimes these restaurants have gotten PPP loans and maybe that has helped prop them up for a bit but there are no more PPP loans. Well, those companies may benefit extensively from reorganizing under what is called a Sub-chapter 5 or a standard Chapter 11.
They may have a tremendous amount of debt and a lot of them are in landlords. Those landlords are now knocking on their doors. Well now is the time to explore options before an eviction is filed before you get too far behind the eight ball, or before the landlord stop cooperating.
There are lots of landlord evictions happening because some landlords have waited well over a year in some cases. In some cases, offering reduced rent or putting rent in the back was done. If the landlords are not getting paid now, they are going to pull that trigger.
It is important for small businesses especially small restaurants to look at their bottom line and explore all the options. Because there may be ways to negotiate with a landlord through bankruptcy, maybe finding a better space that is a little bit cheaper, there may be a variety of options that need to be explored.
b. General contractor
We have seen a lot of cases filed over the past couple of years where people hire general contractors, they get in dispute, overcharges, change charges, and next thing you know the general contractor is in a $200,000 lawsuit regarding a home that was built two years ago. Companies spend hundreds of thousands of dollars if not more on attorneys fighting the lawsuit when they could have spent 50 percent or even less than that just reorganizing the business through bankruptcy.
There is a variety of ways to solve those problems and if you are served with a lawsuit, it behooves you to speak with whatever attorney you are going to hire to defend the lawsuit and figure out what the cost is. Explore options of resolving it that don’t involve chance.
For example, when a general contractor sues, there is a chance to win the case, and there is a chance of losing the case. But we guarantee you that win or lose, they are going to incur attorney’s fees. When you explore bankruptcy, it is not about winning or losing a case, that is irrelevant.
It is about analyzing whether there is any exposure to the company and then resolving issues without having to incur unnecessary attorney’s fees. You do not want to gamble on a judge or a jury making a decision.
In bankruptcy, it is much more black and white and you do not gamble on who is going to win or lose a a lawsuit. It is all about dollars and cents and sometimes it is extremely advantageous to view things from that perspective. Sitting down with an attorney, there is no downside to talk about those options.
c. Moving company
Moving companies are often sued for small amounts, but multiple lawsuits from customers that are upset or unhappy for one reason or another. So they spend tens of thousands of dollars or hundreds of thousands over the span of a year or two.
Resolving those issues and having to go to court is a process. If a company such as a moving company is being sued over and over again, there may be a way to draw a line in the sand and reorganize that business such that all those issues are resolved at once.
Bankruptcy excels at helping businesses solve multiple problems in one central forum. Instead of having to fight ten battles in ten different cases, even if you have just one or two attorneys you can solve all those problems at once.
d. Individual doing business in person’s name
Lastly, is an individual doing business in a person’s name. This is more of a misnomer, because what happens is that a lot of times individuals will conduct business as a DBA. This means that they do not actually have the protections of a corporate entity. The reason why people set up businesses, LLCs, sub Ss, or C-corps is to shield themselves personally from corporate liability.
Sometimes the corporations are not active, sometimes you just operate as a DBA. Sometimes you just set up a company, you call yourself something else, and you are actually operating your own name. In those particular cases, you can still examine bankruptcy options, but you will predominantly be looking at a personal bankruptcy.