Managing a Business in Financial Distress Prior to Closing

The number one goal in managing your financially troubled business, especially if you're closing down, is to avoid personal liability resulting from the actions you take or fail to take. Even if your business is set up so that your are not personally liable (e.g., corporation, limited liability company, limited liability partnership), you may lose this protection in part or in whole if you are not careful.

It should go without saying that debts don't disappear after a business closes down, nor does any liability for defective products or employment-related disputes. Managing a business in financial distress prior to closing is not an easy task, but the following tips can help you dissolve your business entity without inviting lawsuits or other problems.

1. Pay your taxes first: It is essential that you keep your taxes current. The Internal Revenue Service can hold you personally liable for unpaid taxes. Make especially sure that taxes withheld from employees' salaries are paid on time. Keep in mind that even if your tax payments are late, the IRS has a policy that may reduce or eliminate penalties. This requires that you keep meticulous records of business expenses, and that these records prove that you cut out all unnecessary expenditures AND made tax payments to the IRS your number one business priority.

2. Update your business records and financial statements: This will give you a clearer picture of where you really stand and will allow you to set priorities appropriately.

3. Don't co-mingle personal funds with business funds: When businesses are in financial trouble, owners often seek to keep them afloat with personal loans to the business, the use of personal charge cards, or the use of other personal assets. Co-mingling personal and business funds opens up the possibility that creditors will seek to "pierce the veil" between you and your business. If they are successful, you become personally liable for the business debts. Although "piercing the veil" is most often thought of in relation to corporations, it is also a creditor's strategy in collecting the debts of limited liability companies and other business structures that protect the owners from personal liability.

4. Don't hide your debts: If you are attempting to get new income into the business through outside loans, you need to be honest about the business's condition. Hiding debts and other financial circumstances is fraud. Not only will you find yourself personally liable for the loan, you could also face criminal charges.

5. Avoid making preferential payments to your creditors: If you have to file bankruptcy, all payments that your business made for at least the prior year will be scrutinized. If the court finds that certain payments were made preferentially, it can order that those payments be returned. Payments that you can make without worrying about preferences include salaries, rent, payroll, retirement plan contributions, insurance premiums, utilities, and vendor payments.

6. Use caution in transferring business assets: Creditors know how to discover where your property went. The company car must remain the company car. Giving it or selling it for a fraction of what it is worth to Uncle Joe is a fraudulent transaction. Don't even consider hiding business property or income from a court.

7. Make plans to continue or obtain insurance coverage: This includes health, life, automobile, and any other insurance that you may have through the business.

8. Protect your bank account: Determine whether your outstanding business loans give the lender the right to take funds from your account without notice when you fall behind on payments. You may wish to move your business account to another bank. Remember that your number one goal is to keep up with tax payments. If your lender empties your account, the check you just wrote to the IRS will bounce.

9. Set priorities: Make a list of creditors that must be paid for you to continue operating until you can close the business on the most favorable terms. Conducting an asset sale and winding up business affairs takes time.

10. Consider bankruptcy immediately: Don't throw good money after bad! If nothing can be gained by adding additional capital, don't do it. Straight bankruptcy (Chapter 7) and reorganization (Chapter 13) are serious acts that will negatively affect your credit rating for years. At the same time, both options allow you to get beyond the financial troubles and provide the opportunity to start over. Although Chapter 7, in theory, gives you a completely clean slate, it is also more damaging to your credit history. Chapter 13 allows you to pay off your debts over time and is less harmful to your credit history, but it may not be practical if your debts are high and your future income is not enough to meet these debts while supporting yourself and your family.

Need Help Closing Your Struggling Business? Contact a Business Lawyer

If you're shutting down your business, then it likely is in financial distress. But just closing shop and walking away can have disastrous effects, since there may be creditors, customers, employees, and other stakeholders involved. Before you make any major decisions, make sure you discuss your situation with a licensed business and commercial law attorney near you.