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VEGAS INC COVER STORY WHAT TO DO WHEN FILING A BUSINESS BANKRUPTCY • H represented by a lawyer. • Prepare financial statements with an attorney, bookkeeper or accountant. In Chapter 11 bankruptcy cases, monthly operating reports must be filed so it's important that an appropriate accounting system be in place. • Attend an "initial debtor interview" with the office of the Closing a business and walking away United States Trustee, which is part of the U.S. Justice Department and monitors and participates in the bankruptcy process. This is necessary for Chapter 11 cases. • Attend a "341 Meeting" with creditors. These are typically scheduled about a month after bankruptcy filing. Creditors can ask the debtor's representative questions under oath about the company's finances. • Provide for Chapter 7 cases financial records requested by the appointed trustee. • Attend required court hearings. way, attorneys need to • Discuss with an attorney "fraudulent transfers," which involve money inappropriately taken out of a business while it is headed for bankruptcy and while creditors have a claim to finances. • Discuss with an attorney whether Chapter 7 bankruptcy makes sense for a business that is closing. Under Chapter 7, a trustee can look for fraudulent transfers going back four years. • Discuss with an attorney whether to communicate information about a bankruptcy to customers, suppliers and employees. • Discuss with an attorney whether to seek new financing or investors to hold onto a business. • In Chapter 11 cases, discuss with an attorney any responsibility as a fiduciary to the bankruptcy estate. -Steve Green "If you're just willy-nilly saying 'invest Individuals, too, can file for Chapter 11 14 If an owner wants to bring in inves- may be the only option. tors to keep a business afloat, they may demand stringent terms to protect them- selves from risk. Even so, that can be a vi- able option as long as there is a solid plan, Larson said. A Chapter 7 bankruptcy is a liquidation in which a business has or will shut down. A Chapter 11 bankruptcy is a restructur- ing and is typically used by businesses that intend to continue operations. COMPLICATIONS N ot every debt-restructuring deal or bankruptcy goes smoothly. All kinds of complications can crop up. Borrowers and lenders might not agree on the fair market value of a property. If | 2 JULY 2012 | "The reason you do this is not necessar- ily for the benefit of the business because when you walk away, you shut down the business. It's usually because there's a personal guarantee and they want to get rid of the personal liability," Creighton said. As for short sales or deed-in-lieu-of-fore- closure transactions, those are the equiv- alent of closing and walking away from a business without having any obligations remain related to the real estate. For example, "if you have construction equipment that has to go back (to the fi- nance company), your deficiency can be $200,000 to $300,000," Larson said. "So that individual is going to have to file per- sonal bankruptcy most likely." be paid for only one bankruptcy, not two, Larson said. Zach Larson instead. That When an owner is burdened with hefty personal guarantees, it might make sense for him to close the business without filing for bankruptcy and to file for personal bank- mercial property, ruptcy Another alternative is to privately re- structure the company's debt on terms that make sense for both the lender and borrower and that take into account cur- rent economic realities. This avoids the typical scenario in which a lender starts a foreclosure proceeding against a com- then files a lawsuit asking that a receiver be appointed to supervise the property while it's being foreclosed on -- with receivers typically charging hundreds of dollars per hour for their work. "It makes financial sense for all parties involved to avoid bankruptcy, to avoid litigation, to avoid a receivership, which is very expensive," Creighton said. "Unfortunately, you're limited some- times in the behind-the-scenes stuff," Lar- son added. "That's largely dependent on who you owe money to. Will they be able to work with your debtor? If it's a public entity, if it's Bank of America, they're lim- ited in what they can do." FILING FOR BANKRUPTCY I For businesses that plan ahead and hire lawyers and financial advisors early enough, bankruptcy can be a simple and enterprise-saving exercise. Commercial real estate defaults are responsible for many bankruptcies, and the Bankruptcy Code offers a simple and effective way to deal with those defaults: a "cramdown." In that scenario, debt against a property is "crammed down" to its current market value, yielding more affordable mort- gage payments for the borrower. Banks and other lenders have to take a loss, but their loss typically would be the same or greater if they foreclosed on the property and re-sold it in the depressed market. "With single asset real estate entities, Chapter 11 gives you the opportunity work with your lender on a resolution and possibly cram down (the secured debt) to the fair market value," Creighton said. "It's usually in the best interests of all parties involved and can be done to where the en- tity can continue to survive and the bank gets fair market value for the property. With a Chapter 11 business bankruptcy, theoretically you can be in and out in six f a business has failed to deal with its financial issues early on or has tried to re- months." solve them without success, bankruptcy "I often tell my clients: 'Save your mon- ey. Don't pay me, just close your doors,'" Larson said. upside and you don't have that skill or that make the debt go away, generally speak- desire, that business may be marketable for a sale," he added. ing, but I can't make their life what it was." can make sense when an owner hasn't ment costs are too high, no one is going to want to buy that business." made a lot of personal guarantees for leases and trade accounts or is willing to deal with the consequences of those guar- antees. "But if you're struggling because, as a business owner, you're not properly mar- keting the business, there is a tremendous getting a bank to agree to a short sale in which a property is sold for less than its mortgage, with the bank agreeing not to pursue the deficiency; finding investors to pump money into the business; or sell- ing the business and negotiating a mort- gage modification aimed at keeping it operating. ire an attorney. Businesses filing for bankruptcy must be They include shutting the business down and walking away; turning prop- erty over to a bank to avoid foreclosure and further personal liability through a deed-in-lieu-of-foreclosure transaction; OF BANKRUPTCY T DEBT REDUCTION OUTSIDE here are many alternatives to put- ting a business that's losing money into bankruptcy. because it will turn around,' that's a bad idea," Larson said. "You're getting your- self into deeper trouble if it doesn't turn around. Now you owe not only Bank of America, but you owe your brother or your parents." The lawyers also said that selling a struggling business in this environment can be challenging. "A lot of clients think their business is still valued at the 2005 or 2006 (level), but at the end of the day, their business is generally not going to be worth what you owe. Otherwise, they would have sold it al- ready," Larson said. "The problem is, if you're struggling, who's going to want to buy a struggling business?" Creighton asked. "If your costs are too high because of the lease, or equip- if they have business obligations or can't file for Chapter 13 because their debt is too high. Local lawyers say the biggest problem they see locally with business bankrupt- cies is business owners who wait too long to deal with debt or who file for bank- ruptcy and in the interim invest their life savings into a sinking enterprise with no hope of getting it back. "The single biggest issue most business owners have is not seeking advice soon enough," Larson said. "If you have a viable business model and you can see where it's going to go or you think it could go there, it's much better to do it earlier than to just sink every last asset you have into the business." "The bad days are when I have someone who is 65 and they have bled into their business for 30 or 40 years," Larson con- tinued. "It was successful, it weathered the '70s, the '80s, the '90s and the 2000s. And now they're here and they're done. I'll 20120702_VI01_F.indd 14 6/28/12 3:09:43 PM