It is a well-documented fact: most small businesses fail. All too often, I advise business owners and officers on what to do when it looks like the company just cannot make it another month. What to do? Should the business owners file for bankruptcy? Should they file corporate dissolution papers? Or should they just walk away from the whole mess and leave the shell corporation to die a slow, natural death?
This is actually a complex topic that requires good legal advice. But the one teaser I will give you is that, in my experience, more often than not, just walking away is actually the right answer (with some caveats). Dissolution and bankruptcy are sometimes both right, too.
But what you absolutely cannot do: ignore it and literally walk away while Rome burns behind you. Once an officer or owner of a business becomes aware that the business is insolvent or virtually insolvent, he or she has a duty to the business’s creditors and shareholders to make decisions that protect the creditors and shareholders interests. That is why you must consider whether bankruptcy, dissolution, or leaving an empty shell is the best solution. Otherwise, you may end up being personally named in a lawsuit. If you have assets — the reason for forming a corporation in the first place — you do not want to be embroiled in something that could drain you and your finances for several years after the business has already died.
So, very broadly speaking, what are your options?
1. Bankruptcy. Businesses can bankrupt, and a liquidation can be similar to a personal total bankruptcy (they are both Chapter 7). Bankruptcy may not get rid of all the liabilities, however. First, there is no such thing as a “discharge” for corporations — that means that the debts stopped being collected on against the company as it dissolves, but they do not disappear if the business wants to start up again. More importantly, if there are any personal guaranties by owners or officers, the bankruptcy may simply accelerate those, because they would not be stopped by the bankruptcy. So it is necessary to determine whether there is any protection or advantage to filing a bankruptcy. If there are, owners and officers should seriously consider it. Bankruptcies ultimately are neat and final and wind everything up permanently.
As an aside, there is such a thing as a debt reorganization bankruptcy for a business — i.e. Chapter 11s — and if the business is viable, that might be the best route. You will need experienced bankruptcy counsel before going this route. Reorganizations are expensive and frequently fail. But they do offer the chance to save a company and have been used effectively by some of America’s biggest corporations.
2. Dissolution. If the corporation is done and can be wound up, dissolution is the legal way to do this. What this means is that the corporation winds its business, and the shareholders file a document terminating the business entity with the Secretary of State. This has the advantage of finally ending the affairs of the corporation, but can trigger personal liabilities if not done properly. If you are a Type-A personality, you may choose to go with this option because it just feels neater. It also allows you to be in front of liabilities and wind them up so you can move on with life.
3. Empty Corporation and Suspension. When I first began practicing business law, I was surprised to learn that this is a very common practice. It is essentially the “you can’t get blood from a rock” strategy of corporate wind down. The company winds up its affairs as best as possible and simply stops conducting business. Any liabilities that remain exist in theory, but are noncollectable in practice. Eventually the Secretary of State suspends the corporation for failing to adhere to certain requirements, like paying the franchise tax. The corporate entity exists, but only in an empty-husk form. In many cases, this is a real and surprisingly cunning strategy.
So, if you are ever faced with this unpleasant prospect, which should you choose? That depends on what your books say, what your liabilities are, how much personal skin you have in the game (i.e. personal liability), and what you plan to do next. The best thing to do is just call your lawyer, who can give you some savvy and realistic advice on how to maneuver through the depressing bone yard of the dead and dying business. You may be surprised at what you can end up salvaging for your next (hopefully more successful) venture. Contact our business law and real estate law attorneys today for a consultation.