A common misconception is that filing for bankruptcy means financial failure. This could not be further from the truth, especially when it comes to businesses. Most businesses that file for bankruptcy do so in order to be able to continue operating. Bankruptcy is simply a tool that allows a business to restructure its operations and finances in order to become profitable. In fact, bankruptcy is often a more effective tool than non-bankruptcy alternatives, because the Bankruptcy Code provides mechanisms for restructuring debt, and obtaining new financing, that are not available outside of bankruptcy.
Naturally, not every business can be saved through bankruptcy or reorganization. A full analysis of a business’s financial situation and eligibility for bankruptcy reorganization can get very complicated. But, in simple terms, to determine whether bankruptcy is a good option, the business owner must answer two simple questions.
The first question is: does the business generate revenue or have a potential to generate revenue? In other words, does the business have value as a “going concern?” Why is this important? The goal of the reorganization process is to save the business and to allow it to continue operating. In order to do that, there must be something to save. If the business has no value as an existing operation, or a “going concern,” there may not be anything to save. Another way to look at this is to ask whether it would be of any financial benefit to try to save the existing business, as opposed to shutting down the existing business and starting a brand new business doing the exact same thing. If there is no financial benefit, then reorganization probably does not make sense.
Of course, a business may be currently struggling to generate revenue, but have a potential to generate revenue with changes in its operations, or with changes in external factors. For example, a business may have a large customer list that it can utilize to increase its revenue with better management. Or, in the case of a retail business, the drop in revenue may have been caused by external factors, such as road construction restricting access to the business’s storefront, which are temporary. In such cases, bankruptcy can provide the business the opportunity and breathing room to institute the necessary operational and management changes, or to weather the impact of the construction, as the case may be.
The second question to be asked is: are the business’s debt service, or its contractual obligations, preventing the business from being profitable? If the answer is yes, then bankruptcy could be the solution. Let’s delve into this a little more. Any business will have a number of different ongoing expenses. Some of these are tied to the size of the operation and are, for all practical purposes, unavoidable. These include utilities and employee wages. Wages, for example, can be managed by reducing the number of employees, or by reducing the rate of compensation. But any business will require a certain minimum number of workers without which it cannot function, and in order to obtain those workers the business will have to provide a certain minimum level of compensation that is generally determined by the market. This minimum expense cannot be avoided.
There are other expenses, however, that may be fixed, but are not unavoidable in the sense that they are not required for the successful operation of the business, and may in fact impede the business’s success. For example, in a common scenario, a newly-formed business may enter into a long-term contract with a vendor or a supplier on unfavorable terms. The business may be forced to accept these terms because it is new and lacks negotiating leverage. As time goes on, better options for the service or product become available, but because there is no easy way to get out of the unfavorable contract, the business is forced to continue using an inferior product or service, or to overpay for it, or both. Bankruptcy addresses this problem by allowing the business to reject unfavorable contracts and leases.
In another example, a business may purchase a significant asset like real estate or an expensive piece of equipment, and finance it through a loan. As time goes on and the business’s circumstances change, the original payment terms may become impractical. However, as is often the case, the lender may not be willing to renegotiate the payment terms. If the real estate or equipment is necessary for the business’s operation, the business is then facing not only the loss of the asset, but the termination of its operations. In such cases, bankruptcy can also provide the solution, because bankruptcy allows for modification of payment terms on secured debt, even without the lender’s consent.
These are just two examples, and there are a number of other situations commonly encountered by businesses for which bankruptcy can provide the most efficient solution. The best approach, of course, is to promptly consult a competent business bankruptcy lawyer as soon as the business begins experiencing financial difficulties. Even if bankruptcy ends up not being the right solution for the business’s difficulties, a good lawyer can suggest strategies on dealing with the financial problems.
The above is provided for general informational purposes only. It is not intended to and does not constitute legal advice, and does not create an attorney-client relationship. If you need legal advice for your specific situation, you should contact a qualified attorney in your area.