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The Myth of Chapter 11

Want to use bankruptcy to renegotiate with your company's lenders? Sorry, only big boys play that game

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Preparing for Bankruptcy

The best approach is to plan ahead. Nevertheless, Guben notes, most of his clients — even sophisticated business people — come to him at the last minute, often prompted by an eviction or foreclosure notice. “So we’ll file and see how things turn out in the next couple of hours,” he says. “Because I’ve got to be in court within 24 to 48 hours on something called ‘first-day motions.’” It’s this rush that’s one of the biggest differences between the bankruptcies of small companies and large corporations.

“Take a look at the Hawaiian Telcom case,” Guben says. “They must have filed 60 or 70 motions on the first day.” That’s because they began planning months earlier. “They knew that, on Nov. 30, they would not be able to make their debt-service payment, and they started to prepare their first-day motions. I haven’t got that luxury in local bankruptcy cases. So, it’s a real scramble. That’s why, without advance preparation, they’re not as successful.” That doesn’t mean you can’t negotiate with your creditors— ideally long before you declare bankruptcy. “The creditors are willing,” Guben says. “In this day and age, they’re being squeezed, too. That’s why General Growth is negotiating ‘give-ups’ with most of its tenants now. It’s better to cover something than nothing.”

Signs that can alert creditors

Of course, most of the people affected by bankruptcies aren’t debtors; they’re creditors. Just like the business owner, creditors are much better off planning ahead, says Tina Colman, a creditor attorney with Alston Hunt Floyd & Ing. That means keeping your eyes open for telltale signs of trouble. Some, like late payments, are obvious. Others are subtler. “Lot of times, you have problems when the generations change,” says Colman, pointing out that the children of founders may not have the same work ethic or business acumen as their parents. One of the best bankruptcy watches is well-trained sales people. “Because sales people are on the front line with the customer, they’re the ones who will notice changes in the company,” Colman says. “If you chat with the owners and they tell you that they’re thinking of retirement: red flag. The wife says, ‘My husband’s real sick:’ red flag.”

Bankruptcy Court judge Robert Faris
says most small companies don’t have
enough money or a workable plan to get through Chapter 11.
Photo: David Croxford



What do you do with that information? “Start watching how you get paid,” Colman says. “Put them on C.O.D. Try to get some collateral.” The important thing is for the creditor to initiate a discussion, Colman says, because the debtor, in all likeli-hood, won’t. “There are embarrassment issues. Loss-of-face issues. Honor issues. You’ve got a lot of delicate things that mitigate against people being forthcoming about their problems.”

Thinking ahead

According to Ken Gilbert, senior consultant and partner at Business Consulting Resources Inc., proper planning for failure begins even earlier. Gilbert has a more than academic appreciation of bankruptcy. Thirty years ago, after flirting briefly with big success, his first company in Hawaii failed spectacularly. (Full disclosure: This writer’s father was a partner in that business.) “What I learned through that whole process,” Gilbert says, “is that you have to plan, protect and insure against the potential downfall of the business.”

Some of that planning is preventive. For example, any bankruptcy attorney can advise you about assets that are exempt in a bankruptcy proceeding. Faris points out, “Retirement plans are pretty much protected. Life insurance is basically exempt. And then there’s tenancy-by-the-entirety.” The latter is a way to structure the ownership of your home so that it can’t be used to secure a business loan without a spouse’s express approval. But these assets should all be in place years in advance.

Like Colman, Gilbert also recommends being more vigilant — preplanning for critical thresholds. “Let’s say you have $150,000 of corporate money in the bank and you start to see some of these trends. If you had planned and preplanned for financial distress, you might have decided that the maximum of that $150,000 that you’re prepared to lose is $75,000.”

“At some point,” Gilbert says, “you have to make these difficult decisions: to downsize; maybe to move the company into the second bedroom of your house; to go from 15 employees down to six. To protect what you have.” Noting that this goes against the basic optimism of most entrepreneurs, he adds, “I would rather be in the situation where I have to rebuild than be up against the wall with no options.” This planning should happen in good times, not bad. “That’s when you go to see a bankruptcy lawyer,” Gilbert says.

 

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