How to Avoid Business Bankruptcy: 7 Moves While Cash Remains

Many a business has started with no cash, and in the same way many others can come out of a cash shortage. But your first charge is to pay all payroll taxes taken from employees to date. Then call the IRS to set up a pay plan. Use SBA EIDL relief if you can qualify. Seek lease reductions, free advice and counseling, know what costs you will face in bankruptcy. Your decision will be an informed one.

Your options for paying now are cheaper than your options when there is no cash left. After that money is gone, the cheapest choices have too high a threshold or cannot be started. And then what’s available will all take longer and end up being costlier.

Trust Fund Recovery Penalty

Withheld employee taxes are a hornet’s nest. The IRS treats them as a trust fund. If you don’t pay them, the IRS can charge each person who has the responsibility to pay tax obligations and can write a check (including you as the owner) 100% of the unpaid tax - it’s called the Trust Fund Recovery Penalty. The IRS will try to collect that amount not just from the company but personally from anyone who controls which creditors get paid and willfully fails to pay. Anyone who knows the tax is not getting paid, then spends the money on another creditor instead, risks being seen as “willfully” failing to pay the tax.

Paying the IRS is never fun, and it is a mess if you are in a cash crunch. To set up a payment plan, you need to call 800-829-4933 or the number on the notice. An Offer In Compromise settles the debt for less than the full amount, but it involves a $205 fee, which cannot be waived for low-income businesses.

If you have a COVID-EIDL loan, you can ask the SBA to cut your payments to half for six months - but only once every five years. To qualify, you can’t be more than 90 days past due on your current loan; you must still be open and operating; and no owner can be in a bankruptcy filing that is currently active. If a loan is 120 days delinquent, SBA might hand it off to the U.S. Treasury Offset Program to recover the debt. So if you think it applies, ask early and be specific.

You may not realize what a well-intentioned attempt to keep the business going can do to you later, if that plan does not work. You might think that repaying your own loans is your own business, but under bankruptcy and collections rules it isn’t so simple. If the business later files a bankruptcy, its trustee can take back or “avoid” certain payments made to general creditors if they were made within 90 days of the filing. Payments to owners and relatives count as insider payments and they extend back one year. Moving assets away for less than fair value to keep them away from creditors can be undone within two years of bankruptcy filings if the business was insolvent.

Talk to landlords and counterparties before your business falls too far behind: your landlord or counterparty will likely prefer steady payments under an ongoing lease to an unsecured claim in bankruptcy that may be worth much less. Chapter 11 bankruptcy lets you decide which contracts and leases to keep and which to reject, subject to court approval. Reject a lease and its unpaid rent becomes an unsecured claim that may well not be paid in full. At that point, a landlord would be better off to reduce your rent to something that you can afford. Contract counterparties have a similar incentive to take a lower payment while they still can.

You may think you’re the only one facing these dilemmas. There are a lot of people out there who want to help you through this, including SBA resource partners such as SCORE and Small Business Development Centers that offer free or low-cost counseling.

These choices may not be enough for your business. If not, there are more drastic solutions, and the time to learn about them is before they happen to you.

Chapter 11 bankruptcy lets a business stay open and reorganize its debts. On filing, what is known as the automatic stay halts most collection efforts and lawsuits, and existing management usually stays in control as debtor-in-possession. But it’s complex, expensive, and can take several years. You need to go before a judge to get approval of your reorganization plan, so you need lawyers and advisors for the process. Creditors committees may oppose the plan you propose.

Subchapter V is new, and for businesses with total debts of no more than $3,424,000, it opens the door to keeping equity even if all creditors are not paid in full. It’s also cheaper and runs on a stricter timeline than the old Chapter 11 structure. A trustee is appointed to help get the parties to a consensual plan, but only the business can file a plan. You need to file within 90 days. There is usually no creditors’ committee appointed, and you usually do not need to file a disclosure statement, either. There are also no quarterly U.S. Trustee fees to worry about.

If you really have no prospects for paying vendors or staying afloat, a Chapter 7 bankruptcy shuts down the business and usually leaves most owners with nothing. And the business doesn’t get a discharge, and certain creditors can still come after your personal guarantors for their claims. And none of this touches the trust fund taxes that owners can owe personally. A trustee sells assets to raise money and pays the creditors in a strict order.

The cash you have now is what gives you choices. Don’t lose that advantage.