When Times Get Hard
J. Robert Nelson
In this time of low interest rates, increasing employment and improving consumer confidence, it may be difficult to envision, let alone prepare for, difficult times. Appreciation of the good times always should be tempered by the realization that business is cyclical and that good times are not permanent. Whether driven by increased interest rates, competition, an unexpected disaster, sector weaknesses, increased operating costs, reduced demand, bad management or just bad luck, circumstances can change, sometimes very quickly.
Many business owners react to “thickening clouds” with a combination of disregard, disbelief and paralysis. The experience of a friend of mine illustrates the point. My friend, call him John, had a highly successful insurance brokerage with a number of major corporate accounts. His success supported an expensive lifestyle, including a lavish entertainment budget needed to maintain favorable relationships with his high profile clients. When things turned, they did so quickly and totally unexpectedly. Several of his major accounts simultaneously opted to move their operations the east. The moves led to decisions about changing brokers. John’s substantial operating expenses had assumed an uninterrupted flow of business and revenues. Reducing those expenses to match his plummeting revenues proved difficult. John’s cash reserves were inadequate to bridge the gap. Convinced that he could weather the storm if only he could buy a little time, John decided to “finance” his operation with client premiums which he held in trust. He was convinced that the trust funds would be returned before anyone even noticed. Of course, his expectations were too optimistic. The loans were not repaid, and John’s life turned upside down with a bankruptcy and a criminal conviction.
There are a number of lessons to be learned from John’s case. They are applicable to all who face business reversals and the problems they bring. They include the following:
1. Anticipate and prepare for reversals. Although some problems literally come out of the blue, most can be foreseen. Contingency plans, establishment of reserves and other preparations can facilitate a reasoned response when problems do materialize.
2. Denial can be a dangerous thing. In my insolvency practice, I have been shocked by the number of individuals and companies that fail to recognize, let alone address, problems when they appear. There seems to be a deep seated belief that problems will take care of themselves. Operating under that misimpression, many delay corrective action until the very last minute. If survival is the goal, it is critical at the earliest juncture to accept problems, identify possible causes, outline possible solutions and formulate a survival plan.
3. Reach out for help in addressing problems. In many cases, challenges shake confidence and result in indecision. In that regard, professionals (financial advisers, crisis managers, attorneys) can provide valuable experience and assistance not to mention the perspective that comes from an outsider.
4. Avoid "solutions" that only increase the problem. There is an unfortunate tendency of some managers, faced for the first time with significant business challenges, to look for a quick fix. Such fixes frequently are only counterproductive. A few examples will illustrate this.
* When cash is tight, some managers succumb to the temptation to use cash that is earmarked for others. In the case of my friend, it was premiums. Another common example involves the trust fund portion of withholding taxes. In either case, the use of “other people’s money” is a game of Russian roulette which may have criminal implications but, at a minimum, may expose the decision maker to personal liability for the “borrowed” funds.
* To induce a lender to extend additional credit to a distressed company, some owners may offer their personal guaranty. While that may not be an irrational course, it requires careful consideration and assessment of risk. The loss of a company may be significant; however the loss of a home and other personal assets after execution of a personal guaranty is even more weighty.
* The decision to continue to operate a distressed company carries with it potential exposures to current and to future creditors. When a company is insolvent, there is a fiduciary duty on the part of management to maintain and preserve assets for the benefit of creditors. If asset values plummet as a result of continued operations, the decision makers could be called by their creditors to answer for the loss. Managers of distressed companies which continue to take delivery of new product and supplies without reasonable expectation of ability to pay could face civil actions for fraud.
* The transfer and concealment of assets is not a wise course. Once a problem has manifested itself, it is too late to make a transfer to friend or family member as a "rainy day fund". Such transfers by distressed companies can easily be set aside.
* Although it is not unusual for a distressed company to "manage its accounts" and pay some creditors in preference over others, such selective treatment has both practical and legal risks. On the practical side, if they learn of it, the creditors that did not receive payment can be stimulated to action. That action may involve suit on a debt. In some cases, a group of disgruntled creditors may even join together to force an involuntary bankruptcy. On the legal side, the payments may be avoidable and recoverable under either state or federal bankruptcy law. Under the circumstances, some crisis managers even encourage a general meeting with creditors to establish ground rules for payment while a company works through its problems.
While the foregoing suggestions do not guaranty success, they do increase that possibility by, among other things, minimizing collateral damage.
J. Robert Nelson is a bankruptcy and insolvency attorney with the law firm of VanCott, Bagley, Cornwall & McCarthy. Mr. Nelson assists creditors and debtors in a broad range of industries throughout the world. He can be reached at 801.237.0270 or at rnelson@vancott.com.
Many business owners react to “thickening clouds” with a combination of disregard, disbelief and paralysis. The experience of a friend of mine illustrates the point. My friend, call him John, had a highly successful insurance brokerage with a number of major corporate accounts. His success supported an expensive lifestyle, including a lavish entertainment budget needed to maintain favorable relationships with his high profile clients. When things turned, they did so quickly and totally unexpectedly. Several of his major accounts simultaneously opted to move their operations the east. The moves led to decisions about changing brokers. John’s substantial operating expenses had assumed an uninterrupted flow of business and revenues. Reducing those expenses to match his plummeting revenues proved difficult. John’s cash reserves were inadequate to bridge the gap. Convinced that he could weather the storm if only he could buy a little time, John decided to “finance” his operation with client premiums which he held in trust. He was convinced that the trust funds would be returned before anyone even noticed. Of course, his expectations were too optimistic. The loans were not repaid, and John’s life turned upside down with a bankruptcy and a criminal conviction.
There are a number of lessons to be learned from John’s case. They are applicable to all who face business reversals and the problems they bring. They include the following:
1. Anticipate and prepare for reversals. Although some problems literally come out of the blue, most can be foreseen. Contingency plans, establishment of reserves and other preparations can facilitate a reasoned response when problems do materialize.
2. Denial can be a dangerous thing. In my insolvency practice, I have been shocked by the number of individuals and companies that fail to recognize, let alone address, problems when they appear. There seems to be a deep seated belief that problems will take care of themselves. Operating under that misimpression, many delay corrective action until the very last minute. If survival is the goal, it is critical at the earliest juncture to accept problems, identify possible causes, outline possible solutions and formulate a survival plan.
3. Reach out for help in addressing problems. In many cases, challenges shake confidence and result in indecision. In that regard, professionals (financial advisers, crisis managers, attorneys) can provide valuable experience and assistance not to mention the perspective that comes from an outsider.
4. Avoid "solutions" that only increase the problem. There is an unfortunate tendency of some managers, faced for the first time with significant business challenges, to look for a quick fix. Such fixes frequently are only counterproductive. A few examples will illustrate this.
* When cash is tight, some managers succumb to the temptation to use cash that is earmarked for others. In the case of my friend, it was premiums. Another common example involves the trust fund portion of withholding taxes. In either case, the use of “other people’s money” is a game of Russian roulette which may have criminal implications but, at a minimum, may expose the decision maker to personal liability for the “borrowed” funds.
* To induce a lender to extend additional credit to a distressed company, some owners may offer their personal guaranty. While that may not be an irrational course, it requires careful consideration and assessment of risk. The loss of a company may be significant; however the loss of a home and other personal assets after execution of a personal guaranty is even more weighty.
* The decision to continue to operate a distressed company carries with it potential exposures to current and to future creditors. When a company is insolvent, there is a fiduciary duty on the part of management to maintain and preserve assets for the benefit of creditors. If asset values plummet as a result of continued operations, the decision makers could be called by their creditors to answer for the loss. Managers of distressed companies which continue to take delivery of new product and supplies without reasonable expectation of ability to pay could face civil actions for fraud.
* The transfer and concealment of assets is not a wise course. Once a problem has manifested itself, it is too late to make a transfer to friend or family member as a "rainy day fund". Such transfers by distressed companies can easily be set aside.
* Although it is not unusual for a distressed company to "manage its accounts" and pay some creditors in preference over others, such selective treatment has both practical and legal risks. On the practical side, if they learn of it, the creditors that did not receive payment can be stimulated to action. That action may involve suit on a debt. In some cases, a group of disgruntled creditors may even join together to force an involuntary bankruptcy. On the legal side, the payments may be avoidable and recoverable under either state or federal bankruptcy law. Under the circumstances, some crisis managers even encourage a general meeting with creditors to establish ground rules for payment while a company works through its problems.
While the foregoing suggestions do not guaranty success, they do increase that possibility by, among other things, minimizing collateral damage.
J. Robert Nelson is a bankruptcy and insolvency attorney with the law firm of VanCott, Bagley, Cornwall & McCarthy. Mr. Nelson assists creditors and debtors in a broad range of industries throughout the world. He can be reached at 801.237.0270 or at rnelson@vancott.com.
Copyright 2005. Published for general informational purposes only, and should not be construed as legal advice. If you need legal advice please consult with your attorney.