Ten Steps to Reduce Your Liability in a Troubled Business

If your company is facing financial difficulties, read these tips to keep out of trouble with the IRS, bankruptcy courts, and your bank.

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1. Keep taxes current. Rule Number One is to meticulously pay all payroll taxes on time, especially those withheld from employees' paychecks. Even if your business is a corporation or LLC, the IRS and state tax authorities can hold you personally liable for these taxes -- and assess penalties. And business bankruptcy won't get you off the hook personally for these debts.

2. Stave off cash flow problems. When you realize you don't have enough revenue to pay the bills, slow your "burn rate" by cutting expenses to the bone. Then prepare a short-term cash projection and plan for your immediate needs. Make a list of monies owed to you, and collect as much as possible. Pay necessary items like taxes and overhead costs, but delay paying other bills by working with suppliers and other creditors.

3. Don't lie about debts. Struggling business owners may frantically try to borrow more money. But if you apply for a new loan or to consolidate old ones, be forthright in disclosing the financial condition of your business. Otherwise, the law may regard your new debt as having been obtained by fraud, thus making you personally liable (even if you file for bankruptcy). The debt could haunt you for years.

4. Be careful about transferring business property. Sometimes, out of desperation, a business owner will try to protect personal assets by hiding them or giving them to friends and relatives. Since creditors are used to ferreting out such hidden assets, these tactics tend to be ineffective and give rise to civil and even criminal charges of fraud.

5. Avoid preferential payments to creditors. The Bankruptcy Code frowns on your paying some creditors and not others; that is, "making preferential payments." If you file for bankruptcy, all payments you make during the year before the filing will be scrutinized by creditors to make sure that some creditors weren't given an unfair advantage. Outside of bankruptcy, if you owe money to creditors who hold collateral, the creditors have special rights in the property that is the security for the debt, but you may legally pay one unsecured creditor ahead of the others.

6. Protect your bank account. If you owe money to a bank, it's often wise to keep most of your checking and other accounts elsewhere. This is because your loan agreement may give the bank the right to take your funds without prior notice if the bank thinks you're in financial trouble. (This is called a "setoff.") It can be a rude surprise to learn that your lender has drained your checking account.

7. Plan for ongoing insurance coverage. If your business winds up in a Chapter 11 reorganization or you end up in a Chapter 13 reorganization, you may have a tough time finding an insurance carrier willing to renew your business coverage or issue a new policy. You'll want to have insurance in place that extends at least 12 months into the future. As long as you pay on time, the insurance can't be canceled, and you'll enjoy some peace of mind.

8. Don't panic about utilities or your lease. If you declare bankruptcy, the utility companies can't use this as an excuse for shutting off services, although they can require you to post a reasonable deposit to keep on the lights, phone service, and heat. Similarly, as long as you continue to pay your rent, your landlord can't kick you out. Don't be spooked by the clause commonly placed in commercial leases saying you're automatically in default if you file for bankruptcy. These clauses are generally not enforceable (except against sublessees and assignees).

9. Consider returning some leased property. If you're leasing equipment and know you won't want to retain it if and when you file for bankruptcy, consider giving it back to the leasing company before you file. If you do so and the equipment is currently worth less than what you owe under the lease, this "deficiency" will get discharged in bankruptcy. On the other hand, if you prefer to keep the leased property, you'll need to continue making payments on time -- this obligation won't be discharged by your going through bankruptcy.

10. Don't borrow from the company's pension plan. Many pension plans don't allow you to borrow (or remove) money from the plan account. If you do, you could be assessed a penalty of up to 115% of the "borrowed" money. Worse, the plan could be "disqualified," meaning that all deductions would be disallowed, all plan assets distributed, and income tax and late payment penalties applied. Other plans may allow you to borrow money for approved purposes, but think twice before you do this: It leaves you with a smaller nest egg, and if you fail to pay back the loan, you could end up paying income taxes on the withdrawal, plus penalties of 10% to 25%.

11. Consider selling your business. If the outlook continues to look poor, and you've ruled out bankruptcy, it may be time to sell. Nolo's book, The Complete Guide to Selling A Business, by Fred S. Steingold, can guide you through the entire selling process, from deciding whether to sell to preparing a sales agreement and going to the closing.

To Learn More

Nolo's Save Your Small Business: 10 Crucial Strategiees to Survive Hard Times or Close Down & Move On, by Ralph Warner and Bethany K. Laurence (Nolo), can help you develop and implement the best possible plan to cut costs, increase marketing and develop the basic entrepreneurial strategies to succeed.

by: , J.D.

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