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Bar News - March 18, 2011


Business Law: Sometimes You Just Have to Kill Your Client

By:


Peter N. Tamposi
Of course I’m speaking of figuratively killing your client here, not literally. Not that we all haven’t had the thought of client-cide pop in (and quickly out) of our heads at least once in our careers. What I am talking about here is deciding when to tell your client to throw in the corporate towel, give up the ghost of their operations and call it a day.

As lawyers we are often cursed with undying optimism. This results in us believing our clients’ word to a fault or agreeing with them that their business is fundamentally sound. Many of us at one time or another have found ourselves representing a financially compromised corporate entity. In many cases it’s a small or mid-sized company and we are trying to keep the wolves at bay while the client tries desperately to save the business – and it’s hard to remove those rose colored glasses. However, the best advice we could give may just be to give it up. Yes, this is contrary to our innate lawyerly optimism and will likely result in the death of our client, and the loss of good work, but when such advice is offered and followed on a timely basis, the client can often move more quickly into their next act.

If a client timely closes the doors and enacts an orderly wind-down or liquidation before the business is in complete shambles, there are a number of potential benefits, which can be summarized as follows:
  • You can minimize personal exposure for the owners – your client’s principal will likely still be on the hook for the bank debt which they have undoubtedly guaranteed (and just as likely have maxed out). However, they will not fall deeper into the hole for the trade debt and corporate credit cards which they have guaranteed.
     
  • Your client may also avoid getting deeper into debt with respect to unpaid payroll and/or payroll taxes. Such debts are likely to lie against the principals of the company personally and may not be dischargeable in bankruptcy.
     
  • The longer the death spiral, the more good will is lost in the industry. This outcome is particularly important if the client’s principal intends to continue in a similar business or industry for the round II career. Likewise one’s relations with key employees are less likely to suffer long-term damage if the employees are not strung along or suffer unfunded benefits.
     
  • Personal credit and assets are more likely to be preserved if the break happens quickly. In many cases of small business failures, a personal bankruptcy is inevitable, together with its effects on the individual’s credit. However, the credit hit may be far less dramatic and recovery much quicker if the personal credit does not fall too far before the bankruptcy.
     
  • A clean kill of a dying company is also less likely to result in your client’s principal cashing in otherwise protected assets (such as 401(k)) or hitting up friends and relatives for "hail-Mary" loans to bail a sinking ship. Both of which resources may be better used down the road.
     
  • A quick death reduces legal fees. Unfortunately, when your client dies, so does your revenue stream. However, the struggle to keep a troubled company legally alive can be very expensive and often requires your client to borrow additional funds to pay your fees (or more often than not, you take the risk of non-payment just as your client’s other creditors).

Making the decision to close the doors involves more of a business than a legal analysis, but your contribution to the decision making process is just as important as the accountant’s. Once the decision is made to end it, there are a few strategic options that should be kept in mind. The first decision is whether to put the company into a chapter 7. Many practitioners feel it is a waste of time, because a corporation does not get a discharge in a bankruptcy – it just closes and ceases as a corporate entity. However for relatively short money, a chapter 7 bankruptcy defines a corporate endpoint and allows your client’s customers to write off the debt with certainty, stops creditors from calling and generally ends all the chaos.

Whether the client files bankruptcy or not, its principal should stay involved in the liquidation of its assets to ensure the bank or other creditors get as much as possible from whatever assets there are (thus minimizing guarantee obligations and generating some measure of good will). Not only do the directors or officers of the company have a fiduciary duty to maximize returns for its creditors in a liquidation, but it is often in their best personal interest to do so, because the more the creditors recover, the less likely they are to pursue the guaranty or alter ego obligations against the principals.

Moreover, whether it is a trustee or a secured lender liquidating the assets, each would be well advised to have your client assist in the process – and even pay them for it (often on a percentage basis). Nobody knows the assets and the market for those assets better than your client and certain assets – mostly notably accounts receivable – can be worth a fraction of their value if collections are attempted by a third party. It is also important to keep your lender in the loop once you have decided to liquidate. However, recognize that once this information is conveyed, they are likely to offset whatever funds they are holding in deposit accounts.

Economists and political pundits often hail the small business as the engine of our economy. That engine is no good if it is hopelessly stalled. By encouraging your client to pull the band aid off its dying business, you are really giving them the opportunity to move on to the next round of entrepreneurship before they completely exhaust their resources. Hopefully that new effort will mark a return to profitable production, new job creation and a new client.

Peter N. Tamposi is a principal of the Tamposi Law Group, 603-204-5513, peter@tlgnh.com, and an adjunct professor of bankruptcy and The University of New Hampshire School of Law.

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