Is Filing A Chapter 11 Bankruptcy The Best Option For Closely Held Corporations?

When it comes to closely held corporations, you are better off doing a restructuring by liquidating the company through an assignment for the benefit of creditors rather than filing a Chapter 11. The difference is that a Chapter 11 is a long, drawn out process. The dump-buy back, for lack of a better phrase, is a process that allows us to liquidate the company on a Friday, set up a new company, and have it operating by Monday. Now, you must be wondering how that works?

When you are dealing with insolvencies, the values of a business’s assets are liquidation values. What the assets will bring under the hammer is the standard by which values are determined.

In Massachusetts, liquor licenses can have a value ranging from bupkiss, which in Yiddish means nothing, to selling for several hundred thousand dollars. On top of that, we have wine and beer only licenses.

We once liquidated a convenience store in Worcester that had a beer and wine license that was worth about $10. To obtain a wine and beer license like this, all you have to do is obtain a license from the city and pay the fee. You don’t have to go through an application process and pay several hundred thousand dollars like is required in many part of Massachusetts. There was a collection attorney who was questioning the value of the liquor license because it was worth $10. He had an opinion that it was worth thousands. I told him that I would sell it for $100 if he thought that it was worth that much money. I never heard from him again.

Things are only worth what they are worth. A Chapter 7, if a corporation has assets, the Chapter 7 trustee is going to call in an auctioneer to auction off those assets. The same thing is undertaken in an Assignment for the Benefit of Creditors except the Assignee can sell the assigned assets by public auction or private sale. There is no 341 meeting. There are no schedules or statements of affairs to complete. The Assignee, who is the person who liquidates the assets, much like a Chapter 7 trustee, deals with the facts on the ground on the date of the assignment. For instance, if a company makes an assignment for the benefit of creditors, we call in an appraiser/auctioneer. The appraiser/auctioneer we use is local. I’ve been dealing with one family for over 40 years. When we obtain an appraised value, the banks and lenders don’t question it because they have been using this appraiser/auctioneer for decades like I have, which is a long time.

Let’s look at the example I previously gave. The Assignee has the assets appraised and they come back at $20,000 at liquidation. The assignee is faced with several options because s/he is supposed to liquidate the assets in a commercially reasonable manner. In this situation, the assignee can abandon the assets to the secured creditor since there is no equity in the assets for anybody but the secured creditor. Or, the assignee can sell the assets back, subject to the secured debt to the creditor that would agree to assume the secured debt and pay a small dividend to the unsecured creditors. At that moment, a notice goes out to the creditors informing them what happened, and we solicit their assents. It’s a much quicker and cleaner way of doing it. It’s also less expensive than a Chapter 11 and when all is said and done, it is up to the principals to make the new business profitable and work.

The reason that it may not work all of the time is if the secured creditor is not happy and threatens to seize the assets. The assignment doesn’t stop the seizure. That’s where you need a Chapter 11. For instance, if the IRS or DOR has recorded a tax lien against the assets, they can be more aggressive than a bank. For this reason, you may need a Chapter 11. That’s how a dump-buy back is done. Whether the company survives remains to be seen.

Going back to the gentleman who took me under his wing, sometimes he was the only person who made money on a business’ location because it was cursed. You know, one of this locations that have seen a parade of varying businesses pass through that location. He used to represent a lot of pharmacies. Back in the mid-70s, all of the independent pharmacies were being replaced by CVS and Walgreens. Many pharmacy owners (these small pharmacies were all typically closely held corporations) wanted to stay in business, so they liquidated the assets and set up a new company. He would arrange for them to buy the assets back into a new corporation. The business would eventually fail because the location was cursed, but he made a fee every time. The ultimate denouement was the auction of the failed businesses assets. Doing it this way, while fraught with dangers, gives people a second opportunity. Hopefully, they succeed, but if not, they at least had a chance.

Representing debtors for over four decades, I often find I have many stories that can be used as examples or cautionary tales. Recently, there was a movie theater which the owner had been trying to sell. He ran a contest around Christmas time for potential purchases and many people entered the contest to try to buy it. Despite this effort, it still remained unsold. When COVID hit, it forced him to shut down completely.

In the end, the company made an assignment for the benefit of creditors. We had the assets appraised and sold them to a new company that has yet to reopen the place. You have to question the reopening of a theater in these Covid times of social separation. Society does not appear ready to flood movie theaters again. But, they are moving forward. Using an assignment for the benefit of creditors is a good way to sell a company that is insolvent.

Now, if we sell the company, we can have the purchaser pay the liquidation value of the assets and possibly put some money into the principal’s pocket. How? The sale of an insolvent company usually results in the sale proceeds being paid to the company’s creditors with gornisht (nothing in Yiddish) going to the principal. So, why bother? Let’s say his company’s assets are worth $20,000, but the buyer wants to pay $25,000. In this situation, we’d go to the bank and give them the appraisal from the local appraiser that specifies they will get the $25,000.

The rest of the balance gets paid to the assenting creditors, and we send them a notice. It’s much like a Chapter 13 where only the creditors who file a proof of claim get a dividend. Only creditors who assent to the assignment participate in the dividend. What happens is that the company makes the assignment and then there is a buy back. We send a notice to all the creditors telling them that the company has made the assignment. The paperwork involved with the assignment doesn’t come close to the 72 pages of a bankruptcy petition. Instead, it consists of the assignment for the benefit of creditors, an affidavit of the principal of the business as assets and liabilities, and a certificate authorizing the assignment.

The same applies for a buy back. There is a purchase and sale agreement. It all depends on how they are buying it back. The sale can oftentimes be financed by the assignee. If it’s done in a commercially reasonable manner by the assignee taking back a security interest in the assets sold, a promissory note representing the purchase price for the assets and requiring a monthly payment with interest, and a security interest securing the assets sold so that if the purchase defaults the Assignee can seize the assets sold and liquidate them. Notice then goes out to the unsecured creditors, which tells them what happened.

Let’s say you’re selling a business. The purchaser is offering $75,000, but the assets are only have liquidation value of $25,000. The assets get sold, but the sale is accomplished in two parts. There is the purchase agreement between the assignee and the purchaser. In this agreement, the assets are sold for more than their appraised value or for between $25,000 or $30,000. How does the purchase price’s balance of $45,000 or $50,000 treated? By the purchaser giving the principal either a covenant not to compete or a consulting agreement for the remaining balance. Otherwise, if the balance sheet is out of whack, how do you do a sale and put any money in the principal’s pocket? That’s typically what occurs in closely held corporations. There once was a cabinet company. It was having a myriad of financial problems. The owner had gone to all of these big attorneys none of whom could come up with a solution to his tsuris (Yiddish for troubles). He was ready to close the doors when someone referred him to me. I structured a situation in which we did a public auction on the old assets while the new company was operating away without missing a beat. Out of that public auction, the owner eventually sold the business for over $1 million. He took money out $150,000 every year and while I managed to save his business that went on to operate for another 20 years, the flush with cash owner still managed to stiff me on my legal fees proving no good deed goes unpunished!

For more information on Chapter 11 For Closely Held Corporations, an initial consultation is your best next step. Get the information and legal answers you’re seeking by calling (978) 922-8440 today.