At the End of Your Financial Rope?

How to pull yourself up from the brink of bankruptcy.

When a business has more debts or liabilities than assets and can’t meet its financial obligations as they come due, or when it suddenly can’t make credit problems go away, bankruptcy goes from the unthinkable to a possibility.

Before a business absolutely has to make the wrenching decision to pursue bankruptcy through an established legal process, either the state of Wisconsin’s Chapter 128 or federal Chapter 11 reorganization, there is another type of reorganization that is more of a proactive, rather than legal, process. 

Perhaps the most important thing for struggling business owners to know is that when they get to the point where the obligations of the operating business are too great for the business to support from its cash flow, they are not alone. Their professional service providers – bankers, accountants, or attorneys – have a vested interest in working with them to prevent bankruptcy.

Most business owners realize this, of course, but those who end up in bankruptcy often fail to seek help. “At times, business owners are slow to recognize these issues, or they may recognize them but don’t want to come forward and ask for help,” said Jim Munhofen, senior vice president of the special loan group at Associated Bank. “It can be a difficult process for them personally.”

Others might have recognition problems. “The obvious sign is when companies are not cash flowing, when they are showing losses on their financial statements,” Munhofen said. “But even before you get to that point, you can see signs where perhaps their vendors aren’t being paid on a timely basis, or they are maxed out on their line of credit with the bank. Those are all signs of financial stress in a business.

“We look at their overall debt repayment obligations compared to the cash flow the business is generating to see if there are some adjustments that can be made, on a short-term basis, to ease their cash-flow requirements.”

Associated often recommends that clients in that situation seek the help of a turnaround management consultant who has expertise in running various types of businesses and who can analyze what a financially troubled business can do to improve cash-flow generation. In some circumstances, the bank recommends a short-term moratorium on some principal payments “if that is appropriate,” Munhofen said.

A business partner might also work out a debt-restructuring plan with that business in association with a turnaround management consultant. “That is where most of these situations end up, and many of these businesses are able to return to normal operations,” Munhofen said. “It might take a little while to do that, a year or sometimes longer to work through a turnaround process, but 12 months is not unusual.”

Attorney Daniel McGarry, a shareholder with Whyte Hirschboeck Dudek, said the law firm would start by analyzing the company from the top down to figure out how it got where it is. There could be a piece of litigation gone bad, they could be in a declining market sector, they might have some bad business practices that finally caught up to them, or a combination of all three. 

“Once we understand what those pressure points are, then the question becomes, ‘Does Chapter 11 or some other out-of-court restructuring make sense?’” McGarry explained. “Now if it’s a secured lender and they are in default with them and the bank has cut off their credit, that’s a separate issue than if they have a piece of litigation that is pending and they are concerned that a large judgment is going to come down and they aren’t going to be able to handle it.


“So where the company is, how it got there, and does the business model or core business still make sense? Can we restructure it so they can continue to go on in some way or form?”

If there is ever a time to apply the 80-20 rule, where the focus is on the profit centers responsible for 80% of revenue, it’s when you’re en route to bankruptcy. “We definitely do work with them on cash flow, and on profitability in general, isolating which items they are selling that are making them money from the ones that aren’t,” said Julie Bogle, a tax manager for Smith & Gesteland. “Any business, whether they know it or not, is a mix of profitable and unprofitable sectors. The key is to get in there early enough to identify the profitable sectors, and then devote resources to the profitable side, and starve the other side or get rid of it if you can. That can be incredibly successful.”

State Streamlining: Chapter 128

According to Munhofen, federal Chapter 11 reorganization is not used much anymore, particularly in the state of Wisconsin, because it’s too expensive and it’s a long, drawn-out process. Many small businesses can’t afford to pay for the process, particularly since they are already having financial issues.

One alternative is a state of Wisconsin process known as Chapter 128 receivership, which is considered more efficient in terms of time and cost. Chapter 128 receiverships can vary from several months to up to one year, but usually the process plays out between three and six months.

“It’s a state receivership, and so this is commonly used for businesses that have insurmountable financial issues and need to seek some type of reorganization,” Munhofen explained. ”Typically, the debtor, in conjunction with discussions with their primary secured lender, agrees to voluntarily enter into a receivership, and then the receiver is appointed by the courts, typically an attorney who specializes in receiverships.”

Receivership means the assets of the debtor are going to be sold, which is really the only option at that point. The receiver appointed by the court is an independent party and acts as a fiduciary for all of the creditors. The receivership is an estate, like a bankruptcy estate, and the receiver gets paid from the funds of the receivership, or the liquidating business that is in the receivership.

Said Munhofen, “As you can imagine, a company having financial issues is typically not paying its vendors, at least not on a timely basis, and it is getting a lot of pressure from the vendors, in addition to the primary secured creditor putting pressure on them, because they are utilizing all of their available credit.”

When a company enters a Chapter 128 receivership, it turns over its assets to the receiver, and the receiver will attempt to sell the business as a going concern. The receiver usually does this with the help of a turnaround consultant, who will help run the business. “The owners of that company do lose control of the business and at that point usually become employees of the receiver,” Munhofen explained. “It’s a way to resolve the issue because the receiver does have the power to transfer the title of assets to a buyer.”

There are similarities between state Chapter 128 and federal Chapter 11 in that there are certain secured creditors, such as lenders and landlords and taxing jurisdictions, who have priority in terms of having debts paid off. “It works in a very similar fashion,” Munhofen said. “The same priority rules apply pertaining to who gets paid first. The secured creditors get paid on the assets that they have priority security interests in.”

Chapter 11: Getting Reorganized

It’s not unusual for smaller businesses to seek receivership, and mid-size to large companies usually are more willing to go through Chapter 11; larger companies apply for 128 as well.

Chapter 11 reorganization can be a means of rehabilitation, a way to hold creditors at bay until the business is on a stronger financial footing. 

When a business files a bankruptcy petition in federal bankruptcy court, it launches a statutory process in which creditors have an opportunity to challenge the discharge or restructuring of debts owed to them. That gives rise to an automatic stay, which prevents creditors from taking additional steps to collect their debts. While a bankruptcy court can give creditors relief from an automatic stay, the stay generally gives debtors a temporary opportunity to figure out how to deal with their financial problems.

McGarry said that in Chapter 11, you can have a sale of assets of the company, and then a new company will buy those assets and continue operations. Often, they will create a liquidating estate, taking the leftover assets, liquidating them, and paying off the remaining creditors on a pro-rata basis.

“A lot of times a Chapter 11 can be a restructuring of the current company and executive team,” McGarry said, “but often it’s the ability to sell the assets of the company to a new company that will come in, take over, and continue to operate without having the burden of the debt of the old company.”


If you file a Chapter 11, there typically is a period of time to put together a plan of reorganization; in the meantime, you may be required to make some payments to those specific secured lenders for use of their equipment. This protects them from a decline in the value of assets while your reorganization plan is being formed. “The last thing you want is all secured creditors to come in and take their stuff because the company goes under,” McGarry explained. “The idea is to stop that process and work with them so that once you exit Chapter 11, you have a confirmed plan and you have the ability to keep the assets you need to successfully reorganize.”

In Chapter 11 and other forms of bankruptcy, there are rules to the game. According to McGarry, during the bankruptcy process, the biggest no-no for both debtors and creditors is to take certain actions without court approval. Once you are in a bankruptcy proceeding, much of what you want to accomplish has to be approved by the court, and all interested parties must be provided with notice of what you are trying to do. 

On the debtor side, “you can’t be selling off assets, entering into things that are not in the ordinary course of your business without getting the consent of secured lenders and the consent of the unsecured creditors committee, or by bringing a motion before the court and getting its approval to do that,” he said. “Probably the biggest no-no from the creditor’s standpoint is violating the automatic stay.”

Some debts can be discharged from bankruptcy, including certain taxes. If you have any kind of trust-like tax, like the payroll tax, that kind of tax is not erasable in bankruptcy. However, if your income tax is an old tax, you might be able to get that discharged, according to Diane Nienow, a tax manager for Smith & Gesteland.

Conduct unbecoming

Businesses reach this stage after all other options have been exhausted. When the downsides of loss of business, damage to credit history, flat-out embarrassment, and stigma are outweighed by the last resort, it’s time to file for bankruptcy. But is it impossible to recover from the damage to your business reputation?

“There may be that perception among companies and executives that once you get into bankruptcy, you never get out,” McGarry said. “They might be thinking of some of the cases of restructuring of airlines that would appear to go on for years and years. Part of our job, if we take a case and represent the debtor in bankruptcy, is to educate that business’s vendors and customers that this is not a death sentence – this is an opportunity for this company to restructure.

“In some cases, we say to unsecured creditors that they might not get paid 100 cents on the dollar, but the alternative of tanking this company is that you might have a viable entity that can come back and continue to perform and perhaps pay off some of its old debt, and then continue to thrive going forward. So really we want buy-in from all the stakeholders that bankruptcy is not a death sentence. It’s not an exit. It’s an opportunity for a fresh start, and that is what we’re trying to achieve.”

In terms of what bankruptcy does to one’s business reputation, a lot depends on how you handle yourself during the process. “Are you being forthright with everyone and trying to give them as much of what you owe them as you can, and are you being honest and not taking lavish vacations?” Nienow asked. “If you’re honest, they will see that you are trying and they are going to be much happier with you than if you are driving a fancy new car and saying, ‘I can’t afford to pay you.’”


In Bankruptcy, Do Creditors Have Rights?

Attorney Joshua C. Kopp, a partner with Boardman Clark, pondered the following question: In bankruptcy, what rights does a creditor have? “They are limited, but they are there,” he said. “I don’t want to understate the rights that a general unsecured creditor has. There are specific unsecured creditors that have special treatment under the law.”

Actually, some creditors are higher up on the food chain than others. Those occupying the upper reaches are known as secured creditors – typically lenders and landlords and certain taxing jurisdictions. Depending on the chapter of bankruptcy (7, 11, 13, etc.), different rights are afforded to different creditors. 

“For example, with secured creditors in a situation where they financed the purchase of a forklift, they have some relatively well-recognized rights in terms of what the debtor can do with respect to the repayment of the obligation and how long they have to repay that obligation if they choose to do so, and what interest can be charged, etc.,” Kopp explained. “Likewise, you see creditors that are secured by real estate, there are limitations and rules that are applicable as to what the debtor can do to continue to occupy the premises, for example, in a residential situation, and what they would have to pay, so there are protections available to creditors.” 

That doesn’t mean everyone else will be scrambling for crumbs. Among the various unsecured creditors, employees who are owed wages occupy a very specific and special position in the hierarchy of claimants. Regardless of your classification, you want to be mindful of the deadlines, the due dates, and make sure you assert your claims. “Don’t just say, ‘oh, they are in bankruptcy, and well, I’m not going to get paid,’” Kopp advised.

In most cases, however, rights become more limited for general unsecured creditors. A landscaping service firm or a lawn service provider is not going to have a lot of rights and protections in a general situation. 

That could be why larger unsecured creditors band together to form committees to look out for one another’s interests. Other rights and interests of unsecured classes, however, will be diametrically opposed, and there may not be a great willingness to work together.

Creditors who want to do some due diligence might want to look into what bills the debtor actually paid 90 days prior to a bankruptcy filing, just to make sure any preferential treatment – such as payments to important vendor partners – are on the up and up. That’s not normally the role of the creditor, but if an aggressive creditor has played by the rules in the collections process, and the creditor can uncover something rotten in Denmark, that might persuade the bankruptcy trustee to rule in its favor.

“I could fathom a situation where a creditor could undertake that task with the idea of bringing that information to the attention of the trustee to try to accomplish a disgorgement,” Kopp said.

Being aggressive in collections also carries some downside risk in the event of a bankruptcy, but since nobody can really predict that a bankruptcy will be filed, it might be a risk worth taking.

A mechanism called a preference action, where the trustee is asked to “look back” 90 days prior to the bankruptcy filing, is employed to see if anyone who got paid received special treatment. “So there is this 90-day look-back period in which those payments received by a debtor 90 days prior to the filing can be looked at and, if they’re determined to be made on a preferential basis, go back into the estate,” said attorney Daniel McGarry, a shareholder with Whyte Hirschboeck Dudek. “The trustee or a debtor would have an opportunity to claw back those payments and have them redistributed in the context of the bankruptcy, either later in a liquidation, or if it’s a Chapter 11, through the [reorganization] plan.”

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