Recently, Revitalization Partners (RP) was contacted by a company that had the problem facing many small companies: It had run out of cash.
The company is in a business sector that was impacted by difficulties in that sector, problems caused by covid and an unwillingness of the owners to keep funding losses. They approached RP to discuss a wind down plan.
WE LEARNED THAT …
In discussing the situation, we learned that the company had a family-based board of directors and one member of the board served as the managing member of the company. The board and management disagreed on the proper direction to take for the company.
In listening to the board members that would talk with us, (the manager would not) we learned of a number of issues that made a simple wind-down problematic.
The first was that the board had not seen any financial statements for months. When asked why, the board members indicated that they had been asking for months, the manager refused to give them to the board.
When asked who prepared them (an outside bookkeeper) the board did not have the contact information for the individual.
A “PERSONAL” LIABILITY …
In addition, the company was apparently paying a partial payroll every pay period.
When asked about the payment of payroll taxes, the board wasn’t certain.
It is important to note that the trust portion of payroll taxes, if not paid, becomes a personal liability of the officers and directors.
The company’s attorney had resigned, for reasons that were unclear, and there was no attorney advising the company at the time of our contact.
COURT PROTECTION ADVISED …
In looking at the company debt, there were liens on the equipment they proposed to sell, a UCC filing against all assets by a bank and an EIDL loan with personal guarantees.
The board members were not sure which other loans contained personal guarantees.
Given the above and the internal disagreements, we strongly recommended that any restructuring or wind down be done with the protection of a court.
This means a bankruptcy filing or, in the State of Washington, an Assignment for the Benefit of Creditors (ABC) followed by a receivership.
We proposed an ABC and Receivership, but the board members that we were talking with did not have enough information to complete the required information necessary to file an ABC. The board decided to hold off on any action and retain a new corporate attorney. This is currently in progress.
A DUTY OF LOYALTY …
We are using this example as a refresher on the fiduciary duties of directors and officers of a Washington corporation in financial distress.
Please note that this overview is no substitute for sound legal and financial advice on a company’s specific situation.
• Duty of loyalty imposes on directors and officers the obligation not to engage in self-dealing and instead to put the interests of the company ahead of their own.
• When a company is solvent, the directors and officers owe their fiduciary duties of due care and loyalty to the corporation and its stockholders. That remains true even if the company is in the so-called “zone of insolvency.”
• When a company is insolvent and will not be able to pay its creditors in full, the directors and officers still owe their fiduciary duties of due care and loyalty to the corporation. However, upon insolvency, the creditors have the right to bring derivative claims for breach of fiduciary duty against directors and officers.
• Remember, it can be challenging to determine whether a company is just in the zone of insolvency (meaning still solvent but approaching insolvency) or whether it has crossed the line into actual insolvency.
• Discharging fiduciary duties when a company is insolvent means a focus on maximizing enterprise value. This is a highly fact-dependent exercise with no one-size-fits-all approach. In some cases, maximizing value may mean continuing operations — even though that burns dwindling cash — to allow the company to complete a sale that the directors believe is likely to close and produce significant value for creditors. In other cases, it may mean winding down (or even shutting down) operations quickly to conserve cash, especially if any asset sale is not expected to generate more than the cash required to pursue it or pay any secured debt.
These complexities make it critical for directors and officers of a company in financial distress to get advice tailored to the specific facts and circumstances at hand.
WHAT’S THE BEST WAY FORWARD?
If the board decides that the company needs to wind down, options range from an informal approach all the way to a public bankruptcy filing.
Note that if the company owes money to a bank or other secured creditor, the lender’s right to foreclose on the company’s assets could become a paramount consideration and affect how the wind-down is accomplished.
When a company’s cash is running out and there is no additional financing available, the board may conclude that a wind-down is required to fulfill fiduciary duties and maximize value.
The discussion above is a general description of certain wind-down options. Determining whether any of these paths is best for a particular company is fact-specific and dependent on many factors.
In all cases, be sure to get advice from experienced corporate and insolvency consultants and legal counsel when considering wind down or other restructuring options.
Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering, a State Receivership or Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.
