Business Basics: Shutting it Down

Whether it has become impracticable to continue operating, or you are simply ready to move on with your life, there comes a time in many businesses where it is time to shut it down.  Terminating a business can be just as exciting and stressful as starting one; the key is understanding your options.

There are generally three ways to wind down, or terminate, a business:

  1. Chapter 7 Bankruptcy
  2. Assignment for the Benefit of Creditors
  3. Informal Liquidation

Here are the key distinctions between the three:

  1. Chapter 7 Bankruptcy

A bankruptcy filed under Chapter 7 of the Bankruptcy Code (“Code”) is a “liquidation” model.  Basically, a trustee is appointed to liquidate all of the assets of the business, and whatever cash can be raised from the sale is then used to pay the creditors according to a priority scheme set out in the Code.

This is not an ideal means of shutting a business down.  First, a business entity (corporation, limited liability company, etc.) is not entitled to a “discharge” in a Chapter 7 meaning the creditors can still sue for their outstanding debts, even if they receive a distribution in the liquidation.  A business entity only receives a discharge if it completes a true reorganization under Chapter 11.  In addition, the trustee takes a portion of the “pot” to cover their administrative fees, so everyone receives less money.  On the other hand, it is a formal process that can be very cathartic, as it lets everyone know that the entity is “dead.”

  1. Assignment for the Benefit of Creditors

An assignment for the benefit of creditors (“ABC”) involves the transfer of the company’s assets to a third-party fiduciary (the Assignee), who then conducts the liquidation and distributes the proceeds to the creditors.  This is very similar to a Chapter 7 bankruptcy case, but this is conducted under California state law rather than federal law.   However, this process is a much quicker and gives the project to someone else, rather than conducting the liquidation yourself.  On the other hand, you now must rely on another party to take care of the liquidation, which does add more time and expenses.

  1. Informal Liquidation

Another option is to liquidate the business outside of the bankruptcy or state court system.  As such, you go through the process of valuing all the business assets, selling them at the highest price possible, and then contacting your creditors directly to offer to pay off their obligations through their pro-rata distribution of the liquidated funds.

The benefit of this process is you can enter into settlement agreements with each of your creditors, which can include a waiver and release of all claims (meaning they agree to not come back and sue you for any money still owed).  In addition, you save time and money by cutting out the administrative costs associated with a bankruptcy or an ABC.  However, some creditors might decide to not “play along,” which can diminish the effectiveness of this process.

All three options have their benefits and challenges.  If you want to discuss any of this information in more detail, feel free to email or call.