Time to Act
Charlie Goodrich 


Bankruptcy and insolvency - either one is almost always bad for equity holders in a business. But if you're an officer, an owner, an investor or some combination, you can lose much more than that.

Today's newsletter examines the risks and offers suggestions for mitigating these losses.
I appreciate your comments. Just click "reply" to send them to me.
Charlie Goodrich 

Founder and Principal

Goodrich & Associates
March 2014 Vol. 3 No. 3
In this issue...
When Insolvency Strikes, Don't Lose More Than Your Investment
Heard on the Street: Decline in Labor Force Participation
About Us
Goodrich & Associates
[email protected]
When Insolvency Strikes, Don't Lose More Than Your Investment

Bankruptcy and insolvency - either one is almost always bad for equity holders in a business. Often, everything is lost.

But it can be worse ... you can lose more than just your investment. Whether you are an officer, an owner, an investor or some combination, you can individually be tagged for certain types of liabilities.

Let's first take a look at how, then we'll consider what to do to mitigate your losses...

If you are an officer of the company or otherwise a responsible party:
  • Unpaid wages. Most states make officers personally liable for unpaid wages. Which officers? Usually owner/operators, CFOs, Controllers, even OFOs (Only Finance Officer). So, potentially, even the bookkeeper.

    The harder question is defining what is a wage. Salaries are easy, but bonuses, sales commissions, even severance payments can get tricky. The answer is always fact and state law dependent, so make sure employees are paid and get legal help versed in your fact and State specifics.

    If your company is laying off many people, beware of the WARN act. This Federal law requires a 60-day advance notification of layoffs in certain instances. Here as well, the exact timing of and the need for the notification requirement is fact dependent. The risk to you as an officer is if unpaid WARN Act claims are considered valid and are treated as unpaid wages by the relevant State and Bankruptcy Courts.

    Note as well that sometimes, state law treats vendors as employees, particularly in Massachusetts. This relatively new area of overdone regulation sweeps up independent contractors and treats them as employees for salary and benefit purposes. So, an unpaid vendor who normally is just burned when a company runs out of money, may be able to call himself an employee and therefore be due wages instead of an unpaid invoice. This newer area of the law has many unknowns, particularly when insolvency is involved.
  • Unpaid fiduciary payments. Federal and State laws make officers personally liable for these. This refers to money that theoretically belongs to someone else for payment to a third party, usually the government.

    Withholdings from employee salaries for taxes and benefits, for example, is such a fiduciary fund, as is sales tax collected from customers. Remember that employee contributions for medical plans and retirement plans are "employee money" and not the business's.
  • Bank fraud. Surprisingly, this happens often enough by people with good intentions, that it's worth mentioning. Besides jail and fines, lenders can sometimes seek personal recovery from those who commit the fraud.

    Don't be tempted to doctor borrowing base reports, "refresh" invoices, or worse, so that your company can borrow more money and live for another day. Senior management of the big and now defunct law firm, Dewy & Leboeuf, is learning that lesson now. Earlier this month, New York State Prosecutors filed a 106-count indictment against the CEO, his right hand man, the CFO and a poor chump who sent damaging e-mails, accusing these individuals of issuing deliberately misleading financial information so that lenders would lend more money.
But what if you're simply an owner/operator and/or an investor? Well, if you are an operator you are likely an officer and so all of the above applies. Unfortunately, there is more...
  • Guarantees. If your company can't pay, and you personally guaranteed the debt, you pay. Look for guarantees from other entities you own, such as a real estate holding company. Personal Guarantees to banks and lenders are obvious.

    Others are less so. Look out for personal guarantees buried in leases or credit applications from ordinary vendors that you may have signed or an employee may have signed. Years ago, when I was the CFO of the S. S. Pierce Company, we imbedded a personal guarantee in our credit application for restaurants. It was very effective.

    For example, the former Mayor of Providence, Rhode Island, Buddy Cianci, came upon the ownership of a franchised restaurant for a local chain. (Presumably, but never proven, as compensation for granting liquor licenses.) The local sales representative had Buddy sign the credit application - "just a formality." And so Buddy personally guaranteed all the back and new debts to the S. S. Pierce Company. The restaurant tanked and we moved to enforce our personal guarantee by placing a For Sale sign on his front lawn. Buddy joked about it often on the radio talk show he hosted between Mayoral gigs. But the day before Buddy announced he was running for Mayor again (and won), we received a check for all past due amounts - and the check cleared!
  • Underfunded pension plans. The beast known as PBGC (Pension Benefit Guaranty Corporation) is an arm of the US Department of Labor that has made life miserable for many a business owner, including other pension funds that own businesses!

    The PGBC was established by Congress as a backstop to all of the non-government, old fashioned (a/k/a defined benefit) pension plans. If the pension fund tanks, the PBGC picks up the tab. But, Congress gave it powers to go after any entity with money to make whole. The laws were designed to prevent companies from putting the pension plans in subsidiaries and then walking away. The consequence is that if an owner was actively involved in the business, he/she can be tagged for the shortfall.

    In one bankruptcy I was involved in, the absentee owner lost his $60MM investment. Worse, the union pension fund was underfunded and today the PBGC is chasing after his remaining assets to make up the shortfall.

    Not just individual owners can be tagged. This past Summer, the First Circuit held Sun Capital's (a prominent private equity investor) fund liable for the pension funding shortfall in one of their failed investments, as Sun Capital had been actively involved in that business. The irony is, the limited partners in the fund that are picking up the shortfall are mostly other pension plans.
  • "Piercing the corporate veil." This describes techniques used by creditors to gain access to personal assets. My own experience is that this risk is overblown by attorneys that form corporations and LLCs, but it can happen. Get good legal advice on what to do and follow it. Make sure adequate books and records are maintained.
  • Fraudulent conveyance and avoidance actions. This is a complicated area of the law. In short, it means that both inside and outside of bankruptcy, creditors can "claw back" payments to business owners and others. This topic is beyond the scope of this newsletter, but when businesses face insolvency, this is one more reason for business owners to get good legal and financial help.
Whew, lots of potentially nasty surprises to be concerned with. So, what should business owners and officers do to protect against losing more than just their investment?
  1. Avoid surprises with a good 13-week rolling cash flow forecast (see our May 2013 newsletter on the topic). Not paying wages or fiduciary withholding is often the result of predictable - but unpredicted - cash flow shortages. Bank fraud, in turn, is often a foolish reaction to cash shortfalls that should have been anticipated.
  1. Review your insurance policies. Such policies are often a front line defense in that they pay legal costs to defend against such claims.
  1. Get help. From a financial advisor who can guide you through the many traps and from legal counsel that is well versed in the relevant fact situation and legal jurisdiction issues in question.
Remember, when in trouble, don't lose more than is already lost.

Heard on the Street
There has been much talk about the decline in labor force participation. Is the decline due to demographics, a lousy economy or other factors?

James Bullard, President of the Federal Reserve Bank of St. Louis, reviews the relevant research and finds labor participation rose from the late 1940's until the mid 1990's and has been declining since.

Demographic changes offer a much better explanation for the decline in labor force participation than the lousy economy. However, better data coupled with more research is needed for better economic forecasts. Find Bullard's article here.

About Us
Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent financial problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area.

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