6 areas in need of your attention.
September 2017 Vol. 6 No. 9

"Burial Costs" are the special costs that need to be paid when closing a business. Because the wind down of a company is, by definition, a singular event, it's easy to be blindsided by the processes, obligations and funds required. 

Today's newsletter examines the details of burial costs with an aim towards helping you minimize personal liability and future aggravation.

Charlie Goodrich
Founder and Principal
Goodrich & Associates
In this issue...
Don't Let Company Burial Costs Lead to a Personal Liability

In my July newsletter I wrote about winding down businesses and how the value of the pieces is much less than the value of the whole. Today's newsletter is about another key element in the liquidation equation: burial costs. These are the special costs that need to be paid when shuttering a business.

Burial costs are distinct from paying creditors. In fact, creditors would be more than happy if you didn't fund these costs and instead gave more money to them. But be careful - in some instances, if the company doesn't pay these costs, you might be liable for them personally. And for the others, they can be a headache for years to come.

So what are typical burial costs? Let's have a look...
  1. Insurance, particularly what is called "tail" D&O insurance. Directors & Officers coverage insures directors and others from law suits regarding their management of the company. The "tail length" refers to the length of time the insurance lasts after it has been triggered. If you did a good job obtaining D&O insurance prior to liquidating, the cost of the tail will be written into your policy. The longer the tail the better, but buy at least three years and get six if you can.

    Make sure you have what is called "A" side difference in conditions coverage and that you, as a D&O, are named in the policy. This is the coverage that will pay your defense costs and any court judgments against you if the company can't. "B" side coverage only insures the company from defending and indemnifying you per the various corporate governance documents. If there are multiple claims against the B side, there may be no funds to cover you. Also, creditors may take funds from B side coverage to cover their unpaid bills.

    Note that not all claims against directors and officers are covered by D&O insurance. Special fiduciary insurance is often needed for liabilities from employee benefit plans, particularly 401(K) and defined benefit plans. If company stock was an investment option in your defunct company, you'll surely want to buy this fiduciary coverage as well. Work with your insurance advisor to know what is covered by each policy and what isn't.
  1. Payroll, particularly the payroll items you don't typically think about. Why is this important? Because most states hold officers (and often directors) personally liable for salaries and wages if they are not paid.

    First consider regular wages. Many companies pay employees, particularly hourly employees, a week or two in arrears.

    Next, consider accrued vacation, which can be significant. Check what your policies and practices are. When in doubt have counsel versed in employee law matters in the states where you have employees review the policies.

    Take a look at mandatory severance or WARN act requirements. Have legal counsel experienced in WARN act and state equivalents review the situation. Some states consider this expense wages with personal liability to officers and directors; other states do not. While there is, in fact, an insolvency out to not pay WARN act severance, as a practical matter Courts often rule otherwise.

    Many foreign countries have statutory severance requirements, often in the six- to twelve-month range. In this regard, and compared to the rest of the world, the US is very debtor-friendly for companies going out of business. I had one client with an obstinate CEO who ignored counsel and didn't pay severance to the former Hong Kong general manger - in the CEO's eyes the general manager made of mess of things. A local tribunal thought differently and issued a warrant for the CEO's arrest. Extradition? Who knows. But do you want to find out?

    Review employment agreements and similar contracts with legal counsel versed in employee matters in the relevant state. The definition of what is considered a wage that must be paid varies by state. For example, a client of mine employed expensive people, all with employment contracts that were written in such a way that if severance and bonuses were not paid, the directors and officers could be personally liable in that particular state.
  1. Employee benefit plans. Pension plans, 401(k) plans and the like need to be terminated and final forms filed with the Federal Government. The Department of Labor may pursue whoever filed the last form for failing to file a "final" form. Unless a relatively small number of plan participants are involved, the plan must also be audited. The plan language may or may not allow these costs to be born by the plan participants, but sticking these costs to the participants often results in litigation against directors and officers.

    Also have a look at the costs of underfunded defined benefit pension plans, particularly multi-employer union plans. The PBGC (Pension Benefit Guaranty Corporation) has chased some of my former clients. One was a wealthy owner of a defunct business who was last reported to be drinking in the hills, hiding from the PBGC.
  1. Taxes of all kinds need filing and payment. In just about all cases, not filing is a problem. Not paying depends on the type of tax.

    Fiduciary taxes - sales tax collected, payroll taxes collected, and so forth - need to be filed and paid. Here as well, directors and officers are personally liable for nonpayment. Make sure to note the return as a final return.

    Employer payroll and company use tax returns should be filed. It is often not worth the hassle to not pay, so pay these if you can. Again, note the returns as final. If you don't pay these, for the employee portion of payroll taxes that you do pay, mark them as such. Otherwise, states will apply the payment to the employer component and leave the directors and officers personally on the hook for the employee portion.

    Federal and State Income tax returns need to be filed. In a liquidation, there is often a loss, so no taxes are due. But unless the company is a C corporation, the returns must be filed so the owners can file their returns. In larger companies, filing the returns is better than the headache from not doing so.

    Property taxes can sneak in too. Often the tax liability is incurred well before the tax is assessed and/or due. While governments can't pursue directors and officers for these taxes, in a bankruptcy context, they come ahead of most other creditors, after the secured party.

    Lastly, don't forget to issue 1099s and other tax compliance activities.

    What is often the biggest cost in all of these tax returns? Unpaid old bills with your accounting firm. They have the records needed to file your returns and if you haven't paid them, good luck. There are some legal options, but they are costly.
  1. Records, both paper and electronic should be maintained. Follow standard retention guidelines for paper and digital records. If any personal information or other sensitive data is stored, prepay for its destruction.

    Beware of special industry requirements as well. For example, FINRA requires a client of mine to keep trading data for two years. For this client, that means half a petabyte! When discarding files, destroy personal information. One client of mine had detailed pre-HIPAA paper records on 20,000 people, a quantity whose destruction cost was non-trivial. It's money well spent: you don't want to be a former director or officer of that organization if medical records are found blowing in a landfill.
  1. Lastly, there are the ongoing operating costs incurred while winding down - rent, utilities, payroll and so forth.
A few pointers on navigating burial costs...

At the very beginning, lay out the burial items and their respective costs. If you are working with/against a secured lender with liens on all of the collateral, figure out how to pay the critical items, particularly D&O. Put it in the budgets for any forbearance agreements and so forth.

What can and cannot be paid during a wind down is in part dependent on how the business is closed. For example, in bankruptcy there is a relatively low dollar limit to back wages and severance that can be paid ahead of other creditors. This can leave directors and officers on the hook for the balance. Think about the burial costs when choosing the legal mechanism to wind down.

Because the wind down of a company is, by definition, a singular event, it's easy to be blindsided by the processes, obligations and funds required. For best results, assess burial costs before you start and with an aim towards minimizing personal liability and future aggravation.
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About Us

Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent liquidity 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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