Seeing the bottom line awash with red ink yet again, Susie Sears reluctantly decided to shut down her family-owned Widgets-R-Us. Pressured by thinning margins, a weakening labor pool and increasing competition from foreign markets, Widgets-R-Us is leveraged to the hilt and profits are insufficient to pay even her secured debt. With no viable assets or business, there’s nothing to mortgage or to sell. How can Susie and her fellow company officers walk away without becoming personally liable?
No matter if Susie is a director, officer, partner or manager, as a C-Suite decision maker (aka C-Suite Player), she has potential personal liability for employment taxes, franchise taxes, income taxes and, perhaps even individual contractual obligations. First, Susie must assess whether she has “kissed any paper,” that would create personal contractual liability. If Susie has no personal contract obligations, what about unpaid Widgets-R-Us tax liabilities?
Payroll taxes withheld by an employer from its employees’ wages which are not paid to the IRS are considered trust fund taxes held for the benefit of the government and become the personal responsibility of the “responsible person” (aka C-Suite Player) for the total amount of the taxes not collected and paid. Similarly, Texas franchise taxes are imposed for the privilege of doing business in Texas and if not paid on May 15, may result in forfeiture of the Company’s privilege to do business in Texas. The result? C-Suite Players have personal liability for both (i) the amount of the unpaid franchise tax plus (ii) any new third-party debts incurred after any right to do business is involuntarily terminated.
Beyond taxes and individual contractual obligations, each C-Suite Player owes internal duties of obedience, care and loyalty. Assuming that the Company’s secured lender does not control all of the assets (cash, receivables, inventory, equipment and so forth), the C-Suite Players must wind down the business consistent with the entity’s governing documents and Texas state law, often requiring a formally noticed meeting and approval of the required number of owners. For the benefit of the Company, and in satisfaction of their duties, the C-Suite Players should strongly consider creating a plan of termination to create an additional protective wall against personal liability. Such a plan confirms the authority of the C-Suite Players, maps out the details of the termination and liquidation processes, and obtains informed consent from the owner with respect to the winding down process. It also gives creditors and customers clear notice of the company’s termination plans, thereby allowing directors and officers to protect their assets, credit, and reputations. Finally, the Plan can be used as a potential defense in the event of any attacks on the directors’ or officers’ best efforts, good faith, independence, or awareness of the situation.
If one secured lender does not control all of the assets, the C-Suite Players must wind down the business as quickly as is reasonably practicable, including the following in roughly this order:
- Collect accounts receivable, preferably before notifying customers.
- Sell inventory, work-in-process and any unsecured equipment.
- Discharge liabilities and debts. Notify creditors (suppliers, lenders, service providers, utilities providers, landlords of any properties leased) of deadlines for submission and mailing address for claims. Balance the notification and limitation timelines with the threat of litigation / involuntary bankruptcy. If debt payment obligations are discounted, confirm approval of disputed or reduced amounts.
- Notify customers, returning any deposits and customer-owned materials / equipment.
- Notify employees paying wages and payments as may be required by law.
- Distribute property and assets to secured / unsecured creditors as owed.
- Resolve any ongoing lawsuits or other legal matters
- Distribute remaining assets, if any, to shareholders.
- Cancel business credit cards, business subscriptions and business bank accounts.
- Cancel state and county permits and licenses and surrender foreign business rights.
- Finalize any remaining affairs and dissolve the entity.
If one or two secured lenders control all of the assets and there will be insufficient proceeds from those assets to pay any other creditor, the C-Suite Players must still first pay close attention to their individual contractual obligations, then taxes owed by the company and finally their fiduciary duties. After making sure that all entity formalities are satisfied, the C-Suite Players must plan and communicate fully and clearly both to their secured creditor(s) and to all other creditors the orderly marshaling and disposition of the company assets, all the while balancing their duties to each.
Tilting the Scales in Your Favor
If your company is facing the prospect of “winding down” and you are a C-Suite Player, you should:
- Examine carefully what contracts “you have kissed” – your personal contractual exposure.
- Review the company indemnification provisions in the entity documents and confirm that Directors and Officers insurance premiums are current and coverage is sufficient. All of these require the C-Suite Players to act in good faith and in a manner reasonably believed to be in the best interests of the company.
- Confirm all company taxes are paid to date and there are reserves for those not yet due
- Evaluate the assets and whether, if liquidated, they will be sufficient to pay all creditors.
- Develop an agreed upon plan among all C-Suite Players and decision makers.
- Communicate and implement the plan fully and thoughtfully.
- Secure the advice of one or more “trusted advisers” to assist your efforts.