Does A Failed Business Have To Go Bankrupt?

Does A Failed Business Have To Go Bankrupt?

When a corporation fails and is left with debt that it can’t pay, the first thought for the owners is usually bankruptcy.

However, not all insolvent corporations go through a formal bankruptcy process. Bankruptcy is just one of several options to consider.

The best option depends on the specific circumstances of the business and its owners. Here is a summary of the main options for insolvent Canadian corporations:

  • Sale of the corporation: Usually, if a business has failed and has debt it is not attractive to buyers, but sometimes this can be an option. If there is an attractive asset (such as a partially developed new technology or a good customer list), others who have access to enough capital to invest in the business and make it work may be willing to take over, even if that means dealing with some outstanding debt.
  • Proposal or Arrangement: If a corporation could continue (or undergo a lengthy liquidation process) with the help of some concessions from its creditors for more time or a reduction of the amount owing, a Division I Proposal or arrangement under the Companies Creditors Arrangement Act may be possible. Both of these processes involve having a Licensed Insolvency Trustee administer a formal process to allow the company to negotiate a legally binding deal with creditors while a stay of proceedings is in place. Both processes have significant time commitment and costs associated with them. If such a formal process isn’t affordable or would be too difficult to manage, it is also possible to undertake such a negotiation with creditors outside a formal insolvency process. In that case, though, there would be no stay of proceedings preventing a creditor from taking action to collect their debt while negotiations are ongoing.
  • Bankruptcy: This is a legal process wherein a Licensed Insolvency Trustee takes over from the owners. The trustee then formally announces the business’s closure (rarely does a trustee continue operations and try to sell it as a going concern) and deals with any employees, landlords, etc., before liquidating its assets. They also run a claims process to confirm who is owed money and what legal priority they have compared to other creditors. Lastly, the trustee distributes the proceeds from the liquidation (first to their fees and out-of-pocket costs, and then to the creditors).

This creates finality in a way that is reliable and orderly, and by handing the wind-down of the business over to a trustee, a weight is taken off the shoulders of the owners/officers of the company. But if the assets of the company are insufficient to cover at least the trustee’s fees and costs, the trustee will look to the owners/officers of the company to cover those costs, usually by way of an up-front deposit.

  • Receivership: This option isn’t actually available to the company’s owners/officers, unless they are also creditors of the company. Receivership is a remedy available to creditors of the company (usually secured creditors), to force the business into an orderly liquidation process run by a Licensed Insolvency Trustee. Although the owners can’t put a company into receivership, they can provide their consent to allow a creditor to do so if they believe it is best to simply let a willing creditor initiate the liquidation (and cover any related costs).
  • Informal Winding-Up: An insolvent corporation can be informally wound up by its owners/officers who essentially try to mirror what a bankruptcy trustee would do: announce the business’s closure and deal with any employees, landlords, etc., before liquidating the assets, figure out who is owed money and what legal priority they have compared to other creditors, and distribute the proceeds from the liquidation to creditors before notifying the creditors that there are no remaining assets to satisfy their debts. While this can be time-consuming and may require the support of a lawyer or other advisors to ensure it is done in as defensible a manner as possible, it avoids the fees and many of the steps (such as a creditor’s meeting and court appearances) associated with a bankruptcy.

The above is not necessarily a fulsome list – there could be other viable options, depending on the company’s situation. (It is important to note that whichever of the above options is taken to wind the company down, it generally will not provide any protection or release of liability for individuals who have guaranteed or co-signed the company's debts, aside from, occassionally, a successful proposal.)

For many small business owners, the two most viable options are bankruptcy or an informal wind-down, and we often assist business owners with deciding between those options. More often than not, the cost associated with a bankruptcy pushes small business owners to opt for the informal wind-down option.

Before making a decision, the owners/officers of the corporation need to carefully consider the best course of action based on the company's unique circumstances and considering the potential impact on its stakeholders. Seeking professional advice from a lawyer, a Licensed Insolvency Trustee, and/or financial advisors is recommended.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly help business owners review their options for their companies that are dealing with overwhelming debt. If you'd like some advice, please reach out to us.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.


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