My small business needs to go bankrupt… where do I start?

Here’s what we tell people when they call

The first thing we’ll do is ask some questions to determine if bankruptcy really is the right option for the business. More often than not, the outcome of that conversation is that we determine bankruptcy is not a good option for the company. This is usually due to the fact that the company doesn’t have enough available assets to pay for the cost of the bankruptcy, which is a significant cost as a Licensed Insolvency Trustee must be retained, and once they are retained they are bound to carry out a series of specified procedures regardless of the size of the business.

When the business can’t pay these costs, often the company’s owners are either unwilling or unable to fund the cost as they've already invested a large amount of personal funds in trying to keep the business going. It's also worth noting that if the company can’t cover the cost of the bankruptcy there isn’t much chance that the creditors will receive any recovery from the bankruptcy, so its benefit to creditors is limited.

When bankruptcy isn’t an option but the company can’t continue, the owners of the company often simply shut down the business and tell its creditors that it unfortunately can’t pay them back. Often, there is liability for the business’s owners (which can't be extinguished by the company filing a bankruptcy) as they have usually guaranteed some of the company’s debts, have taken on personal debt to try to save the company, and/or are liable as directors for unpaid tax debts. The conversation then shifts to how the individual owners are going to deal with that debt.

In the somewhat unusual event that bankruptcy does appear to be a viable option for a small business, we then discuss what that means for the company, its owners, and any employees. If, after a brief discussion about the bankruptcy process the owner wants to pursue that option, a series of discussions and correspondence typically ensues between the business owner and the Licensed Insolvency Trustee to gather details and documents to help nail down the plan and get a better sense of the costs that will need to be funded. During these discussions, if it appears that other options, like a creditor proposal or a going concern sale, might be available to the company those options will be weighed as well before a decision is made to file the bankruptcy.

So what are the things that impact whether bankruptcy is right for your company?

Here is a non-exhaustive list of things we consider before determining if bankruptcy is a viable option for your company:

Is the business incorporated?

If a business is incorporated, the business itself can be assigned into bankruptcy. However, if the business is a sole proprietorship or a partnership, the business cannot be separated from the individual proprietor or partners. In that case, the only way to assign the business into bankruptcy is to bankrupt the proprietor or partners, too.

Does the business owner want to continue to run the business or shut it down?

If the plan is to make an insolvency filing that deals with the debt so that the existing company can continue, usually a bankruptcy is not the answer, as a business can only exit bankruptcy if its debts are paid in full. The reason most people aren’t aware of this is that the media often talks about large corporations “exiting bankruptcy” - in those cases, the terminology the media is using is either incorrect (they are actually referring to a restructuring), or they are referring to a United States case, which uses different terminology.

A small business that wants to shed debt and continue on may be eligible to file a Division I Proposal, or possibly a plan under the Companies’ Creditors Arrangements Act (CCAA). Such a proposal or plan is essentially a contract where creditors agree to delayed payments and/or a reduction of the debt. A Licensed Insolvency Trustee can discuss these options if applicable.

How much does the company owe and who are its creditors?

The amount and type of debt can make a big difference in determining what options might be available to the company. Some examples of how this impacts the decision:

• If there is a large debt owed to a bank, often that debt is secured against the assets of the company. In that case, even if the company were to file a bankruptcy, the secured creditor has first claim to the assets of the company. And secured debts are not included in a bankruptcy, so bankruptcy won’t deal with the problem. In this case it may make more sense for the secured creditor to seize the assets or appoint a Receiver to do so.
• If the company owes more than $5 million to its creditors, it is eligible to file a CCAA, which is a court-driven, flexible (but expensive) restructuring. If the debts are below that threshhold, this option isn’t available.
• If the company owes money to Canada Revenue Agency (CRA), CRA has first claim to the company’s assets, even before a bankruptcy trustee or a secured creditor, for certain debts like GST and payroll remittances. So if the company’s assets are insufficient to pay CRA, bankruptcy may not be an option unless the Trustee can get CRA to agree to allow the bankruptcy costs to be deducted from what CRA will receive.

What are the assets of the company and how much could be realized from selling them?

In a bankruptcy, the assets of the company are sold and the funds are used to pay the cost of the bankruptcy and provide some sort of distribution to the company’s creditors. However, as mentioned above, we often find that the value of the remaining assets (after secured creditor and CRA claims) are insufficient to provide enough funding to cover the cost of the bankruptcy, let alone leave anything for the unsecured creditors. In this situation, a bankruptcy provides little benefit to creditors.

Additionally, the costs of the bankruptcy have to be covered in some other way, which often involves someone (like the business owner) providing funding to the Trustee. Quite often, the owner cannot afford to provide this funding or does not view it as a good use of funds, so a bankruptcy is not a viable option.

To what extent is the business owner liable for the business’s debt?

It's very common for a small business owner to guarantee or co-sign certain debts of the company like bank loans or premises leases. In addition, there are certain debts which directors are legally liable for if they aren’t paid, such as certain debts owed to Canada Revenue Agency or employees. Before the business owner decides to assign the company into bankruptcy, we review the debts that they may become liable to pay if those creditors can’t be paid from the sale of the company’s assets. In some cases, business owners decide that a bankruptcy of the company will only exacerbate their personal liabilities. This is because a bankruptcy trustee will often not be able to sell the business’s assets for as much as the owner could generate by selling the assets, particularly if they can do so while the company is still operational.

How many employees does the company have?

Commonly, when a small business owner approaches us about bankrupting their company they have laid off most or all of the company’s staff as they tried to cut costs to save the business over time, but sometimes employees remain. Bankruptcy or no bankruptcy, shutting down the company will end the employment of those that remain, but if the company files a bankruptcy the remaining employees (or those that were let go very recently) may be eligible for payments from the government under the Wage Earner Protection Program Act (WEPPA) to cover outstanding wages and/or vacation pay. This can be a reason to file a bankruptcy even if there is no other obvious benefit. However, the bankruptcy Trustee has to administer the WEPPA claims, so while more employees means a larger benefit of bankruptcy to employees, it also means higher costs that have to be funded somehow.

As you can see, there are many things to consider to determine if it makes sense for a company to file a bankruptcy. A Licensed Insolvency Trustee will review these with the business owners and help them come up with a plan to deal with the company. Sometimes, after this review they decide to go ahead with a bankruptcy. Other times, they decide to offer a proposal (either formal or informal) to the company’s creditors. But more often than not, small business owners end up deciding to simply shut the company down themselves, selling assets and using those funds to pay as much as possible to creditors until there is nothing left. Then we can work with them to deal with the impact of the company’s failure on their personal finances.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly provide advice to business owners. If you would like advice on options for dealing with your business's debts, contact us for a free, no-commitment consultation.

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.