by Tom Eldridge
Large amounts of deleveraging have taken place in the private sector. There is a lot more yet to be done, as implied by the following graph.
Click on graph for larger image.
A significant part of the debt reduction occurs through loan defaults and bankruptcy. Bankruptcy is a big decision to make, especially for a business. It is important to tread softly when considering bankruptcy because what is perfectly fine in life may not be fine in bankruptcy. There are some mistakes that businesses just cannot afford to make.
Mistake #1: Trying to Get Out of Debt by Selling Assets
Each state has statutes that determine which assets can be kept when one is filing bankruptcy. These are known as “exemptions” and should be carefully considered. Many will start to liquidate assets that they should actually be keeping. Another thing to really analyze is whether or not selling these assets will actually take the businesses’ debt down enough to make a difference. Will selling these assets get debt to a level where bankruptcy is not necessary? Will selling off these assets bring debt back down to a manageable level? If the answer to both of these is no, then it is probably not a good idea to start selling. One must also consider which assets would be protected in bankruptcy. It does not make sense to sell off what would actually be protected.
Bankruptcy is not something to take lightly. It can help a business get out of their legal responsibility to debt, but it cannot fix the reason that caused the debt in the first place.
Mistake #2: Assets Not Getting Their Fair Market Value
Getting rid of assets and not getting back what they are worth is a big mistake. Businesses should never try to quickly sell off any debt when considering bankruptcy. These processes are meant for debtors who plan on playing by the rules, so never hide or sell off assets to try and profit from them.
Mistake #3: Making Inside Transfers
Many businesses considering bankruptcy think it is the honest thing to do to pay back business associates or other people that they owe prior to filing. This is known as inside transferring in bankruptcy. When a bankruptcy petition is filed, all of this must be disclosed and insiders can be gone after by Trustees for the money the business gave them if said money was repaid within a certain time period before the bankruptcy petition.
Mistake #4: Taking on More Debt Right before a Bankruptcy
Taking trips, taking cash advances or maxing out credit lines before an anticipated bankruptcy can actually be seen as a form of fraud. Committing bankruptcy fraud is seen as a felony and carries jail time. Be honest, keep additional debt to a minimum and ensure that any money spent is absolutely necessary.
Mistake #4: Being Less Than Honest
When a business takes on a bankruptcy lawyer, it is important that the business sees this lawyer for what he or she is and that is an ally. Being embarrassed or shy about the facts behind debt can only get a business into trouble. It is imperative to be perfectly honest about the businesses’ financial history, debt and everything else associated with the business. Honesty will make the process of bankruptcy go a lot smoother.
Assets protected under bankruptcy can vary depending on what entity is entering the process. For individuals and sole proprietor businesses (unincorporated) a good discussion is available from Lawyers.com. An article from Forbes describes more esoteric asset protection planning which can be useful, provided it is done well before the time that bankruptcy so not to be possibly interpreted as a maneuver undertaken merely to stiff creditors.
A good academic paper on the Economics of Corporate and Personal Bankruptcy has been written by Michele White, University of California San Diego. Because bankruptcy codes can have differences from state to state a bankruptcy attorney should be consulted in the state of residency or incorporation.
About the Author
Tom Eldridge is a well-respected freelance journalist with many years under his belt covering business related topics. When Tom isn’t busy reviewing companies who offer sales tax classes, you can find him working on his collection of vintage guitars or coaching his son’s football team.