A Quick Guide to Bankruptcy

A Quick Guide to Bankruptcy

lores_bankrupt_business_debt_due_mbHere are some frequently asked bankruptcy questions. However, these answers only provide general information.

Consult with your accountant and legal adviser about how to proceed in your specific situation.

Q. Times have been hard on our business and we’ve been considering bankruptcy. What are the pros and cons?

A. Bankruptcy filings are generally a last resort. They could ruin your company’s reputation and will damage its ability to get credit for years. If you run into a brick wall with your creditors and run out of alternatives, however, your business may have no choice but to file for bankruptcy, primarily under one of the following two federal statutes:

 Types of Bankruptcy and Characteristics
 The Bankruptcy and Insolvency Act (BIA) Available to companies whose debts total more than $75,000 and less than $5 million. Allows for both reorganization under court supervision and liquidation.
 The Companies’ Creditors Arrangement Act (CCAA)  Available to businesses with debts exceeding $5 million. They continue to operate under court supervision while negotiating a Plan of Arrangement to pay creditors.

Creditors can initiate an involuntary bankruptcy proceeding under both laws, subject to certain requirements.

Under the BIA, if your enterprise is insolvent a trustee takes possession of its unsecured assets and liquidates them, distributing the proceeds to creditors. Under reorganization, your business continues to operate while it comes up with a proposal to pay its debts, generally at a discount. A majority of creditors, as well as the court, must agree to the plan.

Once the reorganization is complete, the trustee discharges your business from bankruptcy. If creditors or the court reject the plan, your enterprise automatically is placed into liquidation.

Under the CCAA, the court appoints a monitor to look after the interests of creditors and to report on the reorganization progress. Your company’s management generally remains in charge, but the monitor will have a certain amount of authority.

Talk to Creditors

Talk to your company’s creditors to try to work out lower payments over a longer time frame.

This may buy your company more time to get back on track and you might be able to settle your debts for less than you owe, while maintaining a good credit record. Your accountant and legal advisors can provide guidance on how to go about these negotiations as well as help you find other options.

Q. One of our company’s customers owes us a great deal of money and has told us that the business is declaring bankruptcy. Should we back off?

A. Yes, provided that the customer has actually filed for court protection from creditors and is reorganizing. In BIA reorganizations, an automatic stay of proceedings is imposed on secured and unsecured creditors. The court can lift the stay under certain circumstances. Unsecured creditors can ask for relief from the stay but rarely are allowed to seize assets.

Similarly, under CCAA reorganizations, a broad stay on collections is imposed on both secured and unsecured creditors. As long as the stay is in place, creditors cannot take any action to collect debts. The initial stay is limited to 30 days, but the court may extend that any number of times if it determines that the Plan of Arrangement isn’t prejudicial to the creditors.

Until the customer actually files for bankruptcy proceedings, however, you can take whatever legal means are available to get your money, including repossession or negotiating a deal under which you might get more than you would in a bankruptcy proceeding.

Caution: If a customer pays you in preference to other creditors under a negotiation and then files for bankruptcy, the company may be charged with fraudulent preference.  If that happens, its possible you — or the customer — will have to pay back the money.

Q. If a customer files for bankruptcy proceedings, will we get any of our money?

A. That depends on the nature of the case and your creditor status.

Under the BIA, if the customer goes into liquidation, the trustee sells all inventory, accounts receivable and other property covered by a court order. The proceeds will be used first to pay priority creditors and trustee costs. The balance, if any, is paid to unsecured creditors. Secured creditors aren’t affected by this process, as they have the right to repossess secured assets and liquidate them to recover what they are owed.

If the customer is reorganizing, the amount you  receive  will depend on the terms you and other creditors agree to and your creditor status.

In CCAA reorganizations, there is a lot of flexibility on what the Plan of Arrangement can involve. It often includes offers to pay a percentage on the dollar of the money owed, and can call for swapping stock or a combination of cash and shares for debt. In order to be able to vote on the plan and receive any distribution you must file a Proof of Claim with the monitor.

Generally, creditors are paid in this order:

  1. Super-priority creditors such as the Crown for environmental damage costs and certain unpaid pension plan deductions.
  2. Secured creditors, including lenders and debt holders, who have a claim for debts incurred for a specific purchase (for example, a bank holding a mortgage).
  3. Preferred creditors, including those with certain wage claims, municipal tax authorities and landlords owed rent.
  4. Unsecured creditors such as suppliers and credit card companies who extended credit based on a promise to pay.
  5. Preferred shareholders.
  6. Common shareholders.

Under the CCAA, if a company defaults on a payment to a secured creditor, that creditor has the right to take possession of assets, sell off collateral and sue the company for any amount still owed. Also, if a class of creditors or the court does not approve the plan, the stay is lifted, which increases the likelihood that your business will be placed into bankruptcy.

Q. Will my company’s tax debts be eliminated in a bankruptcy filing?

A. Only if your business actually goes bankrupt. But even then, there are special rules that deal with tax debts in bankruptcy, so you really need to ask your tax accountant to review your company’s situation and confirm that your tax liability will be discharged if your enterprise goes bankrupt.

Q. I am on a corporate board. Are my personal assets at risk if the company files for bankruptcy proceedings?

A. That depends on the provisions of your directors and officers liability insurance policy (D&O policy). Review your company’s policy to determine if it covers defense costs and damage awards in the event of bankruptcy. For example, among other protections, the policy should:

  • Provide separate coverage for directors and the corporation or include excess coverage for directors and officers.
  • Allow continued coverage for innocent board members.
  • Require the insurer to pay covered defense costs and damages in advance or as they are incurred so that you don’t have to pay potentially millions of dollars and wait for reimbursement.

There are many other significant provisions related to bankruptcy that should be included in your D&O policy. Your professional advisers can help you determine what specific coverage you need.

Q. I hold stock in a company that appears likely to file for reorganization under CCAA. What happens to my investment?

A. Holders of common stock are typically last on the list and often get none of their investment back. Holders of preferred shares rank ahead of common shareholders, but often do not get back the full value of their shares. The CCAA allows a company to include shareholders in its reorganization plan and they then typically can vote on the proposal.

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