GEOFFREY: Why, you chivalric fool — as if the way one fell down mattered.-John Castle and Anthony Hopkins, From “The Lion in Winter” (1968).
RICHARD: When the fall is all there is, it matters.
If you have decided it’s best to shut down, and you are considering shuttering your business, there are some important things you should know—like what to do with your last funds.
The last declaration of Anthony Hopkins’ Richard in “The Lion in Winter” applies. How you spend your final dollars can make the difference between a relatively calm, organized wind-up and a financial disaster that attaches to the business owner personally.
There is an Order of Operations
If you need to close and there isn’t enough money to pay everyone, who should you pay? This decision should be governed by how easy it is to get rid of certain debts. State law governing winding up, and business and bankruptcy law favor certain creditors over others, so there is an order of operations and get good with the fact that if you’re closing, some creditors might not get paid.
Don’t Transfer Money
Before we get to the who to pay first and who to pay last, there is an important thing to know first: don’t transfer money to individual business owners, don’t transfer money between accounts, and don’t pay any one creditor in a favorable way. Just don’t transfer any money. Leave it put in your operating, payroll, tax, and savings accounts.
Don’t Spend it All
Do not spend your last dollar paying creditors and vendors. Going out of business is a little painful, and sometimes involves hard conversations with creditors and vendors who aren’t going to be paid. Do not let them have access to your business bank accounts, and if you’ve made the decision to close, do not promise additional payments. If there are excess debts, and you need a circuit court judgment and state law liquidation, or bankruptcy proceeding, you’re going to need capital to hire counsel. These are complicated proceedings that are not good for “do it yourselfers,” and good legal advice is a legitimate business expense that can prove extremely valuable.
Pay High-Priority, Non-Dischargeable, and Debts that Attach Personally, First. Pay Unsecured Creditors Last.
Taxes. Pay your outstanding tax liability first. Many taxes and the federal, state and local level attach to business owners personally if not paid. The kneejerk reaction is to pay these somewhere in the middle. Resist the urge. In addition to hiring counsel, certain outstanding tax liabilities should be prioritized.
Secured Loans for Retained Collateral. If the business intends to pay secured loans, perhaps to protect the value of work in progress, to preserve the value of a real estate asset for sale, or to stave off foreclosure or replevin, like real estate mortgages, then those should be paid next. It’s of note that a piece of real estate with equity can be liquidated to further pay claims down the list.
Employees. Some employees collectively bargain, some don’t. But one set of expenses that will almost always go un-challenged in a liquidation proceeding is payroll. This should always be a high priority to avoid liability.
ERISA and Qualified Retirement Plan Liabilities. If you are an employer that contributes to employee retirement plans, this is where things get complicated and a good lawyer can help. But you can see where I’m putting this in the list. Withholding payments can create withdrawal liability in certain types of plans, and costly liabilities and penalties in others. Whatever kind of plan you were providing, tread carefully here.
Protection. Payments to secure and protect work in progress, secured collateral, and inventory, such as insurance, security services, and utilities. While not a “debt” in the typical sense, it is wise to protect the remaining value in your business. That value can be work in progress, client work in progress, shelf inventory, and product. Since this category often represents a business’s value and ability to provide some payment to creditors both up and down the list, it is important.
Leases. Outstanding leases for real estate that is necessary for securing and protecting the business property should be paid. Leases of equipment, consignments, and other leases should not be paid, and any lease deficiencies will ultimately become unsecured creditors. This applies if you have already made the decision to close down.
Unsecured Obligations. Last and least, unsecured creditors. Vendors who have no security (with the possible exception of professionals like accountants, if you want to keep working relationship), credit cards, capital lines of credit, notes, lease deficiencies, personal loans, notes owed to officers and equity security holders.
This is not intended to be “one size fits all” legal advice, or legal advice of any kind, but it should give you enough information to understand that you should consult counsel as soon as you make the decision to close, but before you start wind-down procedures.