Hard choices

It’s a situation no one wants to face, but the sooner reality sets in, the better. Bankruptcy of a company is always possible, especially during recessions.

Bankruptcy doesn’t necessarily mean the company is closing its doors. It does mean hard choices will need to be made, such as layoffs, salary cuts, not paying creditors on time, if at all, and trying to keep employees who are looking to leave like rats off a sinking ship. Bankruptcy is traumatic for everyone involved in the business, but the demands on board members are particularly difficult. They sometimes view laid-off workers as the lucky ones.

So, how do board members deal with a bankruptcy filing?

1. Legal duties shift. Boards have a fiduciary duty to shareholders, but when a company goes bankrupt, creditors become an important piece of the puzzle. Once a company nears bankruptcy, board members are legally required to be fair to creditors.

All creditors must be treated equally. The question is, when does the board of the troubled company have to apply this new treatment of creditors? The answer varies by state, type of business, financial situation and the creditor structure.

2. Seek legal counsel. The board needs to discuss its options with counsel — not only legal, but auditors and outside experts — immediately. Unfortunately, these do not work for free, but expert advice is necessary.

3. Maintain a higher level of contact with the management team. Management needs to develop a business plan to keep the company solvent and communicate it to the board. Continual financial reporting is necessary. Key items to monitor include tax payments, receivables, payables, collections and cash, wage payments, insurance coverages and communication with key customers. If these issues are being addressed, a change in management may or may not be necessary.

4. Board members must take a more proactive role in the company. The management team must be monitored, contacts worked and favors called in.

5. Recordkeeping is essential. During bankruptcy, board members run the risk of being sued. The best defense is a good offense. Document everything. Take detailed notes regarding the alternatives that were evaluated and how final choices were made. Include agendas and minutes. Document formal meetings, impromptu ones and phone calls.

6. Avoid negative actions. This includes having board members resign. They may run into greater legal problems if they dessert the company; they are still held accountable, even if they leave the firm.

7. Check the directors’ and officers’ liability insurance. Make sure the premiums are paid.

Board members are fiduciaries. However, when a bankruptcy filing is near, their fiduciary liability is even greater. Louis P. Stanasolovich, CFP, is founder and president of Legend Financial Advisors Inc., a fee-only financial advisory firm located in Pittsburgh’s North Hills. Legend provides wealth advisory services including comprehensive financial planning and investment management to individuals and businesses. Reach him at (412) 635-9210 or www.legend-financial.com.