Communicating With Creditors When Winding Down a Business

No one relishes the idea of winding down their business. Unfortunately, business dissolution is increasingly common these days due to the economic hardship caused by the COVID-19 pandemic. While the big Chapter 11 bankruptcy cases get all the headlines, there are far more businesses that simply shutter outside of bankruptcy because there’s no hope of reorganizing. Data from Yelp suggests that, as of August 31, approximately 98,000 businesses have permanently closed since March 1—and that’s just within the relatively small sample set of businesses on Yelp’s platform.

As anyone who has gone through the process of winding down a business comes to learn, it doesn’t simply entail hanging a “Closed” sign on the door and walking away. In order to avoid personal liability and adhere to various laws and regulations, a dissolution and wind-down process must be undertaken. Such a process often requires the involvement of legal counsel in order to ensure that it’s done right, and owners and officers can walk away confident that they will not face future claims.

A common issue faced by businesses going through a dissolution and wind-down process is dealing with outstanding creditor claims. There are a number of reasons why a business may be winding down, including financial distress, the retirement of a sole shareholder, or the sale of assets to another business (which include the core business continuing, at least to some extent, as a going concern). Regardless of the reasons, if a business is winding down, it’s likely to have at least some number of creditors with debts owed by the business at the time of dissolution. The length, complexity, cost, and certainty of a wind-down process will be determined, in large part, by how the business deals with its creditors.

Communicating with Creditors During a Wind-Down

Michigan’s Business Corporations Act (the “BCA”) provides that, when a business chooses to dissolve under state law, the winding up of affairs includes the collection and sale or transfer of the corporation’s assets, the payment of any outstanding debts and liabilities, and any other actions required to liquidate the business. The BCA requires that the business provide notice to creditors of the corporation’s dissolution. Once notice is given, creditors have a limited amount of time in which to pursue a debt or liability against the corporation.

However, such a notice is not the end (and often not the beginning) of discussions with creditors concerning past due debts. Because creditors won’t, in most instances, simply accept their fate and disappear once they learn their customer is winding down, it’s best to be proactive and form a creditor communication strategy from the start. There are risks for failing to do so:

• The business may get swamped with inbound demands for payment that bog down those responsible for executing the wind down;
• The reputations of the business leaders may be negatively affected, which may inhibit their ability to do business in the industry in the future; and/or
• Certain creditors, feeling jilted, may be more likely to pursue business owners/officers for personal liability.

So what should a communication strategy look like? First, it should be tailored to address each unique creditor cohort. For instance, the frequency and extent of communication with a secured lender, or other creditor holding a debt subject to a personal guaranty, is obviously going to be more robust (and led by legal counsel) than what is afforded a business’ smallest unsecured creditors.

For the larger swath of unsecured creditors, a communications strategy should be context dependent. The term “wind-down” can encompass various scenarios. Is the business shuttering altogether? Is it significantly downsizing but continuing to operate in some limited capacity? Are core assets being sold to a third-party buyer who is also bringing the business owner on as an employee?

In any wind-down scenario, the best approach is to be proactive and honest. There is little upside in hiding from unsecured creditors, given the risks outlined above. Once the business wind-down strategy is determined, the communication strategy should involve transparently addressing creditor concerns, including the extent and timing of any payments they may receive. In situations involving significant secured debt, there may be no distribution to unsecured creditors, and a business can avoid lots of questions by laying out why there will be no money left over to pay unsecured debts.

In short, there is no one-size-fits-all approach to communicating with unsecured creditors in a wind-down. Experienced legal counsel should be involved in developing the strategy. Communication missteps can lead to bad outcomes, such as extra work and expense in the wind-down process, and the possibility of claims of personal responsibility that owners/officers must contend with. A smart communication strategy helps smooth the road for an organized, streamlined wind-down process.

If you have any questions, or require assistance, in determining the best path forward for your business please contact David Dragich at ddragich@dragichlaw.com or 313.886.4550. From restructuring to wind-down, we help our clients address challenges, mitigate risks, and maximize the value of assets.