Planning For A Downturn
Written by: Roger Royse, Executive Contributor
Executive Contributors at Brainz Magazine are handpicked and invited to contribute because of their knowledge and valuable insight within their area of expertise.
The world is experiencing uncertain economic times: high inflation, high interest rates, war and supply chain issues, market crashes and mass layoffs. In these uncertain times, planning is essential.
Flexibility is key. Current economic condition might mandate that a company shift its business strategy or change its business model. Smaller companies have an advantage in that they can be more nimble in this regard. Sometimes chaos may create opportunity. A Harvard Business Review study of past recessions found that companies that successfully emerge from recessions increase R&D, expand where their competitors cut, and speed up the digital transformation. [Gavett, HBR.org, June 24, 2022]
More importantly, the company should protect the people behind the company. Companies may (and usually do) fail, but the founders can go on to later form successful companies. For example, a founder should avoid any personal liability for any debts of the company, such as personal guarantees. The risks of the business should stay with the business.
When cash is tight, employers might be tempted to pay more demanding creditors (landlords, payroll, vendors, etc.) with the idea that they will get the tax payments caught up later. That is a dangerous strategy because if an employer does not remit employment taxes, officers and other responsible persons can be held liable for the tax personally. The law may also impose personal for an employer’s failure to pay wages and benefits or jeopardize employment benefit plans, such as the company 401(k).
Piercing the corporate veil, in which shareholders, LLC members, directors, and others may be liable for a company’s debts. Companies must avoid intermingling of personal and corporate assets, failing to adequately capitalize the corporation or follow formalities, or using the corporation to fraudulently escape liability.
An entrepreneur should never transfer assets beyond the reach of creditors because fraudulent (or avoidable) transfer laws permit creditors to void a debtor’s transaction when a debtor engages in a transaction with the actual intent to hinder, delay, or defraud any creditor or when a debtor makes a transfer without receiving reasonably equivalent value and cannot pay its debts. Similarly, a company should never misrepresent their company’s finances to deceive another person into signing a contract. The fraudulent actor can be personally liable in damages to the defrauded party.
Directors and officers owe fiduciary duties to their shareholders, including a duty of care and a duty of loyalty. If a company is insolvent, however, the directors and officers might owe duties to creditors, depending on state law. The issue comes up when the company (and its management) prefers one creditor or group of creditors over another.
There are many other ways an individual could become liable for the debts of an insolvent company, so every company should have directors and officers (D&O) liability insurance to protect management if they are sued by employees, vendors, competitors, investors, customers, and other parties for wrongful acts in managing a company. No person should ever be a director of any company, public or private, without insurance.
Finally, many companies will re-renegotiate its obligations or extend and reduce its debts. As a general rule, forgiveness or cancellation of debt is a taxable event for the cancelled debt. Fortunately, there are exceptions for insolvent companies. Tax advice is key to any company compromising or settling a debt.
For more information on these issues, see 10,000 Startups: Legal Strategies for Startup Success, Chapter 35.
Roger Royse, Executive Contributor Brainz Magazine
Roger Royse is a partner in the Palo Alto office of Haynes and Boone, LLP and practices in the areas of corporate and securities law, domestic and international tax, mergers and acquisitions, and fund formation. He works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger is a Fellow of the American College of Tax Counsel and former chair of several committees of the American Bar Association Sections of Business Law and Taxation. Roger has been an instructor or professor of legal, tax and business topics for the Center for International Studies (Salzburg, Austria), Golden Gate University School of Law and Stanford Continuing Studies. Roger is a nationally recognized authority on AgTech – the technology of food production ‒ and the legal considerations for companies in this industry. Roger is also the author of 10,000 Startups: Legal Strategies for Success and Dead on Arrival: How to Avoid the Legal Mistakes That Could Kill Your Startup and has been interviewed and quoted in the Wall Street Journal, Forbes, Fox Business, Chicago Tribune, Associated Press, Tax Notes, Inc. Magazine, Nikkei Asian Review, China Daily, San Francisco Chronicle, Reuters, The Recorder, 7X7, Business Insurance and Fast Company.
