Struggling Business: Owners and Management Should be Mindful of Personal Liability

Joe Foster Headshot
Joseph A. Foster
Director, Corporate Department
Christopher M. Dube
Director, Corporate Department
Published: McLane.com
June 1, 2020
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Your business is struggling.  You have tested your cash flow analysis with a wide variety of assumptions and the more likely ones, in your view, don’t change the downward trajectory in time to recover.  Resist the temptation to put off assessing the options for the business; delay can reduce your options and result in higher personal liability than might otherwise be the case with good planning.  It is time to consult with legal and accounting professionals to plan for the best outcome possible.

Identifying which debts and obligations of the business create personal liability (whether by agreement or statute) is the first step in enabling you to plan in a way to limit or even eliminate your personal exposure.  In addition, care needs to be taken to address these obligations in a manner that minimizes the possibility that payments made are characterized as an avoidable  preference or fraudulent conveyance in a  bankruptcy or other proceeding  which could result in the payments being recovered and you becoming directly responsible to the creditor.  The following are areas to explore and review with your accountants and legal counsel:

  1. Personal Guaranties.  Most small business owners are forced to guaranty their bank debt.  In addition, many have guaranteed a panoply of other obligations and frequently do not remember doing so.  Vendor contracts often include personal guaranty language that is overlooked or glossed over.  Other examples include real estate leases and personal property leases (e.g., telephone systems and copiers).  Review each of your material contracts and determine which you have personally guaranteed and those you have not.
  2. Business Credit Cards.  Nearly every business credit card that bears the name of the owner and some that don’t include in the credit card agreement that the owner guarantees the obligation.  Determine if that is the case for your organization.
  3. General Vendor Debt.  Generally speaking, claims of general creditors can only be maintained against the business and not its owners absent a personal guaranty.  However, owners and management should be careful not to run up trade debt once it is determined the business will need to terminate operations and there is little or no prospect that newly incurred trade debts will be paid.  If this occurs, creditors could claim fraud and seek to collect against the management team that ran up the debt knowing the creditors would not be paid and against owners who benefited.
  4. Trust Fund Taxes.  So-called trust fund taxes (taxes collected from employees for income taxes or customers for sales tax) should be timely paid.  If payment is not made, persons deemed in control of the company have personal liability for unpaid amounts and that liability is generally not dischargeable in a personal bankruptcy.  While the government often moves slowly to collect past due taxes, it has extraordinary powers to do so.
  5. Employees Benefits.  Amounts withheld from an employee’s paycheck for health insurance, 401(k), and other benefits also can result in personal liability if they are not paid over to the health insurer, plan administrator, and the like.  The law essentially views use of these funds as theft and it should be avoided at all costs.
  6. Employee Wages.  State law requires that wages and certain benefits (for example, accrued vacation in some circumstances) be paid at dismissal or within a mandated timeframe.  For example, within seventy-two hours under New Hampshire law, on the last day of work under Massachusetts law, and on the next regular pay day in some other jurisdictions.  Owners are automatically liable under Massachusetts law for the failure to pay wages; owners and managers with responsibility over wage payments can be liable under New Hampshire law for willful failure to pay (e.g., paying shareholder or officer loans).  In some cases, the claim can be doubled or tripled.
  7. Consumer Deposits.  Companies which take in consumer deposits and do not deliver the goods or services they contracted to perform are likely to get great scrutiny from the consumer protection divisions of the state attorney general’s office.  While personal liability will not necessarily lie, the regulators could choose to pursue the owners for consumer fraud if deposits are taken when it appears a business failure is imminent.
  8. Insurance.  Be sure to do an inventory of your liability policies including Errors and Omissions/Director and Officer liability policies and if possible get prospective coverage that would continue beyond any business closure.  Claims can and do often arise against directors and officers in bankruptcy courts after a business closes and having a policy in place will insulate the management team from any claims.