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Welcome to the 2020 recession. This will be the fifth significant recession of my lifetime, and the fourth since I’ve been practicing law, so please excuse me if I sound somewhat blasé about it. All recessions are different, yet all are in so many ways the same. The purpose of this article is to give some insights into how to deal with them, based upon my own experiences in advising business owners. What practically should folks be thinking of?
First, get ahead of the downward curve. When things are going swell, businesses buy stuff they don’t need, enter into contracts for stuff they don’t really use, and otherwise bloat their overhead. At the time, nobody really cares much about these things because profits are good and folks would rather spend their time growing their business and profits than trimming fat.
But in a recession, the ability to grow the business and increase ― if not just maintain ― profits will become very difficult. Actually, the most likely thing to happen is that the business and profits will rapidly contract. In that scenario, the business owner who quickly adopts the mindset of “lean and mean” is more likely to survive, while those who just blunder ahead as before will not. This means dramatically reducing overhead, including rental space, employee overhead, rarely-used services, etc. Cut back as far as you can until it hurts, and then cut another 20% off everything. Then be prepared to cut some more as circumstances dictate.
Second, reduce debt immediately. This is the biggie: Debt may empower a growing business, but it is a noose around the neck of a contracting business. Business bankruptcies primarily occur because businesses can no longer service their debt. But simply reducing new borrowing is not the same as slashing debt: Existing debt needs to be paid down as much as possible. This may mean selling valuable things, whether it is intellectual property rights or the spare copy machine, but better to sell them at the early stage of a recession when there may be buyers, than into later stages of a recession when everything is going at fire-sale prices. Yeah, selling stuff hurts, but having debt that cannot be maintained is fatal.
In this context, debt includes not only bank loans, but also long-term rental space contracts and the like. Better to renegotiate those contracts now to shorter terms, if at all possible, than later when it may be impossible to do so.
Third, cash is king. In a recession, nobody gives a flip about business plans and projections or creditworthiness. What everybody becomes desperate for is cash, and whoever holds cash will later be able to find golden opportunities on the cheap. But even if one is just trying to back out of untenable contracts, etc., being able to negotiate with cash is a power bargaining tool, as opposed to trying to get the other side to take a long-term promissory note (that they might consider to be near-worthless). I’ve settled some very large creditor-debtor disputes for pennies-on-the-dollar because the debtor was able to come up with cash. So, start building up as big of a cash reserve as you can today.
Fourth, get out of personal guarantees. What destroys a lot of individuals in recessions are their personal guarantees. When they signed their guarantees, everything seems rosy and the odds of the guarantee ever being called was about as low as the killer asteroid striking the Earth. But recessions kill deals, and that means that personal guarantees get called. Contrary to what a lot of folks seem to believe, there is utterly no legal requirement that a lender limit its recovery to the primary collateral ― depending on the jurisdiction and the terms of the guarantee, the lender may or may not have to pursue that collateral first, but keep in mind that the collateral will likely be sold at fire-sale prices such that it will not realize much money anyway, particularly after attorney’s fees and the costs of sale.
Which is to say that the time for folks to start unwinding their personal guarantees, if they can do so at all, is now. At the start of a recession, a personal guarantor has a much better chance of buying their way out of a guarantee, or at least limiting the amount of the call, than later on when everything has gone South. It is not easy, and it can be quite painful, but not nearly as painful as it may be later.
Fifth, make sure your taxes are paid up. This may not seem like much, but it can be a big deal. Under a relatively new line of cases, such as Kipnis, if a debtor schedules federal tax debt when filing for bankruptcy, the Bankruptcy Trustee can use the IRS’s 10-year Statute of Limitations to challenge transfers as fraudulent transfers, as opposed to the traditional 4-year period available under state law. Thus, if a person has done estate planning even several years ago, that planning may be completely unwound in bankruptcy even if the debtor doesn’t “go banko” until several years from now. Also, tax debt is almost impossible to discharge, whereas ordinary contractual obligations and guarantees may typically be discharged.
Sixth, if you are already financially dead, at least plan your funeral. Folks who know now that they are going to be in financial trouble need to immediately develop a long-term plan to deal with it. Suffice it to say that some states (Texas and Florida, for example) are much more debtor-friendly than other states and have statutory creditor exemptions that will allow for a better lifestyle even if everything blows up. But you have to start early: Even the “unlimited” homestead exemptions of Texas, Florida and a few other states are subject to the 40-month period in the U.S. Bankruptcy Code for protecting home equity. The days of the “debt birds” flocking to these states at the last second no longer exist; you simply have to start very early if you end up having to do this.
Seventh, beware the asset protection hucksters. There are folks out there who will promise financially-distressed folks complete protection from their creditors so long as a sizeable check clears their accounts. But what they are selling is just financial snake-oil. Once folks are already in debt (and those with personal guarantees are already in debt even if the deal is still good today), there is very little that can be done in terms of asset protection that will actually work. To the contrary, creditors will blow through most of it surprisingly quickly, and the debtor may end up with a non-dischargeable debt just for trying. This is not to say that all asset protection planners are bad in this regard, just 99+% of them. There are a few good and conscientious asset protection planners out there, but they are very few and very far between. The old saw “if it sounds too good to be true, then it probably is” carries especial weight here, and folks looking for this type of planning should always ask for a second opinion (if not a third) and run whatever is proposed to them past bankruptcy counsel to see what they think.
It is all about preparedness. The bottom line here is to think ahead and start developing strategies, whether voluntarily contracting the business or making personal preparations. As usual, those who are most prepared will suffer the least and bounce back much more quickly when things inevitably turn back around (and they always turn back around). But preparedness may also mean suffering less pain now to avoid greater pain later ― very much like somebody sticking their fingers down their throat so as to throw up immediately instead of suffering through seasickness for several hours before they involuntarily throw up anyway.
It is a painful choice, but it is the right choice, and it has been every time we’ve gone through one of these.