Workout negotiations can provide struggling businesses with breathing room to reorganize finances without court intervention. These negotiations involve legal considerations that, when mishandled, can create devastating consequences. Before approaching creditors, you must first understand the legal pitfalls that commonly undermine workout arrangements and how to address them.
Accidentally triggering fraudulent transfer claims
Transferring assets improperly before or during the workout can be risky. This includes selling property for less than its market value or paying back an “insider” creditor while ignoring others. This is a dangerous misstep.
Florida law, through the Florida Uniform Fraudulent Transfer Act (FUFTA), allows creditors to recover assets that a debtor transferred to cheat or delay them. For example, giving your business equipment to a related company for a low price may constitute a fraudulent transfer.
You must ensure every transaction during this period provides your company with “reasonably equivalent value” in return. Careful documentation is essential to prove fairness.
Ignoring director and officer fiduciary duties
When your business nears insolvency, the legal duties of its directors and officers change and create a “zone of insolvency” where their decisions face greater scrutiny. Previously, the board focused primarily on shareholder value. Now, the law requires the board to consider the interests of all of its creditors as well.
Poor choices during a workout can lead to claims of breach of fiduciary duty. This means a creditor could sue directors personally, claiming they favored themselves or specific interests over the good of the company. You must show all negotiation decisions were fair and reasonable to all stakeholders to protect the board.
Paying off select creditors (preference claims)
You may feel pressure to pay your most critical vendors or a bank that holds key collateral. Making full payments to only certain unsecured creditors before a formal agreement is in place can backfire severely. If the workout fails and your company enters bankruptcy, a court can legally “claw back” those payments.
This is known as a preference claim. Federal bankruptcy law allows a trustee to void payments made to certain creditors within 90 days before the bankruptcy filing. The intent is to ensure fair and equal distribution among all creditors.
Paying one creditor unfairly puts others at a disadvantage. Often, the trustee will require that creditor to return the money to the bankruptcy estate.
Business workouts can be effective with the right support
The simple truth is that a business workout is less about accounting and more about contractual and corporate law. You need an advocate focused solely on protecting your business and its directors during this precarious time. Securing experienced legal support can help you evaluate the risks and benefits of entering business workouts and structure workout documents to legally bind as many creditors as possible.