Eight Things a Debtor Should Never (or Almost Never) Do

Financial Distress

June 2020

After years of helping borrowers with their debt restructuring options, in and out of bankruptcy, I have compiled a list of eight things they should avoid.

View Brian Spector’s video version of this article.

The Great Recession and its aftermath were an extraordinarily difficult time for many investors and business owners who borrowed or guaranteed debt to finance their businesses and investments. After years of helping such borrowers (debtors) with their debt restructuring options, I have compiled a list of eight things they should never (or, except in certain cases, almost never) do.

8. Don’t just proceed with “business as usual.”

Some debtors expect to continue operating the same business that has been losing money. Before doing so, they need to determine whether adjustments (e.g., reducing overhead or other costs) can be made so that the business can operate profitably on a go-forward basis. If it cannot, then the business likely is not worth saving. Remember: when you find yourself in a hole, the first thing to do is to stop digging.

7. Don’t try to improve your company’s cash flow by nonpayment of payroll taxes.

Directors and officers of corporations, members or managers of limited liability companies, and certain financial employees of both may be personally liable as “responsible persons” (persons with a duty to collect and pay over withholding taxes) for failing to collect and pay over “trust fund” taxes – the portion of income, social security, and Medicare taxes required to be withheld from employees’ paychecks.

Tax authorities regard these monies as theirs and can be very aggressive in trying to collect them from those who directed or released their payment for other purposes. Responsible persons thus may incur personal liability where none previously existed if such taxes are not paid.

6. Don’t withdraw money from your retirement plan.

Funds in ERISA-qualified retirement plans typically are exempt from creditors’ claims under Arizona law. There is no limit on the amount of the exemption, and it therefore is a valuable protection. Retirement funds are exempt for a reason – they are needed for your retirement. Early withdrawal also can result in stiff penalties. These funds should be considered “off limits” to any restructuring efforts and used only as a last resort.

5. Don’t wait until you have exhausted your resources.

It doesn’t pay to use your last available funds to make one more installment payment if you still will have other unresolved debts and obligations. Instead, conserve your remaining resources and use them towards a comprehensive solution to resolve all of your debts.

4. Don’t try to narrow down your debts to the largest one.

While having one remaining creditor might sound simpler than having many, it actually can make debt restructuring more difficult. It is better to have multiple creditors, some of whom hopefully will support your restructuring proposal. That is particularly so if you decide to restructure in bankruptcy, where leaving one large creditor could give that creditor veto power over your restructuring plan.

3. Don’t transfer valuable assets to Aunt Sally.

You might think that if Aunt Sally has your valuable assets, your creditors can’t get them. Wrong! Very broad laws apply to protect your creditors whenever you dispose of assets while insolvent without receiving “reasonably equivalent value” in return. Such transfers can subject you and Aunt Sally to liability and preclude you from protecting those assets (or their value) through better methods. And don’t assume that no one will find out about such transfers. Your creditors might ask about them, and you likely will have to disclose them if you file for bankruptcy protection. Such transfers can taint you in the eyes of your creditors and the court, causing them to question otherwise legitimate conduct.

2. Don’t lie about or fail to disclose assets or transfers.

If you do so outside of bankruptcy, you could be engaging in fraud. If you do so in connection with a bankruptcy case, you could be committing a bankruptcy crime or risking your right to a bankruptcy discharge of your debts. It simply isn’t worth the risk. Remember, honesty is not only the best policy – it will help you avoid more serious trouble.

1. Don’t wait until the last minute to get professional help.

Just as a good coach prepares a game plan, good counsel can help you evaluate your situation, determine your objectives, and devise the best plan to achieve them. And the more time you and your counsel have to do so, the better are your chances of a successful outcome.