Bankruptcy 101: Spotting the Problem
I often joke that I know enough about tax to ask questions, but not to give answers. I suspect that many non-bankruptcy attorneys feel the same about my chosen practice area. In many ways, my tongue-in-cheek approach makes good sense: I want to know enough to ask appropriate questions and spot obvious issues; but don’t want to overreach and give uninformed advice.
If only you could install a device on your office door that would set off a siren when a client walks through who needs to consult a bankruptcy or restructuring attorney (lately, the siren would wear out in a matter of months). There’s not even an exhaustive or precise list that you can keep at your desk of warning signs that a client is teetering on the brink of insolvency. Nevertheless, many years of working with distressed companies and financially challenged people have distilled a list of “red flags” that may help you spot the client for whom a bankruptcy or restructuring consultation might be helpful.
Whether the client is a flesh-and-blood person or a business entity, being involved in multiple lawsuits or disputes is a sign of financial trouble. It’s easier to spot this warning sign when the client is being chased by multiple creditors. It’s less obvious—but still a warning sign—when the client is the creditor/plaintiff or the litigation involves something other than a collection dispute. Multiple lawsuits are a “double whammy”: their mere existence suggests deeper problems, and they certainly create (or exacerbate) financial challenges through the direct and indirect costs of litigation.
Not all lawsuits are created equally. If a client is facing litigation—as a plaintiff or a defendant—that threatens their overall financial well-being, they could go from success to insolvency very quickly. Litigation that presents existential risk ought to prompt a discussion of how to deal with the losing side of that equation.
Looming Loan Maturity
Whether a client seeks your advice about, or simply mentions, that they have a substantial loan that is maturing or up for renewal, you should treat this as a warning sign of financial trouble. Particularly in our recent economic and lending environment, lenders are renewing fewer credit lines and refinancing fewer loans. Even “good” borrowers that are not in financial default can find themselves caught unprepared when their long-standing lender calls their loan and refers them to collection specialists within the lender’s organization. Not surprisingly, loans that are even superficially connected to real estate are particularly difficult to renew or refinance given the historic drop in values.
Multiple Layers of Debt
When a client has two or more mortgages on a residence, or two or more layers of financing secured by a pledge of business assets, there is a strong risk that the client has overleveraged assets and has (or will) become challenged to meet financial obligations. The availability of cheap and easy credit a few years ago combined with the ensuing drops in collateral values, employment rates and business profits has created an environment rife with overleverage, poor liquidity and diminished cash flows.
Virtually any type of tax problem suggests a solvency issue. Outstanding personal income taxes, “trust fund” taxes like sales and use taxes or employee withholding taxes all imply an underlying cash flow or solvency problem—but also present a going-forward risk of levies and other onerous collection tactics that can only exacerbate existing challenges.
Difficulty in Paying Fees or Posting Retainers
Regardless of what else you know about an existing or potential client, their delinquency in paying your bill or professed difficulty in providing a suitable retainer is a classic warning sign of general financial difficulty. Even if a client has no other apparent problem, if they cannot afford to deal with a sudden legal problem appropriately, they are in trouble. This begs the question of how they could afford bankruptcy or restructuring counsel, either, but you may join my wife in wondering why my ideal client is one who will have a hard time paying me.
Most of us readily recognize that the loss of a spouse or one’s health presents a direct challenge to financial well being. For a business client, the loss of a founder, partner or key person (whether to death, retirement or dispute) equally challenges a business’s well being.
Recent Transition in Staffing or Outside Professionals
If a client seems to have had an unusual turnover in senior employees, or is changing attorneys or accountants, this can be a sign of operational and financial difficulties.
There’s a good argument that the presence of any one of the foregoing wouldn’t set off the siren if you actually had a solvency sensor above your office door. Experience suggests, though, that the presence of any two or more would set the siren to wailing.
I’ll end with a final word about broaching the subject with your client. Not too many years ago, I worked with a CEO of a company that we were forced to put into Chapter 11. He couldn’t bring himself to utter the word “bankruptcy” and instead referred to it as “the ‘B’ word.” He insisted that we call the process a “reorganization.” If you reach the conclusion that an existing or prospective client is facing a solvency challenge, call us “restructuring professionals” and explain that we handle more than just bankruptcies. Any bankruptcy attorney worth hiring considers bankruptcy itself as a last resort—just as a seasoned litigator avoids filing a lawsuit until there’s no other reasonable course.