How to Avoid Small Business Bankruptcy and What Happens When a Business Goes Bankrupt

In the realm of business, few challenges are as daunting as facing financial instability, especially for small business owners who have poured their hearts and souls into their ventures. Bankruptcy, while a difficult reality, is not the end of the road. Instead, it can be a stepping stone towards a brighter, more sustainable future. Many current business moguls have used the tool of Bankruptcy to create a pathway to a more profitable business model.

However, why go there if you don’t need to as there are ways to avoid Bankruptcy. Let’s examine how to avoid small business Bankruptcy and what happens when a business goes bankrupt in Canada.

In Canada, the process of small business Bankruptcy and restructuring is governed by the Bankruptcy and Insolvency Act (BIA), offering a structured path for businesses to address their financial challenges and emerge stronger.

Recognizing the Entrepreneurial Journey

Every small business represents a dream realized, a vision brought to life through hard work and determination. When faced with the prospect of financial difficulty, it’s essential to acknowledge the sacrifices and dedication that have gone into building the business. This perspective can serve as a source of strength and resilience during the challenging times ahead.

Steps to Avoid Small Business Bankruptcy

When we meet with people, the possibility of filing for Bankruptcy is always last on the list of possible options. Sometimes a fresh set of eyes looking at a situation can provide some practical alternatives for re-arranging the finances of your business. Here are some ideas that can sometimes be useful for the business owner to create some breathing room:

• Sell redundant assets that are not being used to create some immediate cash.
• Sell assets that are used in the business and lease them back from the purchaser. This can also create some short term cash.
• Examine each part of the business and close any unprofitable divisions.
• Review your situation with your accountant and lawyer to see if they have any ideas.
• Contact suppliers that have had a long time relationship with you and discuss if they would provide some more favourable terms for repayment
• If leasing premises where you have a good relationship with the landlord, consider contacting them to discuss your situation. You may be able to change the terms.
• Review if any employees or third parties might want to inject some capital in return for partial ownership
• Check and see if any government grants are available for your industry
• Consider if you should list your business for sale

Sometimes it is a matter of navigating a rough patch in order to get back to profitability in the future. In other instances, the financial situation could be too difficult to fix or perhaps it is not clear if there are profitable months on the horizon. In those cases, more formal remedies may be needed.

Business Structure in Canada

In Canada, the two most common structures for operating a business are:

1. Sole Proprietor – in this structure, the results of the small business are reported directly onto the owner’s personal income tax return.
2. Incorporated or Limited Company – in this structure, a company has been incorporated which is a separate legal entity that can own land, enter into contracts, and has its own tax return and financial statements. Often, in this setup, we see the shareholders being the president and vice president.

It is important to draw this distinction as to how a business is structured. In order for a creditor of a company to pursue the owner, there must be a signed personal guarantee. However, this does not apply to Canada Revenue Agency debt as CRA has the ability to raise an assessment against any director of the corporation.

Whereas in a sole proprietorship, creditors can collect directly from the owner.

Federal Options for Relief

The BIA provides a framework for small businesses to navigate Bankruptcy and financial restructuring. It offers a clear process for filing Bankruptcy or a proposal to the creditors. By working with a Licensed Insolvency Trustee (LIT), small business owners can explore options for restructuring their debts, renegotiating contracts, and ultimately, rebuilding their businesses. The Federal options for relief are as follows:

• Consumer Proposal – this could be used if the small business is functioning as a sole proprietorship and allows the individual to make an offer, or proposal, to creditors to pay back some of the unsecured debts.
• Division 1 Proposal – this can be used either by a sole proprietor or a company. A proposal is much like it sounds and is basically an offer to the creditors. Upon filing, there is an immediate stay of proceedings which stops all collection action. A downside is that if the creditors don’t approve this type of proposal via a formal voting process, there is a deemed Bankruptcy filing.

Pro Tip : if there is an extreme amount of pressure, a Notice of Intention to File a Proposal can be filed very quickly which also provides a stay of proceedings. The actual Division 1 Proposal can then subsequently be filed.

• Bankruptcy – this option can be used either by an individual or a company.

What Happens When a Small Business Goes Bankrupt?

If the decision is made to file for small business Bankruptcy, the following will generally occur.

1. All creditors will be notified and a stay of proceedings is put into place.
2. The LIT will secure and protect the assets.
3. The LIT will arrange for a creditors meeting where the creditors can get further information, ask questions, and give directions to the LIT
4. The LIT will provide an analysis as to if it would be best to sell the business as a going concern or to liquidate the assets.
5. The LIT will file outstanding tax returns as required by the BIA and other Acts.
6. From the proceeds realized from point #4, the LIT will recover its fees for service and distribute the remainder, if any, to the unsecured creditors on a pro rata basis.

Often, for a sole proprietor, tools of trade are exempt up to a value of $10,000. This BC Provincial Law is designed to help an individual continue to earn a living in the future.

For the small business operating as a sole proprietor, the Bankruptcy filing is a personal Bankruptcy. The individual will be scheduled to receive an automatic discharge after a period of time.

For a small business operating as an incorporated or limited company, Bankruptcy will result in the end of the road for the company.

What About Secured Creditors?

It is quite common for a secured creditor to be involved in a small business. When a creditor, such as a bank, properly registers collateral, it is called a secured creditor.

If that secured creditor is not paid, it has the right, usually pursuant to a general security agreement, to recover the collateral. This can be done by appointing a Receiver.

In those cases where all of the assets of a small business are controlled by a secured creditor, a Bankruptcy may not occur as there would be no assets to be administered in a Bankruptcy. The secured creditor would have control.

Embracing a Fresh Start

Bankruptcy, or restructuring via a Proposal, while a difficult process, can also be a catalyst for positive change. It offers small business owners the opportunity to reassess their business models, identify areas for improvement, and implement changes that can lead to long-term success in future business endeavours.

We have heard some people refer to it as getting an MBA degree in business the hard way.

By embracing this fresh start mindset, small business owners can position themselves for a brighter financial future.

Conclusion

When a small business is faced with financial difficulty, it is important to review what options are available and draw on the expertise of your support network such as your accountant and lawyer. In addition, a LIT can be an invaluable source of new ideas.

Here at Chase & Associates, we offer a free consultation where we will gain an understanding of your situation and provide you with some information about practical options. As Licensed Insolvency Trustees, we aim to provide honest and unbiased advice to help you move forward.

If you need us, we are here to help.