We have seen a lot of business owners whose businesses are failing and who want to start over. That is not as simple as it sounds, and doing it wrong could result in the old creditors coming after the new business and its owners.
Usually, the owners want to just start up the same business, with the same customers at the same location with the same owners. That is a recipe for problems. The problems come from two principles.
The first is successor liability. The second is that business owners operating a firm in the “zone of insolvency” have a “fiduciary duty” (or an obligation to serve as a trustee) to their creditors. A detailed discussion of these principles is beyond the scope of this article.
Starting Over After Business Failure
In New Jersey, a new business can have successor liability for the debts of the old if a court finds that a “de facto merger” occurred, or if the business is the “mere continuation” of the old. This means that the old creditors can pursue the new business for payment, providing they can convince a court that this is the case. Courts look for the following to show a defacto merger/mere continuation:
1. the new business has the same ownership, management, personnel, physical location, assets and/or general business operations as the old one;
2. the old business shuts down suddenly at about the time the new business starts up.
3. the new business or its owners assume some but not all debts of the old business, especially those ordinarily needed to continue business;
4. the new business holds itself out to the public as continuing the old business.
Any time business owners start a new business under a new name, successor liability is a risk. There are steps that can be taken to minimize the risk. Each case is different, and a detailed review by a knowledgeable and experienced bankruptcy or business attorney is needed, in advance of any such move.
The second trap is fiduciary liability of business owners. Violating this duty could expose the business owners to a later lawsuit and debts that might not be dischargeable in a personal bankruptcy. Simply put, business owners are held to a high standard of care towards their creditors when a business is failing. They have a duty to maximize the value of the business, and to not take steps which benefit themselves unfairly at the expense of creditors or which treat creditors unfairly. This does not mean that business owners are not entitled to be paid for their services, or that they have to put more of their own money into the failing business. But lining their own pockets, or transferring assets to themselves or others without the company getting fair value in exchange; engaging in preferential treatment of certain creditors; or making false statements to creditors are some of the “no-no’s” to avoid. Again, this is not a complete list and what can or should be done is very fact sensitive and requires careful review by an experienced attorney. As always, careful planning and advice are critical
Business owners are entitled to try to start over, but without careful planning and the right advice, the result could be that the old debts beleager the new business