CLOSING A BUSINESS

Walter Wm. Hofheinz and Genta Hataoka

 

General Considerations

Closing a business operation can be simple or complex. Some relevant factors include the type of business activity conducted, the scope of the business activity, whether other business activities of the entity are to be continued, and by the number, type, and disposition of employees. This article outlines the considerations generally relevant to the orderly process of discontinuing a business.

Jurisdiction

Since government in the U.S. is a federal system, the law of each state in which business is conducted as well as applicable federal law must be considered.

Review all legally operative agreements

All legally operative agreements should be ascertained and reviewed. Such agreements might include governing instruments for the operating business entity such as corporate minutes or partnership agreements, leases, contracts as either a vendor or purchaser, notes and other financing documents, and employment agreements. If obligations are imposed which continue past the time of proposed termination of business activity, early termination provisions (if any) should be examined carefully to ascertain their precise requirements, and plans should be made and implemented to satisfy those requirements. If no unilateral early termination is permissible, plans should be made and implemented to satisfy the obligation, or a negotiated early termination investigated. It is frequently possible to negotiate an early termination of an obligation at much less cost that a simple breach of the obligation. When such a negotiation is successful, it is important to reduce the agreement to a writing signed by each party.

Timeline

Business requirements and legal requirements each impose time constraints. It is preferable to commence the legal actions advisable in discontinuing activity as soon as possible after a preliminary decision has been made. The initial review of operative agreements will indicate whether notices must be given or other actions taken, and the period which must elapse before those actions become effective. Typically it is wise to allow no less than six months for analysis, planning, and implementation.

Formal communication of required notices

It is important that all required notices be communicated in writing, and that evidence be preserved that the notice was received. The most common means of accomplishing this is to mail each notice by certified mail, return receipt requested. When the return receipt is received by the sender, it should be attached to a photocopy of the notice delivered and be retained with the other permanent records of the sender.

Ongoing requirements even after discontinuance of active business

Since some claims against the business may not become known until after operations cease, appropriate arrangements should be made to preserve the ability to respond when such claims are asserted. Although the limitation period for the assertion of claims varies both by jurisdiction and by type of claim, plans should be made which allow notice for at least four years after the termination of activity.
It is important to maintain an agent for contact and service of process. Without such a designated agent, those previously conducting the business may not receive actual notice of the asserted claim and have the opportunity to dispute its validity. If undisputed, the claimant may be able to obtain a judgment enforceable against those previously operating the business. Legal counsel may be retained to serve in this capacity, or other commercial services are available.

Business entity

In all cases except a sole proprietorship, a decision must be made whether to terminate the existence of the legal entity conducting the business, as well as ceasing operations. In general, it is preferable from a legal perspective to continue the existence of a business entity, particularly where the entity was originally chosen in order to limit the personal liability of owners. While in general the liability of owners after dissolution is limited to the assets received on dissolution, proving the assets and their value may be difficult should a claim be asserted following dissolution.
Defending claims following dissolution may also be more difficult as a practical matter, since each distributee on dissolution (the former shareholders) will usually be joined in any suit, requiring a defense not only of the entity, but potentially of multiple interest owners.
Termination of an entity may also have adverse federal income tax consequences. For example, a corporation which own appreciated real property may cause the recognition of gain to the corporate owners on dissolution, even if the property is not sold. Thus the income tax consequence of termination should be analyzed carefully and considered when making a decision regarding continuation or dissolution.
Where the choice is made to discontinue existence of an entity, appropriate formal action, such as filing articles of dissolution in the jurisdiction in which the entity was created, should be taken to preclude the accrual of additional taxes and other filing requirements. Appropriate arrangements should be made for the maintenance and safekeeping of the legal and accounting records of the entity.

Real Estate

Arrangements should be made for the sale or management or real property. Since real estate sales transactions are generally governed by state law, care should be taken to conform to the requirements of the jurisdiction in which the property is located. Typically, a written agreement is required before either party is bound by an agreement related to a sale of real property, including representation by a real estate agent. Once such a written agreement is entered into, however, it is binding upon the parties and may not be unilaterally changed. The contract-whether for sale, lease, or management-is the most important part of the transaction, since generally all other actions to be taken are governed by the contract and may not be renegotiated or changed except by agreement. It is therefore essential in all but the simplest transactions to have legal counsel before the contract is signed. A real estate contract must never be considered a memorandum of intent (unless specifically agreed in writing to not be binding), but should reflect the final and considered agreement of the parties.
Care should be taken in the selection of a real estate agent, since different agents specialize in different types of property. Sales commissions for real estate agents are generally negotiable, as is the term of representation. Inquiry should be made into the nature of the sales effort to be made by the agent.
If the use of leased property is to be discontinued at the end of a lease term, the lease should be reviewed to determine the requirements for and on termination, if any. All requirements should be meticulously met to assure that no continued liability will arise under the lease.
If discontinuance of the business is not at the end of the lease term, some arrangement must be made to make rental payments, to terminate the lease by agreement, or to minimize the cost of the leased premises. Often landlords will negotiate early termination where the lessee has no or minimal assets which could be reached in a collection action, or will negotiate some other compromise of the full amount due under the lease. Most commercial leases prohibit assignment or subleasing of the leased property without the consent of the landlord. In general, however, such consent cannot be unreasonably withheld, even in the absence of such an express provision in the lease.
Legal counsel can be of great benefit in the resolution of the problems associated with the disposition or termination of use of real estate, and should be involved before problems arise.

Personnel

While generally the employer-employee relationship will be governed primarily by the agreement between the parties, whether written or oral, jurisdictions vary greatly regarding the protection afforded employees on termination. The personnel policy and procedure manual of the organization and local law should be carefully reviewed to assure that the employment relationship is "at will," and if not, that all requirements for termination are adhered to strictly. Care should be taken to implement the termination of employees in a non-discriminatory manner. Notice should be given uniformly by class of employee. While the amount of prior notice is a business decision, from a legal perspective a longer notice period minimizes the likelihood of termination related claims.
Retirement and other employee benefit plans must be terminated or provision made for continuation in accord with federal law or substantial penalties may be incurred.

Formal relief from liability: Bankruptcy

When insolvency occurs, the law provides relief from the claims of creditors under the bankruptcy code. Two types of proceedings are generally applicable to business activities: Chapter 7 and Chapter 11.
Chapter 7 allows the debtor to liquidate all non-exempt assets (which vary from jurisdiction to jurisdiction) and have those assets applied toward the obligations of the debtor. Some transfers of assets made during the period immediately prior to the bankruptcy may be set aside and brought back into the pool of assets available for the satisfaction of creditors. Upon completion of a Chapter 7 bankruptcy proceeding, all obligations other than certain types of claims are discharged, and may no longer be enforced. Generally, non-dischargeable obligations are certain taxes including payroll taxes and claims based on intentional torts such as a fraud.
Chapter 11 allows a debtor which appears to potentially be a viable business to consolidate all claims into one proceeding in Bankruptcy Court, during which a plan of reorganization is formulated for the compromise or payment of claims. Such a plan may allow the debtor to avoid on-going obligations under contracts and other agreements, such as leases and collective bargaining agreements. During the pendency of the proceeding and plan as confirmed by the court, no independent enforcement actions may be taken by creditors.