November/December 2009 / Cover Story
Managing Struggling Businesses
The author lists some warning signs that a business is in trouble. These include a call from the bank alerting management that the financial ratios or loan covenants pursuant to its credit agreement are out of compliance; the filing of a lawsuit or a writ of attachment from a creditor or vendor; and significant or sudden turnover of management staff.
Typically when ownership is forthright in dealing with its lender regarding financial problems, the bank will work with the business to keep it operating.
Specifically, a bank is more likely to accommodate businesses in a turnaround, whether to help the owner reorganize, sell the business, or even find a new lender, provided the borrower has been forthcoming in the initial disclosure of the issues, and kept informed as the turnaround proceeds.
When a business enters the “zone of insolvency,” the duties of the directors and officers change. However, courts have not clearly defined when a company enters the zone of insolvency. One typically applied standard is that a company is insolvent when its liabilities exceed its assets.
Directors of an insolvent corporation have a fiduciary duty to creditors, which has been described as the duty to protect their contractual and priority rights. It is unclear whether the duty to creditors supplants the duty to shareholders.