When a business experiences an acute cash flow shortfall and is unable to access conventional sources for additional financing, directors and officers of the company are presented with difficult choices. Preserving the value of the business for all stakeholders is critical, and directors and officers, quite rightly, will exhaust all available avenues to unlock liquidity to maintain operations and preserve the business. It may be tempting for directors and officers to use funds designated for another purpose to cover essential operating expenses in the short term, expecting that those funds may be replaced once additional revenues are generated. The impulse to preserve the business at all costs, however, must be checked against the legal and fiduciary realities that directors and officers face.

This is particularly true with respect to a company’s “trust fund taxes,” which consist of funds that are withheld or collected by the company, in trust, for the benefit of applicable taxing authorities. These funds are typically collected in the ordinary course of business, but are often not paid until future dates, typically on a quarterly basis. Accordingly, these funds might seem like a useful short-term, low-cost financing tool to meet immediate operational needs, but if future revenue forecasts are inaccurate and anticipated revenues fail to materialize within the expected time frame, the result could be significant tax delinquency, potential penalties, or worse, personal or criminal liability for directors and officers (as well as other responsible employees). It is essential, therefore, that directors and officers have a sound understanding of trust fund tax liabilities and ensure that the company is collecting and paying all such tax obligations, including in connection with a bankruptcy filing of the company.

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This chapter appears in The Directors' and Officers' Guide to Restructucturing, released by FTI Consulting.