Fleshing Out Incorporation Before Bankruptcy

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Miss Manners

As Miss Manners might say, you, Gentle Reader, have a secret fan.

A fairy god-lawyer, so to speak.

She’s my law partner who watches the new bankruptcy lawyers around us, and pokes me:  “You’ve got to tell them ….”

Fill in the blank for the topic du jour.  Renee thinks there’s more you should know than I’ve deigned to write.

Well, this week she said, “You’ve got to tell them about incorporating.  You can’t just say ‘incorporate before filing bankruptcy.’ ”

So, ever biddable (don’t laugh out loud, please), here is my follow-up on the issue of unincorporated businesses in Chapter 7.

Separate legal existence

When facing a Chapter 7 with a business the debtor wants to continue, we want to transform the debtor from a sole proprietor to a shareholder.

We want the debtor to own, not the business, but the shares in the corporation that owns the business.  Because the corporation is a separate, legal “person” (even before Citizens United), the bankruptcy of the shareholder does not make the corporation a debtor in bankruptcy.

Then, the debt and liability issues that fret Chapter 7 trustees are a non issue.  The only issue is whether the shares have any value for the creditors of the debtor.

It’s not enough

Left without instruction or a professional at the helm, most debtors will get only half the job done.  They will create a corporation bearing the name of the business.  

And they’ll stop there.

That’s half the job.  And while I’ve never had a bankruptcy trustee probe too deeply about the sufficiency of the incorporation, I would not be surprised to see it happen.

Incorporation check list

I’m only tangentially a business lawyer so it’s not my intention to tell you how this is done.  I can only urge on you the desireability of getting it done before filing.

Assuming the debtor’s business really is viable, your client will be living with the corporation for a long time to come.  You want it done right.

In no particular order, here are the tasks I see:

  • Form a corporation
  • Adopt bylaws, have an organizational meeting
  • Issue shares to the debtor in exchange for business assets
  • Deliver a bill of sale or other transfer documents to the corporation
  • Get EIN
  • Open bank account for corporation
  • Consider engaging payroll service
  • Transfer titles to vehicles as necessary or possible
  • Consider leasing business assets that can’t be transferred to corporation from debtor
  • Consider assignment of any business premises leases
  • Make sure corporation has requisite licenses and insurance
  • Notify customers of change
  • Handle AR’s consistent with corporate ownership

There’s undoubtedly more.

So, as Renee pointed out, it’s not just a matter of filing articles of incorporation and sitting back.

Do the incorporation right, and you can sit back at the 341 meeting, secure that the business can operate despite the financial woes of the owner.

And that, Gentle Reader, is what we’re here for.

 

Image courtesy of QuoteCollection.com.

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  • http://www.winecountryfamilylaw.com/ Lindsay Smith

    Great article, Cathy! Would there be any fraudulent conveyance issues with transferring all business assets to the corporation prior to filing chapter 7?

    • Cathy Moran

      Not in my experience, since at the end of the day, the former business owner now owns all the shares in the corporation that owns the business. No real net change in net worth.