Who Is On The Hook For Debts?

question marksWhen the person sitting in your office runs a struggling business, I proposed three initial questions to scope out the bankruptcy options available.  (The first question.)

The second question  applies only if the business is operated by an entity ( a corporation or an LLC)

How much of the debt it services is the entity really liable for?

Dig a bit and you will often find that the corporation is not legally liable for the credit cards, leases, and loans that it pays monthly.

Either because of the nature of the credit markets or a mid stream incorporation, it is the shareholder, the manager, the person who thinks he’s the owner, who is legally liable for the debts.

And that may be a boon to bankruptcy planning.

Vendors

Small corporations generally can’t get unsecured credit without the guarantee of the shareholder.

That’s often the case with vendors to a retail business.  The account stands in the name of the corporation, guaranteed by the individual.

Credit cards

But equally often, the credit that is available to fund the business is in the form of a credit card.  And that credit card is assuredly a liability of the individual.

Doesn’t matter that the business name is embossed on the plastic.  Your concern is whether the corporation applied with the shareholder for the credit.

Because if the corporation is not legally liable, the shareholder may be able to file bankruptcy, default on the debt, and it doesn’t impact the business at all.

Who’s on first?

If you want an exercise in frustration, just try asking the person across the desk whether the entity applied for the card.  They won’t know or reply that the corporation’s name is there, isn’t it.

Neither is useful to you.

After twenty years of dealing with small businesses and plastic, I finally hit upon a way to determine, rough and dirty whether the entity is liable.  I have the client call up Card Issuer, tell them he’s the new bookkeeper, CFO, or manager of Corporation, and ask what the balance on the card is.

If the records of the card issuer show the Corporation as a debtor, they should respond to a corporate employee charged with bookkeeping.

If, however, the only person on the bank’s books who is connected with the account is the individual, the card issuer should not disclose anything about the account to someone who doesn’t purport to be the account holder.

Three piles

Your goal in pursing the question of who is liable on each debt is to end up sorting each debt in to one of three piles:

  • Debts of the individual only
  • Debts for which corporation and individual are both liable
  • Debts for which only the corporation is liable.

Get that sorted out, and you’ll be ready to ask the third question.

Next time.

Sample these business bankruptcy questions.

Image courtesy of Valerie Everett. 

 

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