Corporate Bankruptcy: So We Can Start Over

Thou shalt not file bankruptcy for a corporation.

It’s almost a commandment from on high in my practice.

But for every rule, there is an exception and the man sitting in front of me called on the exception.

He wanted, (or really “needed”) to stay in the same line of construction work.  But business was bad, there was a supplier suing the corporation, and then there was that pesky, state corporations law.

The duties of corporate officers

Hearken back to law school and Corporations.  Officers and directors owe the corporation a duty of loyalty.  They must not usurp corporate opportunities nor compete against the corporation.

My normal advice to business folk when a corporation needs to fold is to simply close the doors, liquidate any assets, pay the most important bills to the extent possible, and move on.

A corporation won’t get a discharge in Chapter 7.  If there are few assets, the trustee will probably close the case immediately following the 341 meeting.  So, the automatic stay won’t give a bankrupt corporation much breathing room.

Not much to be gained in a corporate 7.

My concern on these facts was that closing the doors on the corporate business, and reopening as a proprietorship, in the same line of work, using the same phone number, and the same small nest of tools would be subject to attack by the unpaid vendor.

Either, the claim would be that the individual had misappropriated the corporate assets and opportunities for himself, to the detriment of creditors, or that the new business was really just the alter ego of the failing corporation.

Bankruptcy as corporate funeral

The threat of breach of the duty of loyalty or alter ego claims fade if the corporation files Chapter 7.

Bankruptcy is a clear signal that the business, if not the corporation, is dead.  The bankruptcy court publishes the obituary.

A bankruptcy trustee conducts the final services.  With some ceremony, the business is interred.

The shareholder is left free from claims that going into business in the same line of work breaches his duty to the old corporation.  There is clearly no corporate business remaining.

Tidying up the corporate assets

Assuming that the trustee closes the corporate case as a no asset case, we will still have to dispose of the business effects of the corporation.

I will propose that the shareholder buy from the corporation, post bankruptcy, any tools or equipment useful in his new endeavor.  The purchase price goes into the corporate bank account.  A bill of sale will document the transaction.

If the phone number is actually in the name of corporation, rather than the individual as sometimes happens, we can either try to switch it to the individual’s new business name, or leave a recorded message on the old number referring callers to a new number.

This approach should make clear to creditors that the old entity is gone.  The no asset report establishes that there was nothing there.  The real live human being who needs to put food on the table is free to start over.

In this case, breaking my rule had a good outcome.

More

When the business is a proprietorship

Alternatives for winding down a business

Image courtesy of Flickr and John Taylor