Is Your Debtor Corporate or Corporeal?

Which way?Mitt Romney famously insisted that corporations are people.

We can disagree about the nature and quantum of rights that gives them relative to human beings, but for the purposes of a business bankruptcy analysis, Mitt was spot-on.

A corporation is a legal person separate from the individuals who own the stock in the corporation.

When the human across the table from you uses the first person pronoun to describe the state of the business, you have to stop them and ask:

Who is “we”?

Is the struggling business we’re talking about owned and operated by a corporation?  If so, we  head in one direction.

If, however, the business is a sole proprietorship, we have different choices of destination.

Corporate business

Tell me that your business is incorporated and I need to pin down, before the interview is over, whether the individual or the corporation is my client.  Their interests may be different.  Even if there is no apparent conflict, good practice suggests you get a waiver of conflicts from each entity.

What’s possible if the business is an  entity separate from the shareholder?  Most importantly, the bankruptcy of  either one doesn’t involve the other.

The corporation could file a Chapter 7 without pulling the shareholder into a bankruptcy.

Conversely, the shareholder could file a bankruptcy, and his estate includes the shares in the corporation, but not the business itself.

Is there a meaningful distinction there?  Damn right.  An incorporated business can continue to operate as usual when the shareholder files a personal bankruptcy.

Chapter 7 trustees are instructed to shut down a business operated by a Chapter 7 debtor.  The articulated concern involves post petition liabilities that might acrue to the bankruptcy estate as a result of continuing to operate.

The “rule” is applied with less vigor and more variation as the business trends toward a consulting or personal services business.  But if there are employees, business premises outside the home, or activities with significant risk involved, the trustee will  generally want a Chapter 7 debtor to cease doing business.

Not so, usually, if the individual is only the shareholder.  The estate has the benefit of the net value, if any, of the shares, but the trustee isn’t accountable as directly for the activities of the corporate business post petition.

Depending on your goals for the client, you can consider either incorporating a business before filing, or dissolving the corporation before filing.

Sole proprietorships

When the business is nothing more than a dba,  the bankruptcy decision is an all or nothing proposition.  The bankruptcy of the individual brings with it the business assets and business operation.  The Code doesn’t provide for a bankruptcy that deals only with the business assets and business debts of the client.

A Chapter 7 filing will address and discharge the business debts.  It will probably require a business shut down.

A Chapter 13 filing gives you and your client the option.  You can close the enterprise or continue to operate since §1304 expressly allows the debtor to continue to engage in business.

We’ve counted heads, now, around the conference table and know how many “people” we’re dealing with.  Next time, we’ll look at other facts we need to extract before planning bankruptcy relief.

There’s more about business bankruptcy issues on Bankruptcy in Brief.

Image courtesy of Geograph.