Four Dangers In Bankrupting A Corporation

If the whole point in bankruptcy is getting a discharge of your debts, it’s obvious why corporations don’t need Chapter 7 filings:

Corporations don’t get discharges.

(a) The court shall grant the debtor a discharge, unless—

(1) the debtor is not an individual; § 727

Chapter 7 is so closely associated with financial failure and finality that you often interview a client who thinks bankruptcy is required to end corporate existence.

Not so.  Chapter 7 may liquidate the assets of a corporation but it does not terminate the corporation’s legal existence under state law, at least where I practice.  Corporations are creatures of state law, so check state law for provisions relevant to this issue.

A corporation that has gone through a bankruptcy continues to exist and continues to have enforceable debts (assuming the assets weren’t sufficient to pay them in full).  The assetless corporation lives on, til state law or the actions of shareholders end its existence.

Reasons not to file Chapter 7

1. Trustee empowered to examine corporation’s dealing with its shareholders.   Payments from corporation to shareholders treated as loans on the business books may result in suit to collect the “loan”,  when all that was really intended was to avoid paying income tax on the payment.  The trustee can challenge transactions with insiders as fraudulent.
2. Trustee avoiding powers can claw back payments to insiders.  A year’s worth of legitimate corporate payments on insider loans can be avoided for the benefit of corporate creditors.  Insiders are exposed where they guaranteed debts paid within the 90 day look back period.
3. Trustee controls the checkbook.  The trustee is free to spend corporate assets on costs of administration, looking for the pot of gold in corporate affairs, and consume funds that could pay taxes or other corporate debts where shareholders have liability.  Where corporation could ear mark tax payments to trust fund taxes, trustee payments will be applied at IRS whim.
4. Trustee unlikely to get top dollar for business assets.  Trustees are inclined to sell assets in bulk to liquidators.  Asset value is not enhanced.  In specialized or technical businesses, the trustee may not understand the value of assets or may sit on them til they lose value.

Even if, at the end of the day, no money moves from the pockets of shareholders to the pockets of the bankruptcy estate, the exercise can consume a lot of time and generate a lot of angst for the responsible person.

My advice often boils down to close the doors, sell off the assets, pay those debts more advantageous to the shareholders, resign as an officer and be done with it.  There is no need to respond to collection suits thereafter that name only the corporation, as it has nothing to defend.

Next time, we’ll talk about the view from the other side:  those times when a corporate 7 may serve some important purpose.

Image courtesy of richardfburgh