Does your corporation need to file bankruptcy?

When, or if, to file bankruptcy for a corporation (or partnership or LLC) is the subject of major confusion among many corporate owners and officers.

There are only two bankruptcy choices for a corporation: 

Chapter 11 would be used if the goal is to continue operating the corporation’s business and reorganize the debts by proposing a repayment plan to creditors.  Creditors get to vote for or against the plan.  Sometimes less than 100% can be repaid, but there are a lot of complexities to Chapter 11, which is beyond the scope of this article.

Chapter 7 is a straight liquidation of assets of the corporation.   It is also known as a “complete bankruptcy.”  The corporation must (if it has not already) stop doing business when the Chapter 7 case is filed.   A Trustee is appointed to sell the corporate assets and disburse the proceeds in accordance with statute to creditors.

Corporate Debts Are Not Eliminated in Chapter 7

Most corporate owners believe that by filing bankruptcy for their corporation, the corporation will be relieved from its debts and obligations.

Not true.

Corporations do NOT receive a discharge of debts in a Chapter 7 case.

Corporate Bankruptcy Doesn’t Protect the Owners

Even if the corporation did receive a discharge of its debts, it would not help any personal liability held by owners of the corporation.   Whether or not a corporation files bankruptcy has nothing to do with any personal obligation the owners or officers of the corporation may have.

For example, if the owner of a corporation signed personal guarantees on certain corporate debts, or has personal tax liability for corporate tax obligations (such as employee payroll trust fund taxes), that obligation does not disappear unless and until those debts are paid.  If a corporation filed a Chapter 11 bankruptcy and repaid 100% of its debts, then that would resolve the personal liability problem, but not in a Chapter 7.

So unless there are enough assets available in the corporation to pay all those debts, the owner will still owe on those debts for which they are personally responsible regardless of what the corporation does.

Whether or not a corporation receives a discharge of debts is a big “who cares?” because it simply doesn’t affect anything.   If a corporation is going out of business, it simply doesn’t matter whether the debts are discharged or not because the corporation’s creditors will just sue the corporation and recover against whatever assets of the corporation are available and that does not affect the principals of the corporation.

Most of the time, what these owners of corporation are really looking to do is file a bankruptcy for themselves personallynot the corporation.

In such cases, they should consult with a bankruptcy attorney about an individual bankruptcy case.

When Corporate Bankruptcy Does Make Sense

However, there are times where filing a Chapter 7 case for a corporation is beneficial.

In the case where the corporation has assets and wants to stop doing business, having an independent Trustee appointed to sell and disburse assets to creditors can eliminate that responsibility for the owner(s) of the corporation and release them from liability for not having properly disbursed corporate assets and winding up the corporation properly.

In fact, corporate officers have a fiduciary duty to corporate creditors when the corporation becomes insolvent, so taking a step such as filing Chapter 7 can fulfill that duty.

Another benefit of filing a Chapter 7 for a corporation is that it puts all the corporation’s creditors on notice that the business is terminating and whatever assets may be available will be distributed through the bankruptcy, and that will be all.

Thus, there would be no reason for the creditors to sue the corporation post-bankruptcy, whereas if a bankruptcy is not filed, the owner of the corporation may have to continually appear in court to inform the judgment creditors that the corporation is no longer operating and has no assets.

There are a lot more pros and cons to be discussed and any owner of a corporation in this situation should consult with a qualified bankruptcy attorney to have their situation fully evaluated.

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