Liability of shareholders for corporate debt:
Separating the owners from the business
Many individuals do business in the corporate form. While
the individuals think of themselves as the "owners" of the business, in reality
they are the owners of the stock in the corporation that owns the business.
They are probably also its
officers and directors.
When it is necessary to consider bankruptcy, it becomes
important to know just which debts of the corporation, if any, the shareholders may be
personally liable for.
Simply owning the stock in a corporation does not make the
individuals liable for the corporation's debt. The shareholders may,
however, become liable
for the debts of the corporation either by agreement or by operation of law.
Liability by agreement
The most common way that a shareholder becomes liable for the
corporation's debts is by guaranteeing the debt. That guarantee is a contractual
agreement that makes the guarantor personally liable to the corporation's
creditor on that debt.
Sometimes that liability may arise by the mistake of the
shareholder, who signs a contract or lease for the corporation in his own name, rather
than in his capacity as an officer or employee of the corporation. Under state law,
signing as "John Shareholder" may make John personally liable. The
correct way to execute a document for a corporation is by signing "John Shareholder,
President, Smallcorp, Inc."
A bankruptcy filing by the corporation does not discharge the
liability of a guarantor or another entity or individual who is liable for the bankrupt
corporation's debts. Neither does a corporate bankruptcy stay action against others
who are liable.
Liability by operation of law
Creditors may sometimes "pierce the corporate veil" to
impose liability on the shareholders where the shareholders have neglected corporate
formalities, such as corporate meetings and required filings, or, more
often, where they have ignored
the legal separateness of the corporation and treated the corporation as an extension of
themselves. This can occur if the shareholders intermingle their money
with that of the corporation or identify themselves as the business owner,
suggesting that the business is a proprietorship.
Another way that individuals become liable for the corporation's
debts is where state or federal law makes the shareholders liable for the corporation's
employment taxes, sales taxes or for uninsured worker's compensation claims. More
on trust fund tax claims in personal bankruptcy.
|Analyze which debts are personal and which are
Planning where liability is shared
When a small business corporation fails, the shareholders need to
examine the debts of the corporation and its history to determine whether they have some
liability for the corporation's debts. It may be appropriate to see that the
corporation pays first those debts for which the individuals may be liable ahead of other
Get competent legal advice to
understand the application of bankruptcy preference statutes.
Thoughts on finding a lawyer.