Individuals engaged in business can be personally liable for business creditors’ claims even when the business is a separate legal entity, such as a corporation. One way to be personally liable for corporate debt is if the individual signed a personal guarantee. Shareholders of the corporation also can be personally liable for the debts of the corporation even if they did not sign a personal guarantee under an “alter ego” theory. Shareholders are often also the officers and directors who manage the business/corporation.
An “alter ego” theory means that the shareholders have acted in such a way that it is difficult to distinguish the interests of the corporation from the interests of the individual shareholders. Remember that a “corporation” is a separate legal entity. If it does not act as such, the corporate entity, or “veil,” can be “pierced” thus exposing individual shareholders to personal liability.
Creditors often assert alter ego claims against individual shareholders. Having to defend these claims can be costly and time consuming. Because creditors seldom have knowledge of how a corporation is managed, their claims may be just an attempt to gain advantage in trying to negotiate a settlement on their claims against the business entity.
If the business is winding down because it is insolvent and will not continue to operate, then a Chapter-7 liquidation bankruptcy is an option to avert any attempts to assert an alter ego claim against shareholders. If the corporation has any assets, the bankruptcy trustee will liquidate those assets to pay creditors. If the individual shareholders are potentially liable for the corporate debt, then it is also necessary to evaluate the individual shareholders financial situation. If a corporate bankruptcy is still going to leave the individual shareholders liable for most of the corporate debt, then a corporate bankruptcy may not be necessary, especially if the individual shareholders are going to be forced into a bankruptcy.
As in all financial situations, the starting point to evaluate this situation is the financial records of the business. Corporate records must be segregated from the personal records. If the corporation has not complied with the legal requirements of a corporate entity, problems will arise when creditors cannot be paid. Creditors will assert claims against the individual shareholders and one of the main purposes of incorporating a business would have been defeated-keeping you from being personally liable for business debt.
For information on these and other related topics, please contact attorney/financial counselor, Susana B. Tolchard, Esq. at 661-287-9986.