A Creditor’s chances of collecting a debt from a defunct or insolvent corporation are somewhere between “slim and none”. Collection of such debt invariably requires imputing the corporate debt to Third Parties using various collection remedies.
Proceedings supplementary is such a Debt collection remedy, commenced by a Judgment Creditor against either fraudulent transferees of a Debtor’s assets, (usually the Debtor’s officers, directors, and/or shareholders) or a successor business owned by the same people, known as INSIDERS. And if the Debtor’s INSIDERS used the corporation to perpetrate a fraud on Creditors, that can also be a basis to pierce the corporate veil and hold the Insiders liable for the debt.
Tax advantages aside, people incorporate businesses because they believe, “like the gospel”, that they are fully protected from liability for corporate debt by the “shield of limited liability”, the ultimate corporate prophylactic. This “gospel” is proof that “a little bit of knowledge is a dangerous thing”.
As long as a corporation pays its Creditors, its financial transactions are exempt from outside scrutiny (except for the IRS). However, when a corporation becomes insolvent, either by not timely paying its debts (cash flow or equitable insolvency), or if its liabilities exceed a “fair valuation” of its assets (balance sheet insolvency), corporate fiduciary duties and obligations are radically affected. The Insiders’ fiduciary duties shift from the Debtor’s shareholders (to maximize share value) to its Creditors (to preserve assets to pay debts). The corporate assets become a trust fund for the benefit of the corporation’s Creditors and the INSIDERS are the Trustees. The Debtor’s financial transactions are now subject to scrutiny by its Creditors (even before Judgment) and, like the Chief of Police in “Casablanca”, one would be “shocked” to find fraudulent transfers to INSIDERS, their families, and successor businesses as well as use of the Debtor’s assets to pay Insider personal debts, among other abuses. Well, they are all fraudulent transfers and provide bases to impute liability to the INSIDERS.
How many professionals, business people, trades people, (or anyone for that matter), when facing financial difficulty, close their corporate doors and take up a new, unrelated vocations. “None”, you say? Yes, it’s true; leopards don’t change their spots and old dogs rarely learn new tricks! People almost always re-open businesses that are “remarkably similar” to the Debtor. These new businesses are successor entities, and successors may be held liable for the predecessor’s debt.
What about the Debtor who incorporates today, defaults on a credit line next month, and is defunct a few months later? Insiders may be held liable if they either set up or used the corporation to perpetrate a fraud on Creditors. It is the basis to pierce the corporate veil.
Obtaining a Default Judgment against a defunct or insolvent corporation is not exactly rocket science, but for too many attorneys, pursuing collection of such a Judgment is analogous to a dog chasing a car. What does the dog do when he catches it?
Debt imputation requires more than chasing some poor debtor with a credit report that screams “Debtor’s Prison”. There are corporate Tax Returns to analyze, asset trails to follow, and legal issues (sometimes of first impression) to argue. It’s not just a job, it’s an adventure!
