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by David Greenberg
Assistant Vice President, International Collections
In discussing the out of business corporation, one must first understand the nature of corporations in this country. The U.S. corporation is a legal entity unto itself, separate from the principals or directors. In other words, our law regards a corporation as though it were an actual person, complete with its own life, health, wealth and death. The corporation’s purpose (beyond making money) is to hold the principals free from liability. Therefore, when a corporation dies, it is extremely difficult to attach liability to any of the principals.
As in most countries, the majority of U.S. states have set procedures to properly conclude or dissolve the affairs of a corporation. However, as a practical matter, those steps are only required if the principals wish to resurrect the corporate body at some point in the future. There are no real penalties for failing to follow the dissolution steps.
That being the case, some corporations cease all operations by simply vacating the premises, sometimes in the middle of the night and without any warning.
Where does that leave unsecured creditors?
In most instances, frankly, it leaves them without any recourse. In fact, it is safe to say that the vast majority of unsecured debts owed by out of business corporations are never paid – not even in part. This is a basic fact of business life in the United States.
Is it possible to pierce the corporate veil and attach liability to the directors? Or, if a new company has been formed, to hold it responsible for the defunct company’s debts?
With significant legal effort, it may be possible. However, it should be underscored that such an effort will be an expensive endeavor to any creditor undertaking the task.
The typical scenario for this battle will entail demonstrating to a court (in a lawsuit) that the principals either commingled their personal assets with those of the corporation or actually transferred the assets of the initial corporation upon its demise. Either is a very heavy burden under our legal system, requiring definitive evidence.
Unsecured creditors may be tempted to commence such a lawsuit against the new corporation in the hope they can discover the needed evidence along the way. However, the Fifth Amendment of the U.S. Constitution provides that no person (which, as explained earlier, includes corporations) can be forced to testify against himself. Consequently, a corporation cannot be compelled to provide its records to others hoping to develop evidence of wrongdoing. Therefore, beginning such an action without proper evidence in hand could put you in the position of defending yourself against a malicious prosecution law suit.
So, is it hopeless to even think about such an action?
Definitely not, if you are absolutely convinced there was wrongdoing. But do some decent research before beginning the legal process.
Commingling of Assets
If you are attempting to prove commingling of corporate and personal assets, you might take a look at some of the payments received from the debtor before he went out of business. Were the checks drawn on a business or personal account? Were goods shipped to the debtor’s personal address or to the corporate address? If software was purchased, was the warranty registered in the name of an individual rather than the corporation?
Or, maybe it’s not too late to have one of your people order something from the debtor. She can pay with a personal check and, when the check is cashed, you can easily determine if it has been deposited to a corporate or personal account.
Your attorney can also obtain public documents kept on file by the local State government that may prove useful. Initial Capitalization records might show the corporation was under-funded at inception. Failure to file copies of Minutes of the Annual Shareholders’ Meeting may indicate the corporation was so closely held that, in fact, it operated as a non-corporate entity. You might even consider hiring an undercover investigator to take pictures of personal use of corporate equipment.
Fraudulent Transfer and Successor Liability
You will have different hurdles to overcome if attempting to prove successor liability.
Generally, a company purchasing the assets of another company is not liable for the debts of the seller. However, there are four circumstances that can affix liability to the purchaser:
The buyer company expressly or by implication promised to assume the seller’s obligations.
The acquisition amounts to a de facto consolidation or merger.
The buyer is a mere continuation of the seller.
The new company was formed for the purpose of defrauding the predecessor’s creditors.
You might be able to sue the prior, though defunct, corporation for the purpose of getting the right to subpoena the principal of both companies and examine him under oath to see if any inventory has been wrongfully transferred. Or, if you can develop enough evidence to prove the successor corporation is a continuation of the out-of-business company, it might be possible to convince the principals to “pay up” short of legal action
Relevant factors to determine that a corporation is a de facto consolidation or mere continuation include:
Continuity of management, personnel, physical location, assets, general business operations
Continuity of ownership between the seller and purchaser
Dissolution of the seller immediately after the sale transaction
A number of approaches can be taken. But, you will want to move quickly. There is a two-year Statute of Limitations in fraudulent transfers in many states. However, any creditor intentionally attempting to defraud is not going to sit still so you can build a case against him. You don’t want to give him time to sell the transferred inventory, or even close down and open up yet another business.
Is it ever possible to see a recovery when your corporate debtor goes out of business?
The answer is “Yes”. However, it remains a matter of economic and common sense to determine if the effort involved will be worthwhile.
Before undertaking any of the actions outlined above, the bottom line should be: Does the potential outcome justify the costs? You should have a reasonable assurance that the principals have sufficient assets to result in a recovery that will not only pay off your account, but also reimburse your expenses. If they don’t, will just the satisfaction of bringing a “crook” to justice really be worth your time and money?
Some further resources on Successor Liability and Fraudulent Transfer
Making Sense of Successor Liability by Marie T. Reilly, Professor of Law at The Dickinson School of Law, Penn State University: A 50-page legal treatise on fraudulent transfer and successor liability for the Hofstra Law Review, Hofstra University, Long Island, February 19, 2004 (PDF)
The Disappearing Debtor, Bernstein Law Firm PC: Four part series by Robert S. Bernstein, Esq.
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Disclaimer: This information is provided by ABC-Amega Inc. for informational purposes only and is not intended to be legal advice and is not a substitute for competent legal advice on the referenced subject.
David Greenberg's collection industry experience spans three decades. Dave was instrumental in the expansion of ABC-Amega’s international collections department and their earning of “E” and “E-Star” honors from the U.S. President for excellence. He has served on the Panel of Commercial Arbitrators of the American Arbitration Association and is a current member of the Commercial Law League of America and the Association of Executives in Finance, Credit and International Business. Dave has traveled the world, giving educational presentations in the areas of international arbitration, foreign documentation, and credit reporting management.
This information is provided by ABC-Amega Inc. and is not intended to be legal advice and is not a substitute for competent legal advice on the referenced subject.