Incorporating a small business can save that business when the owners need the protection of filing bankruptcy. A separate entity is created, and is isolated from a bankruptcy filing by the owners. Thus, the only thing that becomes property of the bankruptcy estate is the stock in the corporation owned by the debtors.
My friend and colleague, Cathy Moran, wrote a terrific post about this and how to save a going business when the debtors were besieged by real estate losses and needed bankruptcy protection.
Unfortunately, it doesn’t always work that way. Forming a corporation and transferring all of the assets of the business into it, but not the business debt can backfire on the debtors. If done at a time when the debtors knew or should know they are going to file bankruptcy, this can be considered a fraudulent conveyance. As such, the transfer can be set aside and the corporate assets used to pay the debts.
In Cathy’s hypothetical, the debtors were transferring the business debts along with the assets, so there couldn’t be a claim that the corporation was being created simply to avoid those creditors. Just make sure before you try such a thing, that you have consulted competent bankruptcy counsel to guide you.
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