Cathy Moran recently discussed business debts in bankruptcy in her post entitled Bankruptcy & Small Business, but what if you have incorporated your business? Can a bankruptcy trustee take your business if you file a Chapter 7 Bankruptcy? After all, you went to the trouble of incorporating because it created a separate entity, and you learned from somewhere that people incorporated their small business to insulate themselves from liability. If the corporate entity can protect the shareholder from business liability, can the shareholder protect the corporate entity from personal liability in bankruptcy? The answer is simply that the corporate entity is not protected if the shareholder files for bankruptcy protection.
Technically, the bankruptcy debtor does not own the assets of the incorporated business, but he does own all of the stock! That stock becomes an asset of the bankruptcy estate, and that stock is nothing more than the right to ownership of the assets of the corporation. Therefore, because the estate now owns the corporate stock, the estate now has the power to liquidate the assets of the corporation for the benefit of unsecured creditors.
So, if the stock is an asset of the bankruptcy estate, can the debtor keep his or her business? Absolutely . . . if he pays the estate the fair value of the stock, which is generally the liquidation value of the corporate assets. In many cases, the liquidation value is not that much, especially if there is no inventory or if the business assets are subject to a bank’s lien. Since the value of a business is typically much greater as an ongoing operation, debtors usually “buy back” the business assets from the trustee.