As someone who represents both individuals and businesses in bankruptcy, I get lots of calls from potential clients saying that they want to file bankruptcy for their business. They are surprised when I tell them that it usually doesn’t make sense for the business to file, but that they probably will need to file personal bankruptcy. Why is this so?
The answer lies in who can get a “discharge.”
For most individuals who file for Chapters 7, 11 and 13, the discharge is the goal. It is a court order finding that all dischargeable debts–credit cards, medical bills, most personal loans–have been discharged. This means that creditors can’t go after them at any point in the future to collect a discharged debt. But corporations and LLCs are different. They can only file Chapters 7 and 11, can get a discharge in a Chapter 11 case only under very specific circumstances, and can not get a Chapter 7 discharge under any circumstances. That’s right, a corporation of LLC is ineligible for a Chapter 7 discharge at all. If you’re interested, the Bankruptcy Code section is 727(a)(1): “The Court shall grant the debtor a discharge, unless–the debtor is not an individual.”
The lack of a discharge means that at the conclusion of the bankruptcy case, creditors are free to resume their collection activities as if the business had never filed.
So why would a corporation ever file Chapter 7? There are several reasons:
1. The attorney doesn’t know any better. Although it still surprises me, some inexperienced bankruptcy attorneys are unfamiliar with section 727(a)(1), and act surprised at the Meeting of Creditors when the Chapter 7 Trustee asks why the case was filed. I respond to e-mails and listserve questions on this topic, and am continually amazed at the number of bankruptcy attorneys who don’t know that a corporation can not receive a discharge.
2. There are preferences, recoverable assets or general assets, and taxes are owed. Why would you file in this situation? Because if taxes–particularly trust fund taxes, such as withholding or sales tax–are not paid, the IRS or state taxing authority may go after the individual owners or directors of the business as a “responsible person”. By liquidating the business in a Chapter 7 instead of just letting creditors grab what they can, the owners can make sure that the IRS and state taxing authorities get paid first, thus reducing the personal obligation.
3. There are assets and a lot of creditors, and you want to ensure a fair distribution. I will sometimes file a Chapter 7 where there are assets and a lot of creditors. The filing and administration of the case by a Chapter 7 trustee make most creditors feel that they have been fairly and equitably treated, and may not take any action against the business after the case is closed (or don’t know that it doesn’t get a discharge and think they can’t.)
Whether it’s beneficial to file a corporate Chapter 7 is not a simple matter, and you should discuss this with your bankruptcy attorney.
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Last modified: December 22, 2011