SOMETIMES individual debtors who file for bankruptcy own a corporation which is doing business and wonder whether or not their personal bankruptcy affects the corporation’s ability to continue doing business. At the heart of this issue is the separate legal existence of a corporation. A corporation has its own legal existence, separate from the legal existence of the owner/s of the corporation. This is the legal fiction created by law giving the corporation a life of its own. Thus, a corporation can do practically anything that a person can do by itself as a separate legal entity. It can own assets by itself. It can sue and be sued by itself. It can file bankruptcy by itself without involving its owners or stockholders. For instance, the U.S. government can sue BP, a corporation, for damages caused by the oil spill in the Gulf of Mexico. But the lawsuit cannot include the stockholders of BP because BP Corporation is a separate legal entity responsible for its own acts of negligence. When BP loses this lawsuit, BP will be held legally liable for a lot of damages. Hence, BP’s assets will be liable for these damages. If you own BP stocks, the judgment against BP will not affect you in any way other than the fact that the market value of the stocks you own may depreciate because of the judgment. As stockholder, you will not be held legally liable for the judgment against BP.
Creditors of a debtor in bankruptcy, who owns a corporation, or even a chapter 7 trustee for that matter, may ask the bankruptcy court to disregard the corporation’s separate legal existence to access the assets of the corporation under certain circumstances. To illustrate, client who filed for Chapter 7 owns an ‘S’ corporation called ‘Obama fashions’ which operates a wholesale RTW outlet in LA’s fashion district. Obama Fashions has annual sales of $300,000, a net annual profit of $12,000, and has year-end inventory of $100,000. Can creditor penetrate the veil of legal fiction of the corporation and file a claim against the $100,000 inventory in the bankruptcy case of debtor? Will it make any difference if the corporation is an LLC, or a ‘C –corporation?’ Generally speaking, the answer is NO. All three entities are corporations. They all have separate legal lives. Creditor will have a hard time convincing the bankruptcy court to allow it to file a claim against the inventory of Obama fashions even if the individual debtor is a 100% owner of the S, C, or LLC. However, the trustee will certainly be interested in the net worth of the company because the corporation’s net worth determines the fair market value of the stocks owned by debtor. Debtor’s stocks in the corporation are part of his personal assets. They are part of the bankruptcy estate. Therefore, in order for debtor to keep these stocks away from the trustee, debtor must be able to exempt the entire current fair market value of the stocks in schedule C of his Chapter 7 petition. In this case, if the value of the stocks is estimated at $15,000 and debtor has applicable exemptions, he can keep all of his stocks in Obama fashions despite bankruptcy. If he is able to do this, debtor will still own the entire corporation and operate Obama fashions without any interference from the trustee despite his bankruptcy. Thus, there are debtors who have filed for personal bankruptcy but still own and operate an incorporated business that provides him income. Another example is a bankruptcy debtor who owns a corporation that owns and operates several home care facilities. Assets of the home care facilities such as money in the bank in the name of the corporation cannot be seized by the Chapter 7 trustee or debtor’s creditor despite debtor’s personal bankruptcy.
Corporations are distinguished from sole proprietorship, general or limited partnerships, or joint ventures. These do not have separate legal lives from debtor. Therefore they are affected by debtor’s bankruptcy.
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., Bldg. A-1 Suite 1125 Unit 58, Alhambra, CA 91803.
( Published July 28, 2010 in Asian Journal Los Angeles p. B4 )
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