WHEN a person wants to get into business, he or she can do business as an individual, or set up a different legal entity separate from him or herself to do the business.
The separate legal entity does and operates the business, borrows money, executes contracts and does whatever is required of the business without involving the individual person who decided to set up the separate legal entity.
The separate legal entity is treated as the owner of the business and files its own tax returns. Yes, we are talking about corporations. There are different kinds of corporations that can be set up. There are “C” corporations, “S” corporations and limited liability companies aka “LLC.” All corporations assume their own liabilities, which are separate from the individual person. This is the general rule unless the corporate veil can be pierced to reach the individual.
How does this play out in real life? Let’s discuss an actual client example. The client wanted to get into the restaurant business. To do so, he incorporated an “S” corporation, which only has one stockholder, himself. The corporation was established in 2019, a year before the start of the pandemic, that has already killed a million Americans. Hopefully, most of the deceased have found their way to paradise, to spend eternity with our God. We rely on the infinite mercy that pours out of the sacred heart of Jesus Christ, to lead the souls of those who have departed to heaven, for the sake of His sorrowful passion. Thank you, Jesus, for your most sorrowful passion that has opened the gates of heaven to us sinners who seek your forgiveness!
Let’s call the corporation of the client hypothetically, Z restaurant. The client, as president of Z restaurant, signed a five-year commercial lease at $10,000 a month. This translates to $600,000 for five years of rent. For the entire year of 2019, Z restaurant was able to pay the landlord $120,000 of rent pursuant to the lease agreement. However, in 2020, Z restaurant was able to pay only two months or $20,000. Then, Z restaurant obtained a PPP loan of $100,000 so it could continue operating at a loss, hoping against hope, that the pandemic would just go away after a couple of months.
Z restaurant stopped operating in January 2021. The restaurant owes four years of unpaid rent, which is roughly $500,000. It also owes $100,000 of the PPP loan. So Z restaurant owes a total of $600,000.
Who is liable for this $600,000 of debt? Is it Z restaurant by itself, or is the client also personally liable for the $600,000 since he is the only stockholder of Z restaurant? To make matters worse, on the day before the restaurant closed for good, a customer slipped and fell in the restaurant from a spilled drink on the floor. The customer incurred $200,000 of medical expenses and is now suing the client for $500,000, including pain and suffering and loss of income. The customer was a surgeon making $1 million a year and was unable to work for half a year. Z Corporation had no liability insurance. Is the client, as an individual, liable to the surgeon for $1 million?
Fortunately for the client, a corporation is treated as a separate legal entity from the individual stockholder. Hence, as a general rule, only Z corporation is liable for the $500,000 unpaid lease, for the $100,000 PPP loan, and the $1 million damages that the surgeon is asking for. The client, as an individual, has no personal liability for any of these liabilities incurred by Z Corporation. Then, Z Corporation should just file for Chapter 7 liquidation bankruptcy where the $1.6 million of claims against Z Corporation will be filed.
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Disclaimer: None of the foregoing is considered legal advise for anyone. There is absolutely no attorney client relationship established by reading this article.
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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 20274 Carrey Road, Walnut, CA 91789 or 1000 S. Fremont Ave., Mailstop 58, Building A-10 South Suite 10042, Alhambra, CA 91803.
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