Officer, Director & Shareholder Liability When A NY Corporation Is Insolvent

Good morning, everybody, and welcome to episode number five of the You Can’t Be Serious legal podcast.

I’m Bradley Bailyn, a business lawyer in New York City. And today, we’re going to talk about closing down a corporation and avoiding personal liability when doing so.

The first thing I want to point out is that there is a legal line once the company becomes insolvent and avoiding personal liability becomes much more complex at that time. So once you’re becoming insolvent, it’s very important that you get an attorney involved or another professional who understands the rules of corporate insolvency.

What are the most basic ways that you can be personally liable?

The first way is when you just plain accepted personal liability. A lot of times this happens unknowingly where you go to your favorite banker or you need a business line of credit and they hand you a paper full of dense, tiny boilerplate. You sign it off and you unknowingly have accepted personal liability for the businesses.

Another way you can be personally liable is for unpaid trust-fund taxes. That means unpaid taxes that you are responsible to collect on behalf of the government.

Payroll taxes and sales taxes are the typical taxes that officers, directors and shareholders can become personally liable for.

Now the sneaky part about this is that you don’t have to be the person who is responsible for paying the taxes. A lot of times there’s multiple partners in the business and the partner who handles sales has nothing to do with the finances of the business. Yet that partner ends up becoming personally liable for the trust fund taxes because they have the money to pay it. And under the IRS Responsible Party rule they could have known about the tax situation. They had the authority to know, if they wanted to know, and that authority is enough to make you liable.

Another way that personal liability can occur is when you unfortunately mix your personal assets with the assets of the business. In other words, you pay your personal debts from the business’s account. You take out more money than the business has available to give you and then the business ends up not having enough money to pay its debts. And you have to pay the debts with your personal account or by putting your personal money back in.

Long and short of it is that the company’s account begins to look a lot like your own account. It’s a lot less frequent when there are multiple people who own the corporation as opposed to when there’s only one person who owns the corporation.

But regardless, being irresponsible with corporate formalities like that can result in the business passing through its liabilities to the shareholders, officers and directors of the corporation.

Also, if you don’t hold shareholder and board meetings, if you don’t have board resolutions… If you don’t observe the corporate formalities, then that also can lead to the argument that the corporation is not valid or became not valid at some point, and you are the same as the corporation and therefore you should be personally liable.

Lastly, you have transferee or transferor liability where they say, listen, the business didn’t really go under, the assets were transferred to somebody else inappropriately and therefore the liability should transfer as well.

So those are the ways that there can be personal liability.

Otherwise, how do you go and close down the business plain and simply? You only need to hypothetically call the creditors and let them know that the company is ceasing operations and if there are any assets that they are going to be sold and distributed based on the order of priority when the company becomes insolvent.

A lot of times people on behalf of their corporations will seek a Chapter 7 bankruptcy, especially when there’s a bunch of creditors. This just avoids the situation where angry creditors file baseless personal lawsuits against the shareholders because they are furious and hoping that they can do something to pressure the decision makers into paying them money that they really feel that they’re entitled to.

And typically, once people receive bankruptcy paperwork, they cool down. They’ll take out their anger on the bankruptcy court. And they’ll go away.

So it’s a lot easier and more organized to file a Chapter 7 bankruptcy for the business. And it’s not very expensive either. So if there’s a bunch of creditors, officers and directors will sometimes choose to do a corporate Chapter 7. But before you do that, you just want to make sure that you haven’t done anything which is going to give you exposure. Because once the trustee takes over the business, if you’ve done something wrong as an officer or a director, you don’t want to have personal liability problems or other problems with the government claiming payments that you’ve made to yourself or to other people.

You do need to be careful because if you violated the order of priorities, once the company became insolvent, then that money can be reclaimed against you personally.

So, again, once the company is becoming insolvent, you really should contact an attorney, either me or somebody else, because things become complicated at that point. With all that being said, if you have questions, please feel free to give me a call.

If you have questions you’d like me to feature on this podcast, please just let me know and I may be able to accommodate you.

If there’s a subscribe button, please click the subscribe button on whatever platform you’re watching or listening to this on.

And lastly, as a disclaimer, keep in mind, I don’t know you. I don’t know your situation. This is general information. So do not rely on a mere video that you see on YouTube. And if you do, I will not be liable for that. Thank you and have a wonderful day.