Liability Of Shareholders For Corporate Debt

Brown, golden and ground flax seedSeparating the owners from the business

Even when the business is incorporated,  the individual shareholders think of themselves as the “owners” of the business.

In reality,  they are the owners of the stock in the corporation that owns the business.

They are probably also its officers and directors.

When it is necessary to consider bankruptcy, it becomes important to know just which debts of the corporation, if any, the shareholders may be personally liable for.

Simply owning the stock in a corporation does not make the individuals liable for the corporation’s debt.  The shareholders may, however,  become liable for the debts of the corporation either by agreement or by operation of law.

Liability by agreement

The most common way that a shareholder becomes liable for the corporation’s debts is by guaranteeing the debt.

That guarantee is a contractual agreement that makes the guarantor personally liable  to the corporation’s creditor on that debt.

Sometimes that liability may arise by the mistake of the shareholder, who signs a contract or lease for the corporation in his own name, rather than in his capacity as an officer or employee of the corporation.

Under state law, signing as “John Shareholder” may make John personally liable.  The correct way to execute a document for a corporation is by signing “John Shareholder, President,  Smallcorp, Inc.”

A bankruptcy filing by the corporation does not discharge the liability of a guarantor or another entity or individual who is liable for the bankrupt corporation’s debts.  Neither does a corporate bankruptcy stay action against others who are liable.

Liability by operation of law

Trade creditors

Creditors may sometimes “pierce the corporate veil” to impose liability on the shareholders where the shareholders have neglected  corporate formalities, such as corporate meetings and required filings, or, more often,  where they have ignored the legal separateness of the corporation and treated the corporation as an extension of themselves.

This can occur if the shareholders intermingle their money with that of the corporation or identify themselves as the business owner, suggesting that the business is a proprietorship.

Governmental entities

Another way that individuals become liable for the corporation’s debts is where state or federal law makes the shareholders liable for the corporation’s employment taxes, sales taxes or for uninsured worker’s compensation claims.

More on trust fund tax claims in personal bankruptcy.

Analyze which debts are personal and which are corporate.

Planning where liability is shared

When a small business corporation fails, the shareholders need to examine the debts of the corporation and its history to determine whether they have some liability for the corporation’s debts.

It may be appropriate to see that the corporation pays first those debts for which the individuals may be liable ahead of other corporate debts.

Get competent legal advice to understand the application of bankruptcy preference statutes.

Thoughts on finding a lawyer.

Image:  © elenathewise

About the Author
Northern California bankruptcy lawyer Cathy is a 30+ year veteran of bankruptcy practice in the Silicon Valley. She is known for energetic representation of clients and her command of bankruptcy law.