Chapter 7 for a Corporation vs Chapter 7 for the Owner: 5 Cases That Need Both

Two chapter 7 cases filed on the same afternoon, one for the company and one for the person who owns it, are two separate lawsuits against the world, with two trustees, two estates, and two sets of schedules that had better agree with each other. Owners often expect one of them to carry the other. Neither can.

The reason is written into the Code twice. A company's chapter 7 produces no discharge, because Section 727(a)(1) grants none to a debtor that is not a natural person, and it protects only the company. An individual's chapter 7 can produce a discharge, but only for the individual, and it leaves the company's own debts where they were. (A sole proprietor is the exception that proves the arrangement: the business and the person are one debtor, filing one case on the forms numbered in the 100 series.) Five situations turn that division into a reason for two filings.

1. The Funder Sued the Company and the Guarantor Together

A merchant cash advance lawsuit commonly names the business and the owner who guaranteed it. When only the company files, the automatic stay under Section 362(a) halts the action against the company and leaves the claim against the owner running. The Second Circuit's 2003 opinion in Queenie said it without qualification: "a suit against a codefendant is not automatically stayed by the debtor's bankruptcy filing." Courts can extend protection to a non-debtor, but only in limited circumstances and on a motion.

When the owner files too, the owner's own stay covers the owner. The lawsuit that named two defendants is then paused as to both, for two different reasons, in two different cases.

2. The Guaranties Are the Larger Debt

For many owners the arithmetic is stark. The company's obligations will go unpaid whatever happens, since an entity with no assets and no discharge has nothing further to lose, while the guaranties attach to the owner's income, accounts, and home. That is the debt the owner's own case exists to address.

An individual chapter 7 brings its own requirements. The owner must complete a credit counseling briefing from an approved agency within the 180 days before filing, under Section 109(h), and, with limited exceptions, must finish a financial management course afterward to receive a discharge. The means test in Section 707(b) applies only to an individual "whose debts are primarily consumer debts," defined as debts incurred "primarily for a personal, family, or household purpose," and business guaranties are generally not incurred for that purpose, though whether a given owner escapes the test is a question for counsel with the full debt list in hand.

Nor is the discharge automatic in every respect. A funder that believes it relied on a materially false written statement of financial condition, made with intent to deceive, can ask the court to except its debt under Section 523(a)(2)(B), and under Bankruptcy Rule 4007(c) that complaint must be filed within 60 days after the first date set for the meeting of creditors. An allegation is not a finding. It is, still, a lawsuit inside the bankruptcy, and an owner who files personally should expect the funder's lawyers to read the old application carefully.

The company's case decides what happens to the company's property. The owner's case decides what happens to the owner. Neither court has been asked the other question.

3. The Owner Is a General Partner

A general partnership in chapter 7 creates a claim that no corporation or LLC case does. Under Section 723(a), if the partnership's estate is not enough to pay allowed claims for which a general partner is personally liable, "the trustee shall have a claim against such general partner to the extent that under applicable nonbankruptcy law such general partner is personally liable for such deficiency." In New York, Partnership Law 26 makes all partners liable, jointly and severally for some obligations and jointly for the rest, unless the firm is a registered limited liability partnership.

So the partnership's trustee pursues the partners, and if a partner is also in bankruptcy, Section 723(c) gives the trustee a claim against that partner's estate for the full amount of allowed partnership claims. For a general partner, a second case is less a strategy than an echo of the first.

4. The Owner Took Money Out in the Last Year

An owner is an insider of the company, and Section 547(b)(4)(B) lets the company's trustee avoid payments to an insider made up to one year before the company's petition, where the other preference elements are met. Section 548 reaches back two years for transfers made to hinder creditors or for less than reasonably equivalent value while insolvent, and Section 550(a) lets the trustee recover from the person who received the money. The company's trustee, in other words, may become one of the owner's creditors, holding a claim that did not exist the day before the company filed and that will be scheduled, with all the others, in the owner's own case.

But the owner's case brings its own scrutiny. Section 727(a)(2) denies an individual a discharge if, with intent to hinder, delay, or defraud a creditor, the individual transferred or concealed property within one year before the filing, and Section 727(a)(3) does the same for records concealed or not kept without justification. The same year of transactions is examined twice, by two trustees, for different purposes, which is reason enough for the two sets of schedules to be prepared with each other in view.

By this point the pattern is clear enough to say out loud: in a business collapse, the question is almost never which case to file but which case to file first, and with which facts disclosed in both.

5. The Owner's Shares Belong to the Owner's Estate

When an individual files, Section 541(a)(1) places "all legal or equitable interests of the debtor in property" into the estate, and Section 541(c)(1) does so notwithstanding restrictions on transfer in an agreement. The owner's shares or membership interest become the personal trustee's to administer. For a company headed to liquidation that interest may be worth little, though it may still carry the vote. Authority to put a company into bankruptcy comes from state law and the company's governing documents, the rule of Price v. Gurney, a 1945 Supreme Court decision. Who holds that authority after the owner's own petition is a question counsel should answer before the order of filing is chosen.

What Two Filings Still Leave Unresolved

Some obligations survive both cases. A responsible person's liability for withheld payroll taxes is excepted from an individual's discharge through Section 523(a)(1)(A), and domestic support and certain government fines are excepted too. An owner facing those needs tax counsel as much as bankruptcy counsel.

For some owners, two filings are the right answer, and a bankruptcy attorney should plan them together. For others, particularly those whose personal exposure is mostly guaranties on advances rather than taxes or partnership liability, a negotiated resolution may make one filing, or both, unnecessary. Delancey Street (not a law firm) reviews that negotiated route free and in confidence, and leaves bankruptcy filings and legal advice to independently licensed counsel.

The two sets of schedules should agree, whoever prepares them. The smallest discrepancy between them tends to be the first thing a trustee notices.