7 Restructuring Mistakes That Turn Corporate Debt Into Personal Liability

The Corporate Shield Is Real, and It Is Easier to Give Away Than to Pierce

The reason you formed an LLC is that it works. Courts do not casually disregard entities, and creditors who try usually lose. New York’s test, set out in Morris v. New York State Department of Taxation and Finance, 82 N.Y.2d 135 (1993), requires a creditor to show both that the owner exercised complete domination of the corporation as to the transaction at issue and that the domination was used to commit a fraud or wrong that injured the plaintiff. Domination alone does not do it. Most states run some version of that two-part test, and most veil-piercing claims filed against small operating companies fail on the second half.

Which is exactly why the exposure almost never comes from a creditor prying the shield open. It comes from the owner handing it over during a workout, usually in a week when the phone will not stop ringing and someone on the other end has offered to make the daily debits stop today if you will just sign this. Every item on this list is something an owner in distress does voluntarily, to buy time, without anyone telling them what it costs. Seven weeks of relief for permanent personal liability is a bad trade even when the seven weeks are real.

1. Signing a Guarantee or a New Confession as Part of the Deal

The most common version goes like this: you are 90 days behind, the funder offers a forbearance and a longer term, and buried in the modification is a personal guaranty you did not previously give, or a fresh confession of judgment, or a broadened performance guaranty that converts a limited undertaking into an unlimited one. Owners sign it because the headline terms improved. What actually happened is that a creditor with a claim against an insolvent company traded some cash flow relief for a direct claim against a solvent human being, and from their side that is the best trade available on the whole file.

Confessions in particular are worth reading closely, because the law changed underneath them and some paperwork has not caught up. In New York, C.P.L.R. §3218(a) now requires the affidavit to state the county where the defendant resides, and the affidavit may only be filed with the clerk of the county where the defendant resided when it was executed or resides at filing, which closed the practice of entering New York confessions against out-of-state merchants. New Jersey went further: under N.J.S.A. §2A:16-9.1, no provider of business financing may extend business financing to a New Jersey concern that contains a judgment by confession, and a provision that does not comply is invalid and unenforceable against that business. If your original agreement carries a defective confession, signing a clean new one during a workout hands back a defense you already had.

The alternative is not refusing to negotiate, it is pricing the signature. A guarantee is consideration, so it should buy something specific and measurable: a stated principal reduction, a defined forbearance period with a hard end date, a cap on the guaranteed amount, a sunset after a number of on-time payments, or a carve-out of your primary residence. Have counsel read the whole modification rather than the term sheet, because the terms that matter are usually in the release, the waiver-of-defenses clause, and the definition of the guaranteed obligations. Our page on fighting a personal guarantee covers what to do when one is already signed.

2. Paying Yourself or an Insider Ahead of Creditors

In the months before a restructuring, owners repay the loan they made to the company, catch up their own deferred salary, pay a family member’s note, or clear the rent owed to the entity that holds the building. It feels like the fair thing to do, because that money genuinely was yours. Legally it is the transaction most likely to be unwound and the one most likely to be characterized as bad faith later. In bankruptcy, 11 U.S.C. §547(b)(4) reaches transfers made within 90 days before the petition, and “between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider.” The one-year window is the whole point: insiders get four times the exposure of a trade vendor.

State law reaches it too, without any bankruptcy filing at all. New York’s version of the Uniform Voidable Transactions Act, at Debtor and Creditor Law §274(b), makes a transfer voidable as to an earlier creditor where it “was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.” Since you are the insider and you know exactly how insolvent the company was, the knowledge element is not a real fight. There is also a fiduciary layer. Under North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007), creditors of an insolvent Delaware corporation cannot bring direct fiduciary claims against directors, but they can bring them derivatively, which is how these claims arrive in practice.

The alternative is boring and effective. Stop insider distributions the moment the company is insolvent or heading there, and document the date you stopped. Take reasonable, documented compensation for work you are actually performing, on the same schedule as before, rather than lump catch-up payments that look like a preference on a bank statement. If the company owes you money, get in line as a creditor and say so on the record instead of quietly self-paying. And note the size of the safe harbor if you are wondering whether small transfers matter: §547(c)(9) protects non-consumer transfers only where the aggregate value is less than $8,575.

3. Letting Payroll Taxes Ride While You Pay the Funder

This is the single most expensive item on the list, and it is also the one owners describe as temporary. Cash is short, the funder debits the account every morning at 6 a.m. whether you approve it or not, and the 941 deposit is a payment you have to affirmatively make, so the deposit is what slides. Three quarters later the arrears are six figures and they are no longer a corporate problem. Under 26 U.S.C. §6672, a responsible person who willfully fails to pay over withheld taxes is “liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.” The withheld money was never corporate property in the first place: 26 U.S.C. §7501(a) holds it in trust for the United States from the moment it is withheld.

The doctrine that catches it is willfulness, and the IRS has published the exact fact pattern. Its guidance defines acting willfully as acting “voluntarily, consciously, and intentionally,” and gives this example: you are acting willfully if you pay other expenses of the business instead of the withholding taxes. Paying the funder while the deposit goes unmade is that sentence. The Supreme Court did put a limit on §6672 in Slodov v. United States, 436 U.S. 238 (1978), holding the section was not meant to impose absolute liability without personal fault, and new management is not liable for using after-acquired funds where prior management already dissipated the trust money. That limit protects a successor, not the owner who chose the payment order.

The alternative is to treat the deposit as a fixed cost that comes out before anything discretionary, and to build the restructuring around that rather than around it. If you are already behind, file every delinquent return even when you cannot pay, and designate voluntary payments in writing to the trust fund portion of the oldest open period so they reduce the piece that becomes personal. Do not let a funder’s daily debit schedule set your payment priorities by default. Our page on the debts you cannot restructure the normal way goes through why this liability does not compromise like the rest of your tax debt.

4. Commingling Funds and Dropping the Formalities

During a cash crisis the accounts blur. You wire personal money in to cover a debit and take it back out two weeks later without documenting either leg. The company card pays your mortgage in March and you pay a vendor from your personal checking in April. Nobody has signed a written consent or held a members’ meeting in two years, the operating agreement is unamended since formation, and the annual report lapsed. Each of those alone is an administrative failure. Together they are the record a creditor’s lawyer needs, because a veil-piercing claim is built out of bank statements, and yours now read like one person’s wallet.

The doctrine is alter ego, and it varies by state, but the structure is consistent. Morris requires complete domination as to the transaction plus a fraud or wrong causing injury, and commingling is how creditors prove the first element while the workout itself supplies the argument on the second. A creditor who can show you moved money between yourself and the company at will, then paid other people ahead of them, is telling a coherent story rather than a technical one. Undercapitalization, absence of corporate records, and payment of personal expenses from company funds are the factors that recur in these opinions, and a distressed company usually has all three at once.

The alternative costs almost nothing and it has to happen now rather than at the end. One operating account, one card, no exceptions, and any capital you contribute papered as a contribution or a documented loan with a note and a date. Run payroll for yourself through payroll instead of taking draws. Keep written consents for the decisions you make during the restructuring, especially the decision to prioritize one creditor over another, because a contemporaneous record of a business reason is worth far more than your recollection two years later. Bring the state filings current. An alter ego claim is built on a pattern, and a clean pattern from the date the trouble started is a real defense.

5. Moving Assets to a New Entity for Nothing

The pitch is familiar and it is usually delivered by someone who is not a lawyer: start a fresh entity, move the trucks and the customer list and the phone number over, leave the debt behind in the old one. It is the fastest route from corporate liability to personal liability on this list, because the transfer itself is the wrongful act and you are the person who executed it. In bankruptcy, 11 U.S.C. §548(a)(1) lets a trustee avoid transfers made within two years before the petition. Outside bankruptcy, the Uniform Voidable Transactions Act reaches transfers made with actual intent to hinder, delay, or defraud a creditor, and transfers made without receiving reasonably equivalent value while insolvent, generally on a longer clock than the Bankruptcy Code’s.

Two things make the OldCo and NewCo version worse than a plain transfer. Successor liability doctrines, including de facto merger and mere continuation, can attach the old debts to the new entity anyway, which means you have paid for the new entity and inherited the old liabilities. And courts look at the badges of fraud, which include transfers to insiders, retention of control after the transfer, transfer of substantially all assets, and transfers made after a suit was threatened. A NewCo with the same owner, the same equipment, the same customers, and no consideration paid ticks nearly every box on that list.

There is a legitimate version of an asset transfer, and it involves independent valuation, real consideration paid to the old entity, notice, and frequently a court-supervised or statutory process rather than a private one. That is a different transaction from what most owners are being sold, and it is beyond what this page can cover responsibly, so we have a dedicated page on it: read the fraudulent transfer traps in OldCo and NewCo restructurings before anyone drafts a bill of sale.

6. Overstating Revenue or Collateral in the Proposal

Restructuring proposals are sales documents, and owners write them the way they write pitch decks. Annualize the best quarter. Describe a receivable a customer disputes as collectible. List equipment at replacement cost rather than what it would bring at auction. Leave the third and fourth positions off the liability schedule because you are hoping to settle those separately. Every one of those choices is aimed at getting a better deal, and every one of them converts a contract negotiation into a fraud claim if the creditor relies on it and later discovers the truth.

The consequence is not just a failed deal. 11 U.S.C. §523(a)(2)(B) excepts from discharge a debt obtained by use of a written statement respecting financial condition that was materially false, that the creditor reasonably relied on, and that the debtor caused to be made with intent to deceive. A restructuring proposal is exactly that kind of writing. In Bartenwerfer v. Buckley (U.S. 2023) the Supreme Court held §523(a)(2)(A) bars discharge of a debt obtained by fraud regardless of the debtor’s own culpability, and in Avion Funding, L.L.C. v. GFS Industries, L.L.C., No. 23-50237 (5th Cir. Apr. 17, 2024), the court held those exceptions reach corporate Subchapter V debtors through §1192(2). There is criminal exposure at the far end as well: 18 U.S.C. §1343 carries up to 20 years, and up to 30 years and a $1,000,000 fine where the scheme affects a financial institution.

The alternative produces better outcomes anyway, which is the part owners find surprising. Creditors discount optimistic numbers automatically and they cannot discount a number they can verify. Send the bank statements rather than a summary of them. Show the aging with the disputed items marked as disputed. List every position including the ones you intend to settle elsewhere, because a funder who finds an undisclosed position later will treat the omission as the fraud rather than the underlying stack. Value equipment at orderly liquidation value and say that is what you did. Have counsel review the proposal before it goes out.

7. Dissolving or Walking Away With Liabilities Outstanding

The last mistake is the quiet one. Revenue stops, the owner files dissolution paperwork or simply stops filing anything, distributes what is left in the account, and assumes the liabilities died with the entity. They did not. Dissolution is a winding-up process with a mandatory order of payment, and the order puts creditors ahead of owners. In New York, Business Corporation Law §1005(a) permits distribution to shareholders only “after paying or adequately providing for the payment of its liabilities.” Delaware runs the same sequence through 8 Del. C. §281, which requires a dissolved corporation to pay or make provision for claims before anything reaches stockholders.

The teeth are in the director liability provisions. N.Y. Business Corporation Law §719(a) makes directors who vote for or approve a distribution of assets after dissolution “without paying or adequately providing for all known liabilities of the corporation” jointly and severally liable. That is personal liability for the distribution, arising from paperwork you filed yourself, with no veil to pierce and no fraud to prove. Delaware caps a stockholder’s exposure at the lesser of a pro rata share of the claim or the amount distributed under 8 Del. C. §282, and §278 keeps the entity alive for three years for the purpose of suits, so walking away does not even close the courthouse. On top of all of it, dissolution does nothing to §6672 exposure, and in practice it is what prompts the IRS to pursue the individuals, since the only party that could have paid is gone.

The alternative depends on how much is left. If there are assets, wind down properly: identify known claims, provide for them in the statutory order, and get counsel to run the process, because a compliant dissolution in most states genuinely does cut off later claims in a way an abandonment never will. If there is nothing left, an assignment for the benefit of creditors or a bankruptcy filing puts the liquidation in front of a neutral and produces a record that protects you. The one move to avoid is the middle path, which is distributing the remaining cash to yourself and letting the registration lapse. That is the version that leaves you personally liable for the distribution and personally liable for the taxes, with no process to point to.

Who Should You Call? Our Top-Rated Business Debt Firms

One firm on this list works the entire lifecycle of a business debt file, from stopping the daily debits through attorney-led negotiation, UCC lien removal, and a signed release. The other two cover broader debt categories that often sit alongside the advances. Choose accordingly.