I DON’T CARE IF MY COMPANY GETS SUED…I WILL JUST FORM ANOTHER ONE-BANKRUPTCY- PART 5June 15, 2020 | Category: Asset Protection, Corporate and Taxation, Estate Planning and Probate, News
This Part 5 of our bankruptcy series. So far, we have covered what you need to know if the event of bankruptcy, the premise of bankruptcy in the era of COVID-19, protecting your LLC and/or Limited Partnership, and what to do with a lease.
Many people are under the impression that they are free to form a new company at any time to cut off legal problems with an old company.
This gets into an area in the law known as “successor liability.” When a business is sold, it depends upon what was sold and whether or not the successor expressly or by implication, accepted the old company’s liability. If just the assets were sold, ordinarily the purchaser has not assumed the liabilities.
Now consider the plight of a doctor-employee who had a dispute with his employer, a professional association (P.A.), over an employment matter, sued and was granted a large judgment against the P.A. The P.A. (employer) then tried to do an end run around its former employee, by forming a new P.A. The new P.A. had a similar name, the same shareholders, the same officers, the same address, the same phone number, mostly the same furniture and equipment, and the same employees. Virtually nothing had changed.
This is an obvious example of successor liability and de facto merger. It is also a good example of a fraudulent conveyance. Under such circumstances, the law imposes successor liability on the new entity for the liabilities of the old entity because there has been no real change in the business except for the creation of a new entity to substitute for the old entity.
This has implications for a malpractice suit. P.A. is sued for malpractice by a doctor-employee, a non-shareholder. The shareholder of the old P.A. decides to form a new P.A. under a slightly new name and continue on, similar to the first example. The shareholder was clever enough not to raid the old P.A.’s assets including cash and accounts receivable. Same result.
There are two ways to solve the problem. Usually the simpler way is to file Chapter 7 bankruptcy.
The Trustee is trying to maximize the available assets to the creditors. The new P.A. (owned by the same shareholder as the old P.A.) is likely to be able to work out a deal with the Trustee to take over the lease, purchase the equipment, the name and “going concern” of the old P.A., and in so doing, obtain a release from liability of the old P.A. Indeed, the new P.A. is likely to be the only one interested.
The alternative method is usually not practical. Here the owner of the old P.A. forms a new P.A. with a distinguishable new name, brings in one or more new shareholders, changes the officers and directors, obtains a new phone number, moves to a new location, hires new employees, and perhaps adds new services. While all of this does not necessarily need to be done, the more the second entity is distinguishable from the first entity, the more likely it will withstand legal attack.
By keeping the P.A. with as little equity as possible, should the P.A. there is little to be lost in a lawsuit. The use of bank or shareholder, secured loans against the cash accounts, accounts receivable, and equipment will go a long way in accomplishing this. An Employment Agreement that provides a fixed, regular salary for the professional would help keep the exposure low. A management company owned by the professional’s family could be useful in liening up the P.A.’s assets. Remember, keep the P.A. poor.