Debtor/Creditor Issues for Small Business Startup

1. Observe your form of organization.

• Make sure your form of entity is properly set up and continues to remain in existence, or the principals will be personally liable
• Pay your annual filing fees so your entity remains in existence, or the principals could then become personally liable. 

      2. Pay attention to details.

• If you set up a corporation as your business entity, make sure that you sign the documents with your title as an officer (i.e. as “President”, “Vice-President” etc.).  Do not sign a business document personally.
• Keep records, on site and off site, of business events such as issuance of stock, bonds, notes and capital contributions
• Ex. If a friend or family loans money to your entity, do you have an executed promissory note which states the interest rate, who is the borrower, the repayment terms, etc.?
• Have you set up an accounting system/program such as Quickbooks and do you know how to use it?
• Do you have a budget for your venture?
• Do you know your “burn rate”?
• Have you prepared and reviewed an Income Statement and Balance Sheet? 

      3. Guaranties

• There are two types of guaranties that small businesses will usually enter into: (a) a general guaranty and (b) a “good guy” guaranty
• A guaranty is a written agreement by a third party or entity to pay the debts of an individual or entity (primary obligor) who fails to pay its debts as they mature
• As an example, if the entity wants an American Express corporate credit card, the principal(s) will need to guaranty payment to American Express if the entity does not make that payment.
• “Good Guy” guaranties are generally used for office leases. It is a limited form of guaranty that provides that the principals agree to pay the debts for the Tenant, if the Tenant fails to pay base rent or additional rent, until (i) the Tenant pays its rent arrears, (ii) vacates the space in broom clean condition and (iii) gives the keys back to the Landlord.

       4. Responsible Person Taxes are sales taxes or employees’ share of employment taxes (FICA and FUTA) that are collected by an entity and not paid over to the tax authorities

• The responsible person is generally an officer of the corporation and the taxing authorities will conduct an audit to determine who the responsible person(s) are after the business closes or fails.
• Responsible Person Taxes are also not dischargeable in personal bankruptcy
• Note the principals of a defunct entity are not liable for general corporate income tax liabilities that were not paid by the defunct entity.

      5. Fraudulent Conveyances

• NYS Debtor and Creditor Law and the Bankruptcy Code provide that if an individual or a business does not have sufficient capital to conduct its business, then they cannot transfer property for no consideration (gift) to family, friends or third parties. If they do, a creditor or the bankruptcy trustee can commence litigation to unwind the transaction.
• Hint: The best time to do “asset protection planning” is before one gets into trouble!

      6.  Small Corporation and LLC Wages for Employees

• Section 630 of the New York Business Corporation Law renders every privately held corporation’s ten largest shareholders personally liable, jointly and severally, “for all debts, wages or salaries due and owing to any of [the corporation’s] . . . laborers, servants or employees other than contractors, for services performed by them for such corporation.”  N.Y. Bus. Corp. Law § 630(a)
• Limited Liability Company Law § 609(c) provides similar treatment to laborers, servants and employees of a LLC
• Accordingly, if you are running a small business that is failing, make sure that you pay monies due your employees before the business closes or you may be personally liable for those monies.

       7. Closing a business (letting it go inactive or in windup mode) v. a Chapter 7 bankruptcy filing

• Closing a business benefits:  Lower administrative costs and possible to do without the help of professionals.
• Closing a business detriments: Belief by vendors or creditors that assets or inventory were not properly sold or accounted for, lawsuits, no accounting by a bankruptcy trustee and no “automatic stay” which results from an entity filing for bankruptcy protection 
• Chapter 7 bankruptcy filing benefits: Protection from creditor actions via the automatic stay, orderly payment of creditors if assets are available for distribution, and an orderly liquidation of company assets. The business closes after the Chapter 7 bankruptcy petition is filed with the bankruptcy court.  
• Chapter 7 bankruptcy filing detriments: Filing fee ($335), administrative cost for professionals, preparing schedules and reports for the bankruptcy trustee and meeting with the bankruptcy trustee (341 hearing) and possible bankruptcy trustee litigation (adversary proceeding).