C-Corporation Bankruptcy: Everything You Need to Know
C-corporation bankruptcy occurs when this type of business entity is no longer able to pay its debts.3 min read
2. Life Cycle of a C-Corporation
3. Corporate Chapter 11 Bankruptcy
4. Corporate Chapter 7 Bankruptcy
5. Bankruptcy Advantages and Disadvantages
Updated July 6, 2020:
C-corporation bankruptcy occurs when this type of business entity is no longer able to pay its debts. Forming a C-corporation provides the owners of the business with limited liability, which means they cannot be held personally responsible for business debts. C-corps' profits are taxed both when they are earned and when they are distributed to shareholders as profits. When a C-corp fails, taking the proper steps to dissolve the company can prevent further financial and legal issues.
Forming a C-Corporation
To create a corporation, you must file formation documents with the secretary of state and pay the required fees. Once formed, the business is a separate legal entity. Individuals do not own the company itself, but instead own shares of the business. These ownership interests are documented in the corporation's bylaws. The business can own assets and is responsible for its own debt.
When a C-corporation is formed, the owners can shield their personal wealth from business obligations, including bankruptcy proceedings. If the individual files for bankruptcy, the company would not be listed as an asset; however, his or her shares in the company would. The value of this interest could then be sold by the bankruptcy trustee.
Life Cycle of a C-Corporation
The dissolution or termination of your corporation is governed by the state laws where it was formed. Corporations exist perpetually unless a limited term is established by the formation documents. Termination documents must be filed with the state to discontinue a corporation.
Corporate Chapter 11 Bankruptcy
When a C-corporation cannot make enough money to cover its expenses and debts, it can apply for Chapter 11 bankruptcy. This allows the company to restructure its obligations and then continue to operate in a more streamlined form, with new ownership or management, and/or in a different line of business.
When bankruptcy is underway, stockholders no longer receive dividends and lenders no longer receive principal and interest payments from the company. In some cases, the bankruptcy trustee will require shareholders to exchange their old shares for stock in the new company. This is often fewer shares or shares of lower value.
If a corporation is completely insolvent, the court may rule that stockholders do not get paid. The IRS will seek payment of outstanding federal taxes and may be able to seize the owners' personal assets. Although corporate executives are not often held personally responsible for bankruptcy, company cars and related assets can be seized.
Corporate Chapter 7 Bankruptcy
If you're planning to go out of business, filing for Chapter 7 bankruptcy can streamline the process. However, you can open yourself up to personal lawsuits for company debt. Filing for Chapter 7 bankruptcy closes the company. Ideally, your business can liquidate enough assets to pay debts for which shareholders and officers are personally liable.
When paying debts and distributing assets, you must follow bankruptcy laws' priority rules for an orderly liquidation. Corporations do not receive a debt discharge with Chapter 7; the debt lies with the business and the business no longer exists. However, if you made a personal guarantee for a debt or even if you didn't, a creditor can try to collect from you personally.
Bankruptcy Advantages and Disadvantages
Filing corporate bankruptcy may be advantageous if:
- A creditor is planning to seize assets that could otherwise be sold to pay for tax debts for which shareholders are personally liable.
- You are planning to close the business and need assistance to oversee the process of asset liquidation and distribution from a bankruptcy trustee.
- If creditors are planning to sue the company, since these suits often personally involve officers and shareholders even if they are not liable for the debt in question.
It may not be the best action if:
- Shareholders prefer not to file individual bankruptcy. A trustee can sue officers and stakeholders for recovery of loans or advances they received from the company.
- The company has issues that may be worsened by bankruptcy.
Keep in mind that shareholders may not be paid dividends if other debts of the company have not been paid. However, insiders, as well as third-party creditors, can be repaid for corporate debt.
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