Quick Guide to Bankruptcy Law
Entrepreneurs seeking to expand their businesses must consider the law that applies when things turn sour. While unpleasant, organizing capital and planning for contingencies is a necessary step to prevent higher costs that may arise in the future. As for a potential bankruptcy, the following is information regarding its procedures.
When consulting a lawyer in connection to planning for bankruptcy, according to professional ethics, he or she cannot provide advice on diverting assets in any way that might delay, defeat or hinder creditors. Doing otherwise may place him or her in risk of liability, professional disbarment or imprisonment. As a result, the retainer may not mention any form of guaranteed result. In addition, an accounting of assets would be required to determine whether there are sufficient funds to pay the creditors upon transfer. If a transfer renders a client insolvent, the courts may reverse it. This includes giving a trustee the power to reel-in any transfer that a client makes to gain a fraudulent exemption or place property outside the jurisdiction.
An accounting of assets could go as far back as five years. This includes any accounting of corporations that the client controls, manages or acts as an agent for.
How does this relate to business law?
A client would be required to consider the rules of bankruptcy in the case of corporations, partnerships, or other business entities. In all cases, it is important to know whether the client is insolvent or in financial difficulties, or would be thus immediately subsequent to any transfer or reorganization.
In the case of corporations, a shareholder would generally not be liable for all debts of the corporation; this is because liability is limited to the equity investment. However, the courts may render director shareholders liable to creditors by employing the oppression remedy in the Business Corporations Act. To reduce this risk, a corporation should split divisions into several subsidiaries and avoid any cross-collateralization or guarantees that would create interdependency. This way, liability to creditors would be narrowed to each corporate entity rather than the group as a whole. Furthermore, when there are multiple shareholders, the shareholder agreement should contain appropriate clauses for each remedy concerning shareholder bankruptcies, matrimonial issues or estate freezes.
The same applies to franchises. If the client keeps the franchise separate and independent, there would be little risk of issues regarding creditor liability bleeding into the other business units.
Finally, partnerships have a bit of a different application. Each entity is composed of separate units — the partners — that invest capital into the business. Liability extends to the partners jointly and severally, which means that a creditor may collect from one partner who may sue the others for the difference. However, limited partners or those within professional LLPs have liability restricted to their initial capital investment or each of their own negligence, respectively.
Nick Konstantinov is a member of the BLG Business Venture Clinic, and is a 3rd year student at the Faculty of Law, University of Calgary.
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.