When a business is buried in debt, there’s a tempting idea for struggling owners. They start a new company, move the equipment, customer accounts, and money over to it, and leave the old company—and its bills—behind.
There’s a big catch: This idea almost never works. Courts in nearly every state can undo the transfer, make the new company pay the old company’s debts. And, in some cases, the courts go after the owners personally.
This is a particularly important cautionary tale for businesses struggling with delinquent Economic Injury Disaster Loans, or EIDL, given during the pandemic by the Small Business Administration. Some 500,000 of these delinquent loans have been sent over to the Treasury Department’s collection area, which is causing businesses to look for options given the financial stress. Businesses struggling with an EIDL delinquency or need help with a bankruptcy situation can reach out to the team at Frost Law. Call (410) 497-5947 or schedule a free consultation.
For businesses considering moving assets, here is how courts look at these moves, and what separates a legitimate sale from one that will backfire.
In most states, a company that buys another business’s assets does not automatically become responsible for that business’s debts. The rule makes sense. It lets a struggling company sell what it owns, and it lets the buyer pay a fair price without worrying about bills or lawsuits it does not know about.
But this is only the starting point. Courts follow the rule when the sale is a real deal between independent parties, each looking out for its own interests. When the sale looks like a trick to get away from creditors, the courts set the rule aside. Courts usually rely on two provisions—or tools—to do it—fraudulent transfer law and successor liability.
Almost every state has a law that lets creditors undo transfers meant to cheat them. Most states use a version of a model law called the Uniform Voidable Transactions Act, or its older version, the Uniform Fraudulent Transfer Act. The idea behind these laws is centuries old: You cannot give away or hide property to keep it out of your creditors’ reach.
In this scenario, a creditor can win in one of two ways:
Common warning signs about these transfers include:
If a court finds such a fraudulent transfer, it can cancel the transfer, let the creditor go after the assets in the new owner’s hands, and in some cases order whoever received the assets to pay the creditor directly.
Successor liability works differently. Instead of undoing one specific transfer, it makes the new company responsible for the old company’s debts. The rules vary from state to state, but courts generally do this in four situations:
In practice, the more the new business looks and runs like the old one, the bigger the risk.
Keeping the same name, signs, letterhead, and staff all make the new company look like the old one with a new label. In many states, a key question is whether the same people own and run both companies. Some courts have also said that a creditor does not need to prove an intent to cheat under the “mere continuation” rule. That means a transfer can fail this test even if it would hold up against a fraudulent transfer claim.
Going after the new company is one thing. Going after the owners personally is another—but creditors have several ways to do it:
Restructuring a business is not illegal. Companies sell parts of their business, reorganize for tax or practical reasons, and buy assets from struggling businesses all the time. The question is how the deal is done.
A transfer is much more likely to hold up when:
Red flags that invite a challenge:
If you are thinking about selling your company’s assets or restructuring your business, talk to an experienced business or bankruptcy attorney first. The facts, timing, and structure of the deal are what decide these cases—and those are far easier to get right before the transfer than to defend after it.
If you are struggling with debt or have questions about bankruptcy, the team at Frost Law may be able to help. Call us at (410) 497-5947 or schedule a free consultation. You can also explore our bankruptcy resource center to see what steps might work for your situation.
When a business is buried in debt, there’s a tempting idea for struggling owners. They start a new company, move the equipment, customer accounts, and money over to it, and leave the old company—and its bills—behind.
There’s a big catch: This idea almost never works. Courts in nearly every state can undo the transfer, make the new company pay the old company’s debts. And, in some cases, the courts go after the owners personally.
This is a particularly important cautionary tale for businesses struggling with delinquent Economic Injury Disaster Loans, or EIDL, given during the pandemic by the Small Business Administration. Some 500,000 of these delinquent loans have been sent over to the Treasury Department’s collection area, which is causing businesses to look for options given the financial stress. Businesses struggling with an EIDL delinquency or need help with a bankruptcy situation can reach out to the team at Frost Law. Call (410) 497-5947 or schedule a free consultation.
For businesses considering moving assets, here is how courts look at these moves, and what separates a legitimate sale from one that will backfire.
In most states, a company that buys another business’s assets does not automatically become responsible for that business’s debts. The rule makes sense. It lets a struggling company sell what it owns, and it lets the buyer pay a fair price without worrying about bills or lawsuits it does not know about.
But this is only the starting point. Courts follow the rule when the sale is a real deal between independent parties, each looking out for its own interests. When the sale looks like a trick to get away from creditors, the courts set the rule aside. Courts usually rely on two provisions—or tools—to do it—fraudulent transfer law and successor liability.
Almost every state has a law that lets creditors undo transfers meant to cheat them. Most states use a version of a model law called the Uniform Voidable Transactions Act, or its older version, the Uniform Fraudulent Transfer Act. The idea behind these laws is centuries old: You cannot give away or hide property to keep it out of your creditors’ reach.
In this scenario, a creditor can win in one of two ways:
Common warning signs about these transfers include:
If a court finds such a fraudulent transfer, it can cancel the transfer, let the creditor go after the assets in the new owner’s hands, and in some cases order whoever received the assets to pay the creditor directly.
Successor liability works differently. Instead of undoing one specific transfer, it makes the new company responsible for the old company’s debts. The rules vary from state to state, but courts generally do this in four situations:
In practice, the more the new business looks and runs like the old one, the bigger the risk.
Keeping the same name, signs, letterhead, and staff all make the new company look like the old one with a new label. In many states, a key question is whether the same people own and run both companies. Some courts have also said that a creditor does not need to prove an intent to cheat under the “mere continuation” rule. That means a transfer can fail this test even if it would hold up against a fraudulent transfer claim.
Going after the new company is one thing. Going after the owners personally is another—but creditors have several ways to do it:
Restructuring a business is not illegal. Companies sell parts of their business, reorganize for tax or practical reasons, and buy assets from struggling businesses all the time. The question is how the deal is done.
A transfer is much more likely to hold up when:
Red flags that invite a challenge:
If you are thinking about selling your company’s assets or restructuring your business, talk to an experienced business or bankruptcy attorney first. The facts, timing, and structure of the deal are what decide these cases—and those are far easier to get right before the transfer than to defend after it.
If you are struggling with debt or have questions about bankruptcy, the team at Frost Law may be able to help. Call us at (410) 497-5947 or schedule a free consultation. You can also explore our bankruptcy resource center to see what steps might work for your situation.
