S-Corp Chapter 7 -- debts not dischargeable?

[baffled]

Hi everyone.

My husband filed for Chapter 7 for his S-corp. The reason for the filing is that the S-corp is no longer active -- there are no assets -- and there is a nuisance law suit against the S-corp, which, while meritless, would be expense -- very expense -- to defend.

My husband did not want a judgement against his S-Corp, even though he plans to dissolve the S-corp. (I think this was more a point of honor for him than a business decision.)

His attorney told him that the litigation against the S-Corp could continue even if the S-corp was dissolved. But, the attorney said, if he filed for Chapter 7, listed the plantiff as a creditor, and got a discharge, then all litigation on the matter would stop not only during the Ch 7 proceeding, but thereafter.

The attorney filed the S-corp Ch 7 paper work in August and we went to the hearing on the matter last week.

What happened was sort of incredible.

The trustee almost laughed us out of the room. He said that the law does not allow for the discharge of debts for an asset-less S-corp in Chapter 7. His exact words were, "I don't know what you're doing here. There's nothing I can do for you. This is a non-event legally. Well, I guess I can file a no assets report for you."

So they swore in my husband, got his testimony on the record that his paperwork was accurate -- that the corp is assetless -- and then moved for a final decree with a no assets statement and no discharge.

My husband's attorney seemed genuinely shocked that there was no possibility of a discharge.

My question for the more legally qualified than me: Under the old law (pre-Oct. 2005) could S-corps get a discharge of debts? Is this no-discharge for S-corps new, or has it always been like this?

Thanks for any light you can shed on this legal absurdity.

Baffled

[HHM]

Unfortunately, this forum is more geared toward personal bankruptcy rather than business bankruptcy, so you probably won't get too much of a response.

But the first two lines of Section 727 (Discharge) of the BK code state
(a) The court shall grant the debtor a discharge unless
(1) The Debtor is NOT an Individual.

Under normal legal parlance, an 'individual' is defined as a natural person (i.e. human being). A corporation is not an individual (a corporation is a "person", but in the legal realm of corporate law, a person includes an individual, partnership, corporation etc, thus, when a statute specifically uses the term 'individual' it is generally held to be excluding corporations and partnerships, and referring exclusively to human beings).

In short, filing Chapter 7 on the S Corp. was a waste of time and money since you could never have received a discharge of the debt against the business. (note, that doesn't mean there are not benefits to the corporation filing a chapter 7, it is common when a business is winding up its affairs, but if you were expecting a discharge, you were misinformed. However, remember that the automatic stay stays in place until discharge, so, if there is never a discharge, you get the benefit of the automatic stay, so the net effect is like a discharge)

The real issue is whether your husband might have any liability as the successor in interest to the corporation, but if the corporation is asset-less and he did not take out significant assets, then you should be ok.

On a side not, the S-Corp designation is meaningless in the Bankruptcy Context...structurally, a corporation is a corporation and is organized under "state law". The S-Corp and C-Corp designations are IRS designation that determine the tax status of the corporation. In an S-Corp, if you meet the criteria, the corporation does not pay Corporate income tax, instead the profits are distributed to shareholders who pay tax on the profits at their individual tax rates. Whereas, a C-Corp pays federal corporate income tax on corporate profits and the shareholders will pay personal income tax on their share of the profits at their applicable individual tax rate (or the dividend tax rate).

[tradewiz50]

S-Corps are listed under Chapter 11. You cannot file Chapter 7 on a S-Corp, regardless if it has no assets.

[baffled]

Thanks so much for the very clear explanation. 'Twas a very odd day last week, and some very, very ill-informed lawyering.

[CindyLou]

Hope your lawyer if offering up a full refund due to his goof up!!!

[wrinkleigh]

S Corp Bankruptcy

We are in a S Corp situation also. We have no creditors, other than credit card companies, they are in the businesses name, but my husband was personally responsible for the debt.

Our attorney advised us to include the credit cards in our personal bankruptcy, that way we were covered in case they tried to come after us. We were advised to close the business, and be ready to hand over the inventory (which is our only assett), if the trustee wanted it.

The way I understand it is, yes S Corps are not eligible for a discharge because they are not a "person", they are just dissolved and the trustee can file a no asset for you. YOU, however could be liable for the debt that the S Corp incurred as an officer, so you can protect yourself by including it in a personal bankruptcy. It wont necessarily be discharged, but it would protect you form being liable. If the business is closed with no assets, you cant get blood from a turnip, so to speak. And if you are filing a personal bankruptcy, they cant get it from you either, case closed.

However, if you are not filing a personal bankruptcy, you may find yourself liable, as an officer of the corp, OR if you signed a personal guarantee, and didnt realize it.

I am by no means an expert, I am just in a similar situation, and this is what my attorney told us. I would find another attorney if I were you, and get more expert advice.