Surprise! You May Owe Unexpected
Duties or Money to Your Creditors
By Steven P. Blonder
Most businesses today are structured as either a corporation or a limited liability company (LLC). If your business is a corporation, it probably has officers, directors and shareholders; if your company is an LLC, then managers and members are the norm.
The officers and directors of a corporation owe duties to the shareholders, and the managers of an LLC owe duties to the members. While this may all be black letter law, under certain circumstances, a financially challenged company also owes duties to its creditors, who may be able to recover moneys previously paid as dividends or distributions to shareholders and members.
Confused yet?
The threshold issue in determining if duties are owed to creditors involves a company's financial condition. If a business is insolvent, undercapitalized and/or unable to pay debts as they become due, then creditors have a claim on the company's assets that is superior to the claim of an owner.
While this proposition may seem logical on the surface, it can be difficult to assess the financial position of a company. If a business is in bankruptcy or if its liabilities exceed its assets such that it cannot operate, the company is obviously insolvent. Other scenarios are not so clear. What if the business defaults on a loan, or stretches out trade debt? The situation becomes even more complicated when a company enjoys cash reserves and is current on its debt service, but is still technically insolvent or undercapitalized. This may happen, for example, in a cyclical business at certain times of the year, or when profits are insufficient to pay off accumulated debt (whether senior or subordinate). The bottom line? It is important to look beneath the surface, as a company's positive cash flow may mask technical insolvency or undercapitalization.
In all of these circumstances, a creditor may be able to recover moneys paid to the owners other than for salaries, leaving dividends or distributions for taxes or other purposes at risk. An owner may even have to pay back money from his or her own pocket.
The lesson for business owners and operators is to exercise care when you are facing financial challenges. If your company is insolvent, undercapitalized or unable to pay its debts as they come due, any distribution or payment to the owners (aside from salaries) may be at risk, regardless of why it was made or the historical precedent for making the payments.
As a skilled advocate whose practice focuses on complex business litigation, Steven P. Blonder has argued successfully before the Court of Appeals for the Seventh Circuit, and possesses a record of consistent success in motion and trial practice, both jury and non-jury, in state and federal courts. His litigation practice is primarily centered in the areas of real estate and business issues, financial services, corporate governance control and securities. Steve can be reached at 312.521.2402 or sblonder@muchshelist.com.
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