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Creditors, bankruptcy and fraud -- oh my!

Creditors can face many obstacles when attempting to receive payment from a client. Although many clients pose no problems, others make things more difficult. One such obstacle: bankruptcy.

What role does bankruptcy play in getting payment from a client?

Bankruptcy is designed to offer the petitioner with protections against the actions of creditors. This process is available for both individuals and businesses. Generally, when a business files for bankruptcy the creditor cannot go after the individuals behind the business for payment. However, there are exceptions.

The Supreme Court of the United States (SCOTUS) recently heard a case that analyzed one of these exceptions. The case questioned the rights of creditors when the debtor has filed for bankruptcy protections. The questions in this case: what happens when a shareholder is responsible for the debt of the business due to a fraudulent transfer? Can that shareholder be held responsible for the debt by the creditor even if he or she has filed for bankruptcy?

Can business owners and shareholders be held responsible for business debt?

Before the very specific questions above can be addressed, it is a good idea to look at some of the basics. First off, can a creditor hold an individual responsible for a business's debts? Like many legal matters, the answer to this question is sometimes.

If attempted, creditors initiate a legal process referred to as piercing the corporate veil.

What is the corporate veil?

The corporate veil is a legal term that describes the protections individual business owners and shareholders receive from incorporating their business. When done correctly, if the business goes into debt the individuals are not held responsible. Instead, the creditor must attempt to receive payment from the business itself.

Can these protections be overcome?

In some cases, creditors can overcome these protections and hold the individual responsible. This is called piercing the corporate veil.

This case showcases one such attempt.

What can creditors learn from this case?

Piercing the corporate veil often requires a good deal of evidence. One example involves the presence of fraud. This case provides some valuable lessons for creditors that find themselves dealing with a client that may have committed fraud that led to the debt.

Essentially, SCOTUS provided three lessons from this case that extend the rights of creditors in similar situations:

  • Transfer schemes are considered fraud.
  • Any action completed with wrongful intent is considered fraud.
  • Concealment and hindrance support a claim of fraudulent conduct.

Once fraud can be established, a creditor can often build a case to pierce the corporate veil and hold individuals financially responsible for their actions.

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