Behind the Curtains: When a Business Closes Down
A company can go out of business for various reasons, and not all of them are directly related to money. But when a company is no longer conducting its business, the relevant question becomes whether it was a voluntary or involuntary decision. A voluntary closure usually occurs when the business is being sold or is merging with another, and the business owner transfers operations in order to receive payment for the assets in the sale. But there are payments and benefits awarded for employees sometimes, and if workers are continuing to be hired, that means it’s not a closure or bankruptcy.
Involuntary closure usually occurs through a restructuring or bankruptcy process. While most companies strive to stay as far from the bankruptcy courts as possible, there are obvious exceptions. The state of a company at the time of closure determines what your rights as a creditor are.
If your company is owed a debt, an inspection of the public record registry can reveal details about the asset distribution, secured interests, etc. This will help you decide if filing suit is wise. If a company is simply closing down its doors and going out of business, they probably haven’t entered the courts at all. There is no mandatory requirement for companies to enter the courts when they go out of business, so if a UCC-1 lien filing doesn’t turn up any filings , this may mean that the business isn’t in bankruptcy.
It’s also important to define what is meant by a company being "closed." A company may conduct a limited amount of business in order to pay off debts or creditors, but this does not offer an explanation about what your rights are. One source of information is the state Registry of Corporations which lists the status of companies in the state. This will allow you to check if the company’s registration is active or inactive, the kind of business entity it represents (if a limited liability corporation), and the residency status of its officers. If it’s listed as "inactive," this is an indication that the company is no longer doing business, but it could continue to settle some debts if desired.
If the company is in bankruptcy, it is possible there are certain exceptions to the amount of funds they have to pay their creditors. The general rule is that the amount of money companies possess must be divided among their creditors, but the order in which it happens is generally determined by whether debt is secured or unsecured. This requires a reference to the UCC-1 filing for most creditors. If the person or business you are trying to recover debts from is a major company, there is a good possibility they have filed for bankruptcy.
Legal Remedies in the Aftermath of a Business Shutdown
The legal options that are available once a business closes depend on whether the business goes out of business or is dissolved through legal proceedings like bankruptcy or liquidation.
Bankruptcy
If a business files bankruptcy, creditors – including customers who may have a legal claim against the business – may be able to recover their money or take other legal action. However, the extent of the recovery depends on the type of bankruptcy.
Chapter 7
A Chapter 7 bankruptcy involves the liquidation of assets. The business will stop operating and a trustee will sell the business’s assets and distribute the proceeds among creditors. A Chapter 7 bankruptcy will eliminate most debts. However,, some creditors may object to this distribution and seek a court order to stop it. If creditors’ objections are unsuccessful, the bankruptcy court will issue a discharge that forecloses all future claims against the business.
Chapter 13
A Chapter 13 bankruptcy is a reorganization proceeding in which a company proposes a repayment plan to its creditors. In each month of the repayment plan, the business will pay an amount to the bankruptcy court, which the court will then distribute to creditors. After completing all payments, the business will receive a discharge of its remaining debt.
Liquidation
If a business is simply closing down, without bankruptcy, a creditor may be able to pursue a claim against the business in court. However, the creditor will have to show that the business lacks sufficient assets to pay its debts. A creditor then can ask the bankruptcy court to appoint a receiver to sell the business’s assets and distribute the proceeds among creditors.
Pinpointing the Responsible Entity
To be liable, a company must have violated the law in some way. This can be as clear-cut as not paying back money owed to you after a court judgement or as vague as engaging in business practices that violate consumer protection laws. If a business has committed fraud and closed as part of it, they may be guilty of more than civil law crimes (if they violated any criminal laws, a prosecutor for the state may be able to file charges against them.) If a company closed without filing for bankruptcy, it is likely (though not certain) that the company owes you money and that you are generally among a group of creditors (most likely ranging from "customers" who paid for services or products that were never delivered to vendors and suppliers who were never paid.) In general, the first step to receiving recompense for a violation of commercial law is determining who was responsible. Some companies may be spearheaded by an individual, while others may operate as shareholder partnerships. If a company is structured as a limited liability company, you may not be able to sue the shareholders with any hope of success; corporations and LLCs are generally protected by limited liability laws. However, if you can prove the business was operated under a violation of these laws, you may be able to pierce some of this protection.
Signature Authority If a company has filed for closure or bankruptcy, its "signature authority" should be very clear and well documented. Signature authority is a legal term meaning which individuals are allowed to speak for a company. It does not mean these individuals have to provide anything for the company, it simply means that they can legally speak for the company before they need to get approval from other shareholders (if applicable.) If a company has not filed for bankruptcy or closure, and is instead "closing down" its operations voluntarily and without any official procedures, signature authority may not be documented, but responsible parties (likely high-level executives) must still be located.
Piercing Limited Liability In the cases of corporate structuring, you may be able to pierce the veil of limited liability. Doing so means taking away the limited liability protection against owners, managers and officers of the company, making them all personally liable. While piercing the corporate veil is rarely a successful move for plaintiffs, it may allow you to access recompense from the individuals who led to your loss. In general, if you have been wronged by a business that has closed down without paying or delivering goods, you may be able to pursue recompense. But to do so, you will need to file within the appropriate statutes of limitation and identify the party that can be held responsible.
Necessary Documents and Proofs
You generally need some pretty good documentation to go up against a company that isn’t in business anymore. You may think it’s a matter of just showing a contract and then relying on the argument that under this contract both sides have obligations that survived the company’s demise. But in reality the contract evidence may just be the tip of the iceberg. Here are examples of the kind of information that you need lying around at the time the company goes down for good:
- Contracts including clauses where one side has a right to bring in profits or get equity in the company.
- Final agreements done by the company in which the other side participated as a consultant or otherwise, and the correspondence on the deal showing that your side was of material importance to the deal going through or not and determining the value of the company.
- Any information from the company about the other side’s participation and its importance to the company – perhaps a letter from the company explaining how the work was important.
- The most important evidence, of course, are e-mails between the parties before and during the relationship that are evidence of the arrangements between the parties. You need to get all of these before the company is done for. Documents that show the investments back and forth must be preserved and used.
- Communications with third parties such as directors, employees and shareholders that show what the other side was selling based on your work, or was telling the world (including the government) about the company and its performance. For example, how was the company doing because of your work? Was your work being bragged about by them abroad that created liability for your side.
- For many companies that are long gone, the tax records may still exist.
- What public filings exist? Is there a chance to add your information into a filing? How can you make sure that your information is out in the public domain for others to see about this company?
- What documents are going to hurt the other side. For example, does your side own a patent that is now held by a defunct organization and therefore one of the building blocks to a new shell company?
Potential Hurdles in Suing a Closed Company
One of the biggest challenges when suing a defunct company is locating the assets. If that business no longer exists, is not in a bankruptcy proceeding, and there has been no distribution to creditors, usually there is no public notice by the company to those who might be owed a debt. Because of this, potential creditors have limited ability to track down the existence of the debt, the identity of potential debtors, and their whereabouts. Creditors are forced to pursue their cases as if there has been no bankruptcy filing. On top of that , prosecution of a case against the company can be challenging because the attorneys of record likely represent on behalf of the defunct company and its executives and officers for the duration of the litigation per the terms of an indemnification agreement. In some cases, the company might have assets in the form of insurance, from which the attorneys fees and costs are paid, but even that can be restrictive because the insurance cannot be used to address all claims (for instance, it may only cover certain types of liability) – and the policy limits might not be sufficient to cover an adverse judgment. If the attorneys are proceeding out of pocket, they may lack the resources needed to prosecute the case, or lack the incentive to devote the time and attention the case needs.
Seeking Legal Advice from Professionals
If the damages you sustained are significant, you may wish to seek the counsel of an attorney who has experience with lawsuits. A legal expert may evaluate your case to determine whether you can pursue the case as an individual or with a class action lawsuit. Some attorneys will make this evaluation free of charge or through a nominal consultation fee. If there’s a strong case for a lawsuit against the closed business, an attorney may be able to advise on the next steps. In some cases, the attorney will work with other law firms to take on the case. This allows them to pool resources and money to file a larger class action lawsuit.
When you are affected by a business that closes it comes as a shock to many. However, when a business hands you a pink slip don’t fret. You may not be able to sue a business, but you do have options with the help of a legal expert.
Case Studies and Practical Illustrations
Throughout history, there have been companies that faced lawsuits even after going out of business. These cases are generally illustrative of contract law and the limitations on remedies that remain in effect despite a company’s bankruptcy or insolvency. These examples also illustrate that the complaint is often filed in the early stages of a bankruptcy proceeding or after a bankruptcy petition has been filed but before the bankruptcy is complete.
Here are a few examples:
Sullivan v. Thomas A. McGowan Co., 326 N.J. Super 415 (Ct. of App. 1999).
In Sullivan v. Thomas A. McGowan Co., plaintiff hired a general contractor to build a custom home. When that corporation failed during construction of plaintiff’s home, but before the construction was completed, plaintiff sued Thomas A. McGowan, the controlling shareholder of the general contractor corporation and the project architect. The trial court entered summary judgment in favor of Mr. McGowan, the architect. The appellate division affirmed, finding that any claim by plaintiff against McGowan, the controlling shareholder, was barred by the single and exclusive remedy provision in the agreement between the owners of the corporation and the primary contractor. The appellate division further found that the claims against the architect were barred by principles of res judicata, as they arose out of the same events alleged in the earlier suit. Sullivan demonstrates that corporate officers and directors can’t be held individually liable for corporate torts merely because of their position within the corporation.
FDIC v. International Bank Co., 333 F. Supp. 2d 308 (2004). In another case that illustrates a corporation may be free from liability if it ceases to exist as a corporation, the District Court for the Southern District of New York held that in almost all cases, a creditor may not proceed against a corporation after it ceases to exist as a corporation. In FDIC v. International Bank Co., the plaintiff creditors sued a now defunct corporation in New York. In analyzing the suit, the Court held:
"[I]n almost all cases, the courts have barred attempts to proceed against a dissolved corporation where the corporate charter had been abandoned and the creditor knew or should have known of the dissolution or expiration of the charter." This case illustrates that the court may properly look at the facts of the case to determine whether or not a dissolved corporate entity is subject to civil or criminal liability under the circumstances of each particular case. On appeal, the decision was upheld.
Kubera v. Lawson, 337 Ark. 37 (1999). In Kubera, Plaintiff sued Defendant for breach of warranty, misrepresentation, and violation of state unfair trade practices statutes for selling Plaintiff with nonconforming parts. Plaintiff brought the suit to recover for defective products sold by Defendant, the seller, even though he knew that the company had been dissolved by the state at the time the products were sold. The lower court dismissed the complaint stating that the dissolution of the corporation barred Plaintiff from suing. Plaintiff appealed.
The Arkansas Supreme Court partially affirmed the lower court ruling. On appeal, with regard to the breach of warranty and misrepresentation claims, the court reversed. The court held that Plaintiff was allowed to proceed with these claims because Arkansas Public Corporation Act of 1987 (APCA) provides that an action concerning a right that was accrued before the date of dissolution may be prosecuted to enforce that right. Because Plaintiff brought the action to enforce his rights that arose during the period when the corporation was in existence, the court reversed the lower court’s ruling on the breach of warranty and misrepresentation claims.
However, with regard to Plaintiff’s rival suit under the Arkansas Unfair Trade Practices Act (UUTPA), the court affirmed the lower court’s dismissal. Although Plaintiff argued that because he brought the rival action to enforce his UUTPA rights arising before the date of dissolution, he was permitted to proceed under the APCA, the court focused on the remedies available under the statute. The court found that an APCA suit could not provide the remedies Plaintiff sought under the UUTPA claim and reversed the lower court’s ruling on the breach of warranty and misrepresentation claims.
Solutions Outside of Litigation
Suppose that you can’t collect, or the company has gone out of business. Is there anything you can do? There are several options you can consider.
One option is pursuing a mediation or arbitration. Very often it is provided for in the contract, and if the company has a form of contract – such as a subcontract – that form may have language in it forcing you into some sort of arbitration. I will usually review the language with you and see if we can find a way around the agreement forcing you into an arbitration, but very often, if it’s a form of contract, you probably signed it as it is. If we can’t get around a contract, I will advise you that you should pursue mediation or arbitration. I have had many matters where we have had to go through arbitration, and that has worked to our advantage in getting the matter taken care of.
Also, most contracts have attorney fee reimbursement provisions. You will almost certainly be entitled to an award of your attorney fees if you are successful after engaging in that mediation or arbitration . So that is something to consider.
Another option that you can pursue is suing the insurance company. You could sue the insurance company directly if the company has sued you and you have a counterclaim, or even sometimes a collection company is suing you. You could sue the insurance company under their insurance policy. It is called a "bad faith" claim, and I have successfully won several of those claims and gotten a judgment against a large insurance company and had that insurance company pay me directly. And that was done because they were being unreasonable. They had good reason to be. They shouldn’t have that position, but they do. They have a lot of bargaining power.
In the final analysis, if someone is really aggrieved, they can sue. But there are better ways to handle it, and that would be mediation or arbitration. Sometimes the farthest we can go with an insurance company is getting them to negotiate a settlement. And if there is no chance for the case to be settled, and it is hopeless, there are other means to utilize to get the case resolved.