Once a business closes, it no longer can incur additional debts. While that is a good thing, it does not mean that the business’s existing debts go away. In fact, a creditor with a valid claim can file a lawsuit against a business that is no longer operating. In this post, we’ll explore how business owners can and can’t be held liable for company debts, which is an important topic for owners of struggling businesses that may be looking for a way out.
Many owners assume that if you want to avoid business creditors, a good way to do that is simply to dissolve your business, with the reasoning being that you can no longer be sued since your business does not exist anymore. That kind of logic makes a lot of sense - in theory. But filing for voluntary dissolution does not mean that you have escaped your business’s debts. Generally, the law protects creditors who act in time. Of course, the business may not have the funds to cover the debts. That is a separate question from whether a creditor can sue.
Dissolution, Winding up, and Closing
There is a difference between when a business ends and when a business legally closes. A business stops when it ceases operations and no longer has a place to conduct business, but it may not yet be legally dissolved. As long as the formal closing steps are incomplete, the company can be sued by anyone who has a valid claim. For corporations, LLCs and partnerships, there are three stages: dissolution, winding up, and closing.
Dissolution generally is when a business formally notifies the state of its decision to stop operating, usually by filing articles of dissolution. In Pennsylvania, you file articles of dissolution with the Department of State, Corporation Bureau; in other states, you notify the Secretary of State’s office. Even if the company is dissolved, it still exists legally, and you’re just as protected as before. But dissolution does not immediately terminate a business’s liability for existing obligations. During this stage, the business can be sued for a debt that existed at the time of dissolution.
The second stage is winding up. You can’t give the remaining assets to yourself until all the debts are paid off, and you’ve looked at every possible claim. In other words, the business cannot just refuse to pay a creditor just because it is going out of business. And creditors may sue a company during winding up proceedings. Also, if you had assets and hid them or gave them away to keep them from creditors, you can get sued for fraudulent conveyance. Transfers to family members or insiders are particularly suspect. And any claims that were never resolved before you closed shop can also come back to haunt you.
The third stage is the final closing. In this stage, the business ceases to exist and the liability protection is no longer available. Claims made against the company from that point on may fall to the owners. The reason is that there’s no company anymore to protect you. Those cases are usually messy and involve lots of legal details, especially if there are a lot of people on both sides. There are steps that a business owner must follow to properly close a business.
Can Still Be Sued
So what can a creditor actually sue over? A business that owes money for goods or services can be sued even after it has been closed. The same is true if it failed to honor a contract. If owners or executives took company assets and transferred them to family or friends instead of paying what the company owed, creditors can file suit. Creditors can also sue you for money if they think you didn’t do everything you could to protect their interests when the company was in trouble or when it was winding down. That is a claim against the directors for breach of fiduciary duty. Even if the company is dissolved, it can still be sued for selling products that injure someone. Partners and members of the board of directors of a company can sometimes file lawsuits against it. For example, if they believe someone committed fraud or misused company funds. And if the owners did not follow the proper procedure for closing the business, that can also result in liability.
Whether a creditor will bother is another matter, since many businesses close because they can no longer afford to operate. Is it worth suing for the debt? The answer depends on the circumstances. The company may have had insurance covering the period when the claim arose, and if the creditor wins, the insurance company may pick up the tab. Even after closing, a company can still have assets that have not been sold or distributed yet. A creditor can sue to recover all or part of what it is owed from those assets.
Personally Liable
If a closed business has nothing left, its creditors may want to sue the owners to collect the debts owed. Owners of a corporation or LLC usually are not personally liable for the company’s debts. But a sole proprietorship doesn’t have limited liability protection, so creditors can go after the owner personally. If you close the business, you still owe the money and creditors can come after your personal assets to collect. In some circumstances, a court can “pierce the corporate veil” and hold owners directly liable for corporate debts.
Creditors do not have unlimited time. There is a time limit for filing claims against your company in Pennsylvania, usually four years or less. If the time period runs out, the creditor may have no legal avenue to pursue a claim against you. In short, creditors have to act fast.
If you decide to close your business, the creditors will not simply go away. The company will still owe its debts, and how it closes matters. Whether you have to pay them depends on a lot of factors. Don’t bury your head in the sand when creditors begin to call. If you are struggling, open the doors to your creditors. Get them in the room and talk with them about a new strategy. Dealing with the debts before you close leaves you more options than dealing with a lawsuit after.
