S-Corp Company Officer has Personal Guarantee Company Debt and Goes Bankrupt

An S-corporation (S-corp) is one that is owned by its shareholders.  All profit or loss passes to the shareholders.  These shareholders must report this income, profit or loss, on their individual federal taxes.  An S-corp does not pay federal income taxes, electing to be taxed under the Internal Revenue Service’s (IRS) code: Subchapter S of Chapter 1.  So, what do S-Corp officers do or own?  S-Corp officers are usually shareholders, but do not have to be.  As a corporation, it has a board whose directors elect officers who run the company.  Every corporation is supposed to have by-laws that state which officer is authorized to do what actions, as well as which officers can direct which lower officers to do what actions.  It is not clear what the bylaws state, whether or not the vice-president was authorized to obtain loans, issue credit cards, and make personal guarantees for the S-corp.

As to the bankruptcy filed by the vice-president, the personal guarantees made by the vice-president are likely to be dismissed at discharge because the loan and credit are unsecured.  This is standard Chapter 7 bankruptcy law.  The debt owed, however, still exists.  Credit law states that if a personal guarantor fails to pay, or has his or her guarantee dismissed by bankruptcy, the other people involved in the debt are still liable for that debt.  This would mean that the debt now falls back onto the S-corp itself … and its owners.  By definition, it would appear that the S-corp itself can file bankruptcy, have its assets liquidated to pay off the creditors.  However, whatever debt is leftover following the discharge of the S-corp bankruptcy, the shareholders of the S-corp are now individually liable for the debt.  The creditor(s) will not care who pays the debt and will likely go after each shareholder individually for the entire payment.  It sounds silly when it is written out or one says it, but that is exactly how the system works.  Of course, each of the shareholders can file bankruptcy, but the initial filers are likely to be hit the worst as the debt is higher at first.  The creditors still do not care who pays them off.  The bankruptcy court can force a re-organization, foreclosure, insolvency contingency, or other legal actions available to the court.

One point as yet unexplored is “what if the vice-president was not authorized to obtain loans and issue credit cards?”  In this case the vice-president could be guilty of “forgery” by unauthorized signature, and therefore be criminally liable for the loan amount and credit card charges.  It is a situation that would have to be unraveled by the police or other pertinent agencies to some conclusion, and possible fraud conviction for the vice-president.  In some bylaws, as stated before, one officer can have authorization to authorize another, lower officer to do some action, such as obtain loans and issue credit cards, and use personal guarantees.  It would be prudent if the vice-president has that authorization in writing.  What one can prove or not prove typically makes the difference in this type of situation.

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