Clients who have substantial debts, but where bankruptcy won’t help, are always asking me how they can start a new business, generate income and try to rebuild wealth when all such efforts will inevitably inure to their creditors. No one wants to work for nothing and surely there is little incentive to commit to a new business venture only to know that the fruits of your labor will benefit your creditors rather than your family. Such clients inevitably suggest that their spouse or adult children will form a new entity and client will work for such entity at ridiculously low compensation levels. In this manner they figure, any income will be retained by the new entity which has no obligation to client’s creditors. But nothing is this simple. Indeed, the creditors will claim that the entity is a sham and the mere alter ego, nominee or agent of the client. Their argument will be based upon the fact that the new entity was minimally capitalized, that the owner had little or no experience in the business, that client was really the sole motivating force in generating the income and that the lack of paying fair compensation to the client is indicative of the sham nature of the entire transaction. Indeed, I believe the creditors win this argument hands down every time. So what does one do to create a defensible structure given these concerns? Essentially they must do the opposite of what the example above describes. The entity should be adequately capitalized. It should not be a “one person show” with the sole worker being debtor client. Instead, there should be multiple employees and the enterprise must be run as a real business. Owner should be active to greatest extent possible. Courts will look to the background, expertise and experience of owner to see if the structure makes sense so owner should play to her strengths. Her role should be geared to her background and capabilities. Also, don’t pay client menial wages–they have to be defensible and reasonable. With these guidelines client and his family will have a reasonable shot at building a business that will not be vulnerable to his creditors. Good Luck!!
CAVEAT-THE FOREGOING IS A DISCUSSION OF ISSUES ONLY AND NOT INTENDED AS LEGAL ADVICE. NO ONE SHOULD RELY ON THE FOREGOING WITHOUT SEEKING LEGAL ADVICE FROM A LICENSED ATTORNEY.