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Business Debt/S-Corp Default on line of credit
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Question
Dear Michael,
I run a small business in California as an S-corp. When the business was incorporated, my wife was made a 50% shareholder although she's a completely "silent partner", doesn't take salary, has never been involved in the business, etc. The business is in danger of defaulting on a line of credit that I personally guaranteed. My spouse was not involved in this line of credit (she never signed anything). If the default happens, is my wife liable or on the hook in any way? Can they come after her? Would it be prudent to transfer her share of the business to me in case the default is unavoidable? Thank you for your help.
Alex,
I apologize for the delay, I did not receive any e-mail notification of your question until this morning.
Your situation has a two-fold problem. The first is the corporate debt itself. The impact on the shareholders should be limited, but this could be impacted by the corporate structure. You should have the articles of the corporation plus any corporate minutes reviewed by legal counsel to ascertain what impact there might be as well as to ensure that you have not “pierced the corporate veil” and that the protections afforded by the corporation remain in place. As a corporation, your tax returns might also come into play on any benefits that she has received. If you were granted any contracts as a minority owned business based on her 50% ownership, that could also muddy the waters.
The second is your personal guarantee. Since you are married, the impact on your spouse is not as clear. The state that you reside in, plus the state under which the contract is drafted will determine what obligation your spouse has (if any) for this debt.
If you and your counsel decide to transfer (sell) her shares, this should be done for a fair price otherwise it will not be accepted by the courts and could make the situation worse instead of better.
I’m sorry that I cannot give you a better answer, but there are too many unknowns in this situation. I recommend that you seek legal counsel for a more complete review of the situation. You might also need to consider corporate bankruptcy to protect your spouse, but again – that is something for you to discuss with a lawyer.
Best of luck,
Michael
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Answers by Expert:
Michael Fay
Expertise
My focus and specialty is in credit, so that the risk of the debt itself is minimized. This means understanding it, predicting it, and helping to correct it. Having worked in contracts & credit, I have also worked with all of the related documents such as Guarantees (personal and corporate), and Security Agreements (aka UCC’s or “liens” – but I caution you in using those interchangeably).
Experience
I have a broad background with more than 15 years in the credit industry. Ten years with Dun and Bradstreet, first as a field reporter creating reports, then in customer service, finally I served as the credit manager designing risk models for many national and international customers through D&B’s Outsourcing function. Five years with another publicly traded firm where I created the credit department and then served as credit manager for North America. At both companies we used both business and consumer data.
You probably know that both business and personal credit have scores; what you might not know is how many different types of scores there are. I am familiar with and have used many different scores in each. Also be aware that each credit type (business & personal) is unique with different processes and different time frames.
I have served on the board of directors for companies in many states and still serve in some capacity in a few. I contribute to credit publications and work with the non-profit arm of the SBA called SCORE.
Organizations
ACA International * NACM * Credit Risk Managers * SCORE (SBA)- Counselors to America’s Small Business * Payment Card Industry Network * PaymentSource.com * D&B Alumni * Psi Chi, National Honor Society for Psychologists
Education/Credentials
BIS in Business and Psychology, University of Minnesota * MBA is still in progress (on-line)
Awards and Honors
State of Colorado - State finals in Accounting and Advanced Accounting. * D&B Leadership Winner (3 times) * D&B Leadership Finalist (3 times) *
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