Illinois Bankruptcy Court Denies Trustee's Attempt to Exercise Control Over Nondebtor Corporation's Assets
Jonathan Alper of the Florida Bankruptcy Law Blog considers here the following situation involving an individual chapter 7 debtor client where the bankruptcy trustee sought to control the business in which the debtor was the sole shareholder:
The debtor's assets included 100% of the stock in an operating business with assets including real property. The question arose concerning the debtor's operation of the business after filing personal bankruptcy. Since the debtor's stock is part of the bankruptcy estate, does the trustee by virtue of owning all the stock assume control of the business? Or, can the debtor as president of the business operate the business including disposing of business assets after filing? In this case, the trustee took the position that the debtor's bankruptcy did not act as a stay against business operations.
Similar questions were addressed this week by Judge Mary P. Gorman of the Bankruptcy Court for the Central District of Illinois in Swartz v. Billingsly (In re Billingsley), 2006 WL 538437 (Bankr. C.D. Ill., 3/6/2006) (pdf). The difference between the situation facing Judge Gorman and that posited by Jonathan is that in Judge Gorman's case, the debtor only owned 50% of the non-debtor corporation's stock, whereas in Jonathan's example, the debtor owned 100% of the non-debtor's stock.
This difference is significant because when the trustee is the sole shareholder, it should have the freedom to run the non-debtor corporation as it pleases (subject to compliance with state law corporate formalities). Conversely, when the trustee controls 50% or less of the non-debtor's equity, significant decisions involving the non-debtor would require the consent of other equity participants, and thus the trustee could not make unilateral decisions regarding the non-debtor corporation's affairs.
Here's what Judge Gorman said:
"[B]ecause any shareholder right to receive corporate assets can come only after the claims of corporate creditors have been satisfied or provided for ... [Illinois Business Corporation Act of 1983 § 9.10], and because it is not within the statutorily-conferred powers of shareholders to liquidate a non-debtor corporation to distribute its assets to pay off such creditors, it cannot be that the asserted winding-up power is one of the property rights of... a shareholder that can devolve upon [a bankruptcy] Trustee." In re Winer, 158 B.R. 736, 746 (N.D. Ill. 1993). Moreover, a corporate officer's or director's power to wind up a non-debtor corporation's affairs does not "vest in the trustee so as to pass into the bankruptcy estate." Id. at 748.
As a result, it is well-settled that assets owned by a corporation are not included in the bankruptcy estate of an individual shareholder. Fowler v. Shadel, 400 F.3d 1016, 1018 (7th Cir. 2005) (Assets of debtor's wholly-owned corporation are not property of the debtor and cannot become part of the bankruptcy estate of the debtor shareholder); In re Russell, 121 B.R. 16, 17-18 (Bankr. W.D. Ark. 1990) (Assets of corporation are not property of debtor shareholder's bankruptcy estate solely by virtue of shareholder's 82% stock ownership of corporation). A debtor's shares in a corporation became part of the bankruptcy estate; the assets of the corporation do not....
[I]t is clear ... that the assets of a corporation may not be administered in the bankruptcy case of an individual shareholder, officer, or director. In this case, the Trustee is trying to use Section 542 of the Bankruptcy Code to require the Defendants to turn over and account for the proceeds of a legal malpractice claim owned by [the non-debtor corporation]. Section 542 requires an entity in possession, custody, or control of "property that the trustee may use, sell, or lease under section 363" to deliver the property to the trustee. However, Section 363 only authorizes a trustee to use, sell, or lease "property of the estate". Thus, the Trustee may sell the Debtor's [50% ownership of the non-debtor's] shares..., but he may not sell the [non-debtor's] corporate assets. Neither Section 542 nor Section 363 provides authority for the Trustee to reach the assets of a non-debtor corporation.
© Steve Jakubowski 2006
RE: No power of a Chapter 7 Trustee to administer assets on a non-debtor corporation; Is the answer different if the Trustee attempts to use state procedures to operate the corporation outside of the bankruptcy case, such as electing the Trustee as sole Director and president? Using the power of those offices, can a Trustee usurp the authority of the Debtor-corporate shareholder & President? If yes, do any unpaid debts incurred by the corporate become liabilities of the estate?