1

Somebody I met claims that some 'shady' business owners out there can create a company with the purpose of paying for an expensive service - then make that company file for bankruptcy to avoid paying for said service (after the service was already completed). This person also claimed that businessmen like Donald Trump did this throughout their careers to avoid paying expensive construction or other development projects.

Does the government in the United States (or Canada) do anything to prevent this gaming of the system? Is there any level of truth to what is being said here?

I feel hesitant to believe it. The upfront cost for creating a corporation is low enough ($2k-$3k) to to see an upside for a big enough service/project, which makes the concept somewhat believable. It would truly amaze me though if something so obvious wasn't already regulated in some way. Then again, why do some people (like Trump) own so many companies.

2

This should be caught by the creditors in the bankruptcy proceeding. In particular, in construction, the "service" tends to create an asset. They would want to know that they are collecting against the asset. If the asset was not present in the bankruptcy, then they would investigate the actual ownership. If they could prove fraud (e.g. the bankrupt company actually operating as an agent of one of its owners in purchasing improvements from which it itself did not benefit), they could then collect from the owners of the asset instead.

It's also possible that they could investigate this prior to offering the service. If the service is never performed, then it's not possible to discharge it via bankruptcy. So no fraud. Or they could demand payment in advance or payment by escrow.

Even just making some human being sign an agreement attesting to the facts would make it easier to collect later.

Consider a potential fraudster. We'll call him Richie McDuck, so as not to make accusations against any actual human being. Richie creates two companies: Richie's Fake Co. and Richie's Real Co. He decides to build a mall and asks a construction company to do the actual labor. The construction company writes up a legal agreement. In that agreement, it asserts that Richie's Fake Co. is the legal owner of the property and the mall. If Richie signs the agreement and it turns out that the real owner is Richie's Real Co., then the construction company can sue Richie for fraud.

A more likely outcome is that Richie would refuse to sign the agreement and respond with a more accurate description. The construction company could then amend the agreement so that instead of billing Richie's Fake Co., they could bill Richie's Real Co. Then they don't care if Richie's Fake Co. declares bankruptcy.

This works because everyone knows that Richie is the real owner of the mall, regardless of what companies are involved. So having Richie sign the agreement guarantees that there is someone who can be pursued for collection of payment in case of misrepresentation.

The upfront cost for creating a corporation is low enough ($2k-$3k)

That seems rather high actually. I would expect something more like $200-$600 in the United States. For example, Legal Zoom charges $149-$369 plus "state filing fees" to register an LLC or corporation. Perhaps you are including other costs beyond the initial creation.

  • typically the approach is that RealCo hires FakeCo to build their mall, then choose not to pay FakeCo, who "is forced to" declare bankruptcy and can't pay the subcontractors. Some contracts will say that if FakeCo doesn't pay then the subs have a lien on assets of RealCo. But a long chain of contracts can obscure that. – Kate Gregory Aug 14 '17 at 16:51
1

I assume by "company" the question is referring to a "corporation", the idea being that the liability of the owners of the corporation is limited to the money that they invested in the corporation. That's known as "limited liability", but the law isn't as stupid as this "somebody" makes it sound. Limited liability is not unlimited. If you deliberately create a corporation that doesn't have enough assets to meet its liabilities and it fails, creditors can "pierce the corporate veil" and go after the shareholders.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.