Why We Can’t Collect From A Defunct Company
The chances of collecting on an invoice due from a company that has ceased operating are very slim. If the business was organized as a corporation or LLC (limited liability company) then only the business entity itself is liable for outstanding invoices. If there are no assets remaining in the entity then the entity has no way to generate cash to pay creditors. We call these entities “defunct.”
It frequently requires significant effort to prove a company is defunct. Websites can be active for a year or more after a company ceases businesses, as the website hosting company may not be aggressive in shutting down delinquent customers. The company’s phone may be working with voice mail for many months after operations cease. Owners keep the phone service so they can get messages they want but ignore ones that don’t benefit them, such as collection calls and customer service requests. So just because the phone and website are still working does not mean the company is still operating.
At our collection agency, we’ll do extensive research and field work to try to prove a company is defunct before we give up on a claim. We look for alternative phone numbers, addresses, and web addresses for the business and its owners. We call neighboring businesses and ask if they know if the target business is still open. Usually they confirm our worst fears that it is closed, but occasionally we learn the business is still open. Then it is clear the phone is not answered and messages are not returned when the topic is a past due amount. At that point we know we need to take an alternative approach in the debt collection process.
If the company’s phone is no longer in service, that usually is a very bad sign. It is almost impossible to keep a business going if customers cannot reach a company. If we confirm a company is closed it is usually cost prohibitive to confirm that there are no assets remaining. Business owners are not obligated to provide financial information and rarely even respond to creditors after closing their company – they are focused on finding a new source of income. The only way to force the owner to provide the information is to file a lawsuit, get a judgment, and conduct a debtor exam. Given the cost of the legal process and the low likelihood of recovery, the return on investment potential is not high and our clients rarely can justify this investment.
A company that goes out of business is not obligated to file bankruptcy. It typically costs about $3,000 to hire an attorney to file bankruptcy. Most small business owners rightfully choose to not spend money just to officially bankrupt a company as they don’t get any value for this expenditure. In most cases we see, bankruptcy is only filed if the owner is also filing for personal bankruptcy protection or to deal with personal liability related to tax penalties and interest.
For our collection agency, well over half the claims we close without collecting are invoices due from defunct companies. In 95% of these cases, the invoices were very old before they were turned over to us. Had third-party debt collection started sooner there would been a much better chance of
getting some recovery.
As explained in prior articles on personal liability and piercing the corporate veil, there is a chance of collecting when the company is defunct if an individual is legally liable. However, in most cases where the business was the owner’s primary source of income, their personal financial condition is probably very poor. We often find it can take a couple years before they bounce back financially and we can then collect on their personal obligation. Thus, getting a personal guaranty can have value. But, the best way to avoid not getting paid by a defunct company is to escalate the collection process sooner and get to them before they go out of business.
About The Author:
Dean Kaplan is Principal at The Kaplan Group. Dean's expertise is widely recognized in the debt collection industry. His advice has been published in a number of industry newsletters such as Credit Today and InsideARM and he is a frequent speaker at industry events.