Protecting Consideration Received From Partner For Sale of Common Stock In Small Business

A man told me he is liable on several business loans and lines of credit. He is afraid that the bank may either call the loans or demand substantial principal reductions which he cannot afford to pay in today’s economy. He personally guaranteed all the business loans. The man owns 50% of the common stock in a profitable corporation. The corporation pays him a small salary and profit distributions. If a bank sues on any of his bank loans and gets a judgment against him the bank could then levy on the stock in his corporation. The non-debtor partner would be in business with the debtor's creditors. The man suggested selling his stock to his partner in consideration for a small cash down payment and a promissory note in order to get the stock out of his name. He intends to invest the cash in his homestead. His plan will not work as intended because the judgment creditor could garnish the note payable by the partner and demand payments from the partner.

A better solution would be to sell his stock to his business partner with different terms. First, he and partner should have the stock appraised by a business valuation expert. He can sell his stock to an "insider" provided he document the sale was made at reasonably equivalent value (not the same as fair market value). One option would be for the partner to form a new LLC and fund the LLC with the partner’s own money. The partner’s LLC would then contract with the debtor to buy his stock. Instead of paying with a promissory note the purchaser might give the debtor cash and membership interests in the new LLC, or some form of option to buy the LLC interests. LLC shares are better protected than common stock shares. Or, the LLC could provide consideration by hiring the debtor after the sale with a consulting or employment agreement for continued work on the company’s behalf. Salary paid by the LLC to the debtor would be exempt from the seller’s creditors if he is head of household (in this case, he supports his wife). The partner has a legitimate interest in purchasing the stock at below fair market value and structure the sale so that the non-debtor partner is not entangled in the debtor’s litigation. The debtor’s use of all cash received to reduce his homestead mortgage should be protected.

posted by Jonathan Alper, asset protection and bankruptcy attorney, Orlando, Florida