Company duplication – plain fraud or a ‘poor man's’ bankruptcy? A case study in the financial distress of small businesses
Authors: Rotem Yaad 
Published: February 2011

Two possible solutions to corporate financial distress are traditionally considered: commencing a formal bankruptcy proceeding or arranging an out‐of‐court capital restructuring. Corporate bankruptcy scholarship has largely ignored a third solution occasionally undertaken by small businesses, that is, resorting to self‐help measures. The purpose of this paper is to start filling the gap using a unique case study. The paper describes and analyses an existing phenomenon among small firms in Israel experiencing financial distress – company duplication. A typical scenario unfolds as follows. An entrepreneur who controls the financially distressed Company A registers a new Company B in an attempt to avoid a complete shutdown of her creditors' disturbed business. The assets of Company A are transferred to Company B in what appears to be fraudulent conveyance. Company B serves as a vehicle through which the original business is kept running. If necessary, the entrepreneur will also register Company C and repeat the process. Israeli law regulates company duplication in an ambivalent manner. On the one hand, conventional wisdom considers company duplication to be tantamount to fraud against Company A's unaware creditors. Accordingly, company duplication has been recently denounced by the Israeli Supreme Court as an illegitimate way of conducting business. The Court held that notwithstanding the principle of limited liability, an entrepreneur resorting to company duplication is personally liable to pay any debt of Company A that was not serviced by it. On the other hand, company duplicators do not face criminal charges. To the extent that company duplication is practiced by insolvent entrepreneurs, deterrence is therefore suboptimal, as insolvent duplicators are not sanctioned at all. Against this backdrop, this paper advances two normative arguments. First, a more sympathetic explanation should be considered to account for company duplication. An entrepreneur resorting to company duplication might actually be arranging for a ‘home‐made’ bankruptcy proceeding (i.e. buying time which could help the business establish its viability and regenerate). According to this narrative, the duplication mimics the role of a formal bankruptcy stay on unsecured creditors' collection efforts, thus suggesting that company duplication serves as ‘a poor man's’ bankruptcy proceeding. Second, this new explanation of company duplication, combined with the current level of suboptimal deterrence, mandates a re‐evaluation of this business pattern to assess its relative efficacy. I argue that at least in the Israeli context because of its special features, company duplication should be tolerated with regard to small businesses, assuming that the entrepreneur is not defrauding creditors or attempting to rescue a business that has failed due to economic rather than merely financial factors. To that end, company duplicators should be held personally liable to debts of the duplicated companies and be pursued with criminal sanctions only selectively, as explained in the paper. Copyright © 2011 John Wiley & Sons, Ltd.