Risk and the corporate ‘shield’
The entity status has to be tended to and respected for its liability protections to be effective
Tom James has just pulled into his driveway with his 2-year-old and 4-year-old strapped into their car seats. A nondescript Buick sedan. A professional-looking lug of a guy, dressed like Barney Fife, ambles out of the driver’s side and saddles up to Tom, who by that time has gotten out of his car.
The sheriff hands Tom a package, wishes him a good weekend and off he goes. The kids think this is great. Tom is not quite as enthusiastic. He opens up the package and sees that his real estate development company is being sued for a project that went bad.
That does not surprise Tom. What really gets him hot, though, is that in addition to the company, the plaintiff is suing Tom personally. The complaint says something about Tom making misrepresentations and piercing through his company’s veil to get to Tom’s personal assets.
That can’t happen, right? Well, yes and no.
It is true that the corporate form was designed to allow enterprising individuals to take business risks without risking their family’s separate assets. In the absence of the corporate form, entrepreneurs would be much more cautious (and limited) about the projects they invest in, depriving society of the benefit of many of those ventures. The corporate cloak is not, however, impervious. You should have several things in mind in evaluating the protection afforded by the corporate veil (or in considering an effort to pierce through the same).
First, in order to preserve the protection of the corporate form, the company has to observe corporate formalities. This means the company and its owners must maintain separate finances and respect their separate status: separate checkbooks, proper accounting for corporate expenses, documented loans, etc. The company also needs to make sure it retains its good standing with the Secretary of State by filing its annual paperwork and paying the requisite fees.
A company’s articles of organization and bylaws provide the rules by which it must operate. Consult them, abide by them, and if there is a question about how the rules apply, get counsel.
Second, the state confers legal status on corporations because, as noted above, to do so benefits society. There are those among us, however, who see the legal status of corporations as something to be exploited. They, for instance, undertake risky ventures knowing that they have undercapitalized the same – hoping the deal will work out, but counting on creditors to be left holding the bag if the deal tanks.
Others attempt to transfer assets between corporate entities when creditors call in an effort to defeat those creditors’ legitimate claims. The court, however, can pierce the corporate veil and assess individual liability where the owners have used the corporate identity to promote an injustice or fraud.
Third, the corporate form does not necessarily insulate individuals from liability for their separate actionable conduct even when their acts or omissions are in connection with the company’s business. For example, where an employee of a real estate development company misrepresents the status of the land, and another individual reasonably relies upon that statement, the employee may be held personally liable for any damages that result. If the employee had made it clear that any factual representations were those of the company, the result might be different.
If the corporate form is treated with respect and used for proper purpose, it will generally shield the individuals who work under its mantle from being independently liable for corporate acts and omissions.
This protection from liability is not failsafe. The entity status of the corporation has to be tended to and respected for its liability shields to be effective. Hopefully, Tom has followed the rules and has not said or done something to personally incur liability. If he has followed the rules, then he can relax and enjoy the weekend with his family.
Scott Harris, a director in the Litigation Department of McLane, Graf, Raulerson and Middleton, can be reached at 603-628-1459 or firstname.lastname@example.org.