- posted: Apr. 21, 2016
You did everything right. You negotiated a good deal. You reduced it to a written agreement so both sides knew their obligations. You held up your end of the bargain and delivered the goods and services you promised on time. But now you’re not getting paid. You call them but get no answer. Your emails bounce back. You drive by their office and you find they’ve gone out of business. Finally, you catch up with one of the principals who cavalierly tells you: “Your contract was with the corporation, not with me.” You drive home wondering how you’re going to pay for your labor and material costs. Don’t give up hope yet.
People create corporations for a variety of reasons. One of those reasons is to permit the owners to limit their liability to the amount of their investment. A corporation is a separate “person” in the eyes of the law. Typically, a shareholder of a corporation or member of a limited liability company is not held liable for the debts of the company. Typically . . . but not always.
A court may permit a creditor to enforce a debt against the shareholders of a corporation in certain circumstances. Courts call this “piercing the veil” of the corporation. This is an equitable remedy that invokes the Court’s powers to do justice to the parties. While each state has its own tests, the principles applied are similar. The Court will look at the facts to determine whether the owners so dominate the corporation as to deem it their “alter ego.” In such instances, courts rule that the domination by the shareholders has destroyed the separate character of the corporation, i.e., that the company was a “mere instrumentality” of the shareholders. In addition, the Court will require evidence that allowing the corporate liability shield to stand would be to promote fraud or injustice.
In considering whether to bring a claim against the owners, you should weigh the evidence you think you can be put before the Court. Successful veil-piercers can point to various actions that show the line between the owners and the corporation has blurred or disappeared, including:
- The owners did not “capitalize” the corporation by investing enough money to sustain its operations;
- The corporation failed to issue stock;
- The corporation failed to observe “corporate formalities,” e.g., having meetings, taking minutes, etc.;
- The corporation failed to pay dividends;
- The corporation is insolvent;
- The officers or directors of the corporation did not perform the duties associated with their office;
- The corporation failed to maintain the kinds of records required by law or those that are customarily kept by a company in that industry;
- The funds of the corporation were “commingled” or kept in the same accounts as the private funds of the owners;
- The owners diverted assets of the corporation to an owner or third party for less than fair market value, often for little or no consideration;
- The corporation engaged in transactions at less than arm’s length with shareholders or third parties;
- Shareholders made personal guarantees of corporate debts;
- The corporation was created merely to mask the unlawful activities of the owners;
- The corporation is just a “dummy” corporation for a corporate parent who pays its employees and expenses;
- The corporation does business predominantly with its corporate parent (or grandparent); and
- The parent company uses the corporation’s property as its own.
As the debtor company circles the drain, the pressure on the owners may induce them to engage in some of these activities. The mere fact that the company has collapsed and cannot pay your bill does not mean the Court will pierce the veil. If you can demonstrate that justice requires the debt be passed to the shareholders, however, you can pursue your claim against them. The owners, of course, would be allowed to assert any defenses that the company would have been entitled to raise.
If you would like more information about these issues, please contact Scott Thomas. Scott has helped firm clients pursue veil-piercing claims to recover what they are owed. He welcomes the opportunity to help you collect what you are entitled to. Scott’s direct line is 859.578.3862. You can email him at [email protected]. If there is a particular topic you would like to see addressed in a blog, please send Scott an email with your ideas.