What happens when a company owes you money but does not have enough assets to pay you? How can you enforce collection of the debt when the company is insolvent? For example, a buyer sends money to a company and receives damaged goods in return, or the buyer receives nothing at all. Or, a creditor might have loaned money to a company that is in default on repayment. If the debtor company has no assets in the company name, such as real estate or bank accounts, or if the company is out of business, suing the company and getting a judgment against them wont result in repayment of the debt. Maybe the owners of those companies, though, do have enough assets to repay the debt.
The general rule is that the individual owners of a company, which is formed as a corporation or LLC, are not responsible to repay their company’s debts as a result of a breach of contract by the company (note this is not the case if the company is a d/b/a). A corporation or an LLC is said to be a “liability shield” for its individual owners. The individual owner of a company might, though, have sufficient assets in their own name to pay off the debt, and despite the liability shield of a corporation or LLC, that shield very often doesn’t apply. A plaintiff should make demand upon the individual owner and should add them to their complaint in a resulting lawsuit, if there is a legal basis to do so.
The actor is always liable: The liability shield was designed to protect passive investors of companies and to encourage investment. Individuals are responsible, however, for torts that they personally participated in. One case stating this is Instant Image Print Shop, Inc. v. Lavigne, Keating, Halstead, Inc. 1998 Mass.App.Div. 74 (1998). A tort is harm that one individual or company causes to another which forms the basis of a private lawsuit to the party harmed. Examples include, some of which are further discussed below, fraud, negligence, breach of fiduciary duty, and assault. To give an easy example of when an individual would be liable for a company’s debt, suppose a delivery man is driving drunk to make a delivery for his employer, which is a corporation, and causes bodily injury and property damage to another driver. It would not make sense in these circumstances if the driver could not be held individually responsible for the damage. Here, a law suit against the driver or company or both, for negligence and likely other torts, would be warranted. The liability shield in this situation would only exist for passive investors or other owners of the company who were not directly involved in the accident.
Below is a list of other common reasons why an individual owner or some other party could become liable for the debts of a corporation or LLC:
Fraud: It’s one thing for a company to borrow money, honestly intending to make repayment, and then fall into hard times a few years down the road and start to miss monthly payments to the creditor. It’s another thing if the owner of the company borrows money that they never intended to repay. In this case, the individual owner who goes into makes the promise to repay the loan, knowing that they will never repay it, will be personally responsible to make repayment if sued by the bank or other creditor. The fact that not even one monthly payment was made towards the loan is circumstantial evidence that there was never an intent to make repayment. Similarly, if the owner misrepresented their company’s assets or the company’s level of experience to make the creditor feel secure in giving the loan, this would also be the basis for a fraud claim by the creditor against the individual. The owner might say, for example, that their company has $1,000,000.00 in accounts receivable when in reality the company is not generating any income. The creditor, as a result, might be deceived into believing that the company wont have trouble repaying the loan. As a side note, creditors and other parties making loans or other contracts with companies will very often have the owner/s sign a personal guarantee for repayment. This way, if the loan goes into default, there is no need to show that some tort was committed in order to seek repayment from the individual.
Negligence: This is when someone causes an unreasonable risk of harm to others, and someone is damaged as a result. Common examples include contractors who cause damage to homes by failing to follow industry standards, and traffic accident situations.
Conversion: This is stealing. If the owner of a company steals money or other property then the victim can bring a claim for conversion (this is usually accompanied by a claim for fraud) against the individual/s who perpetrated it. An example might be someone giving their jewelry to a shop that sells it for them on consignment or charges the customer a fee to showcase the jewelry. If the owner of the jewelry shop steals a client’s jewelry, they of course can’t assert the corporation’s liability shield as a defense in a law suit brought by the client.
Mere continuation or successor liability: Often companies will regularly change their name. If John Smith Plumbing, Inc. becomes John’s Plumbing, Inc., or even some totally different name, and everything else about the two companies except the name are the same (e.g. same owners, same type of work, etc.), then the successor company can be held liable for the debts it incurred under the previous company name. If the name change was done for the purpose of avoiding a debt, then the company can be sued under the new name. A claim for mere continuation or successor liability is a type of fraudulent transfer claim because what the first company really did was transfer its assets (such as customers, good will, etc.) to the second company.
Piercing the corporate veil: The term for this often used in case law is “Corporate Disregard”. This is a claim often raised in complaint to try and hold an individual liable for a company’s debts. Prevailing on this claim requires a court to consider a list of factors to determine if an individual should be held liable for the corporation’s debt. The factors are discussed in the case Attorney General v. MCK, INC., 432 Mass. 546 (2000). While it can be a good claim to bring, usually the torts described above are more clear ways to establish liability against an individual.
In sum, there are many common ways that an individual can be held liable for the debts of their corporation, and it should not be assumed that when someone is acting on behalf of a corporation that none of their actions can lead to individual liability. Often, and individual owner should be named in the complaint either as a sole defendant or as a co-defendant with the corporation.
DISCLAIMER- This article was meant solely to give a general idea about the area of law discussed, and should not be exclusively relied on in making decisions in making decisions. Every situation is different, and this article is not a substitute for personalized legal advice.