How to Avoid Personal Liability for Business Acts

One of the primary reasons to incorporate or form a limited liability company is to protect your personal assets. A recent case, DeWeese v. Pribyla from the Indiana Court of Appeals, discussed the importance of keeping personal and business assets separate. In DeWeese, a remodeling company was sued by a disgruntled customer for alleged deceptive practices. The Court found in favor of the customer, but did not allow the customer to go after the owners’ personal assets. The Court reiterated the limited circumstances when the court will disregard the corporate form, noting:

‘As a general rule, shareholders are not personally liable for the acts of a corporation…’ Reed v. Reid, 980 N.E.2d 277, 301 (Ind. 2012). However:

courts may invoke the equitable doctrine of piercing the corporate veil in order to protect innocent third parties from fraud or injustice. When a corporation is functioning as an alter ego or a mere instrumentality of an individual or another corporation, it may be appropriate to disregard the corporate form and pierce the veil. The propriety of piercing the corporate veil is highly dependent of the equities of the situation, and the inquiry tends to be highly fact-driven. The burden is on the party seeking to pierce the corporate veil to prove that the corporate form was so ignored, controlled or manipulated that it was merely the instrumentality of another and that the misuse of the corporate form would constitute a fraud or promote injustice. Id. (citations, alteration, and quotation marks omitted).

In DeWeese, the owners were not involved in the underlying work and kept the corporate form separate from their personal affairs.  Therefore, the owners were not liable for the $56,000 judgment against the company. In Reed, the case cited in DeWeese, the Court gave examples of the types of behavior that might allow a party to go after company owners personally, including: (1) undercapitalization of the corporation; (2) the absence of corporate records; (3) fraudulent representations by corporation shareholders or directors; (4) use of the corporation to promote fraud, injustice, or illegal activities; (5) payment by the corporation of individual obligations; (6) commingling of assets and affairs; (7) failure to observe required corporate formalities; and (8) other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form. In Reed, the Court allowed the issue to be determined by a jury because officers mixed their personal assets and business assets, certain corporate documents were missing, and the officers had also made a number of undocumented loans to the company and personally paid for company debts.

According to Reed, a corporate officer can be potentially responsible for certain environmental violations by a business under the responsible corporate officer doctrine even if the corporation followed all corporate formalities. To be liable: (1) the individual must be in a position of responsibility which allows the person to influence corporate policies or activities; (2) there must be a nexus between the individual’s position and the violation in question such that the individual could have influenced the corporate actions which constituted the violations; and (3) the individual’s actions or inactions facilitated the violations.  Comm’r, Ind. Dep’t. of Envtl. Mgmt. v. RLG, Inc., 755 N.E.2d 556, 561 (Ind. 2001) (quoting Matter of Dougherty, 482 N.W.2d 485, 490 (Minn. Ct. App. 1992))

Setting up a business is easy, but I have often seen business entities which have never documented any important business activities after the initial setup which can be one factor in building a case of personal liability against business owners. Personal transactions should be carefully separated from business transactions. Any loans to or from the corporation should be documented with a note or other necessary documents.

 

 

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