Risk of Personal Liability Despite Incorporation

By Kenneth A Rosen

In the complex landscape of corporate law, the principle of limited personal liability for corporate debts is a foundational concept. However, this shield is not impervious, and in the realm of small-to-midsize and family-owned businesses, blurred lines between individuals and corporations can lead to pitfalls. Understanding the scenarios where personal liability may arise is crucial for owners, directors, and officers to safeguard their assets.

Corporate law establishes a protective barrier between individuals and corporate debts, fostering a conducive environment for risk-taking. However, this shield can be compromised, especially in financially distressed situations. This article delves into key areas where personal liability may surface, such as trust fund taxes, real estate transactions, credit card usage, unconventional loans, and misleading financial statements.

1. Trust Fund Taxes: Governmental entities can hold "control persons" personally liable when trust fund taxes remain unpaid. Vigilance in remitting these obligations promptly is essential for directors, officers, and those with check-signing authority.

2. Director and Officer Liability: Claims against officers and directors, particularly for breach of fiduciary duty, are increasingly common in bankruptcy cases. Diligent oversight and decision-making are crucial to mitigate these risks.

3. Real Estate Transactions: Creditors scrutinize real estate transactions, especially when the lessor has ties to the debtor company. Ensuring the legitimacy of leases and adherence to market terms is vital to prevent challenges.

4. Credit Card Usage: Questionable use of corporate credit cards, such as in luxury settings, may trigger forensic investigations by creditors. Repayment or categorization as taxable income may be sought.

5. Loans in Lieu of Payroll: While giving executives loans instead of paychecks may seem financially prudent, such transactions can be challenged in bankruptcy. Creditors may push to classify these loans as equity contributions.

6. Pay but No Work: Payments to family members who do not contribute substantially to the company may be deemed recoverable as fraudulent conveyances. Transparency in compensation practices is crucial.

7. Free Labor and ERISA: Failure to pay employees as per applicable laws can lead to personal liability for owners. ERISA fiduciaries may also face personal liability for breaches related to the management of ERISA plans.

8. Financial Statements and Credit Fraud: Knowingly falsifying financial statements to secure credit can result in personal liability. Misleading representations about a company's financial condition may expose individuals to legal consequences.

In times of insolvency, creditors seek avenues for recovery, often leading to the pursuit of personal liability. Owners, directors, and officers must proactively take legal measures to shield their assets in such challenging circumstances. Diligence, transparency, and adherence to legal frameworks are imperative for navigating the intricate terrain of corporate governance.