BUSINESS PRACTICES: LIMITING PERSONAL LIABILITY (PART I)
In the aftermath of scandals and economic crisis (e.g. housing bubble, Enron, Ponzy Schemes), the law has shifted in the direction of weakening corporate liability protection by making it easier to “pierce the corporate veil.” This expression is used when the court allows a plaintiff to reach the personal assets of the company owner(s) rather than limiting exposure to just the company’s assets.
It has long been the case that American courts protect owners and directors from being sued personally for the misconduct of their companies. That protection has been eroded, however, as a result of corporate abuses.
So, as a business owner, what can you do to protect yourself? After all, you do not want to be sued personally when a business investment goes bad, a customer slips in your store, your company breaches a contract, your employee is negligent, etc. The place to start is understanding the factors the court considers when determining whether to pierce the corporate veil and make the owner personally liable for damages.
Limited Liability: Relevant Factors
In business litigation, Florida courts focus on three key factors in deciding whether or not to shield owners from personal liability:5
- Was the company controlled by its owner(s) in such a way that it was merely an “alter ego” used for the owner’s benefit,6
- Some sort of improper conduct in either the formation or the use of the corporate form,7 and
- The improper conduct imposed an injury on the claimant.
- Most courts tend to focus the analysis on the second element: “A critical issue in determination of whether the corporate veil will be pierced for imposition of personal liability is whether corporate entity was organized or operated for an improper or fraudulent purpose.”8
- The central issue then becomes identification of the degree and types of misconduct that results in personal exposure. Example of what the court might look for include the following:
- use of company to evade existing obligations (i.e. defraud creditors),9
- a perpetual monopoly, or
- use of company to protect against criminal liability
While understanding the legal standard provides some guidance, the courts have purposefully made the standard broad and somewhat vague. After all, judges have learned from recent events that business owners and directors can be very creative when it comes to filling their pockets while at the same time covering their hides.
There are few things that offend the public more than seeing a rip-off end with the responsible person sipping drinks on his yacht instead of facing punishment. Judges and legislators want to avoid that embarrassment.
For that reason, there is some “wiggle room” in the law that allows judges to use their discretion when faced with the scenario.
Limited Liability: Guidelines
Notwithstanding the current political climate, owners can take certain precautions with their business practices to minimize exposure. The upcoming parts in this series will delve more deeply into techniques for limiting liability, but here are a few general guidelines for starters.
Owners can limit the risk of personal liability by making good-faith attempts to pay the company’s creditors. This is not to say owners must necessarily pay company bills from their own pockets in order to avoid being held responsible for company debts. Rather, the emphasis is on “good faith.” If there is no perception of misconduct, then the company’s inability to pay its creditor’s should not obviate the liability protection.
Also, be advised that, given today’s political and legal climate, any criminal conduct will likely expose owners to personal liability. Courts are alert to owners filling their personal pockets through unscrupulous means while allowing the company to bear the repercussions.
Commingling Personal and Corporate Finances: “Alter Ego”
The final guideline is for small business owners who are perhaps less careful about separating personal assets and liabilities from those of the business than they could be. For example, it is common for some owners to pay personal expenses with the company credit card or utilize company equipment for personal business, etc., especially when there is just one owner or the owners are a couple. While common, this kind of disregard for the corporate entity can lead to exposure. This is a key issue, so let’s a moment to understand the rationale behind it.
The court’s concern is that commingling resources may leave the company undercapitalized, so the company may not be an autonomous entity capable of assuming its own liabilities. For example, the company might be unable to pay its debts because the owner improperly spends company funds for personal use. In that scenario, it might be unfair to leave a plaintiff whose suit is against the company without any means of recovery.
One way to alleviate this concern is for the company to maintain adequate insurance, but perhaps the easiest and most cost-effective thing to do is to respect the company’s autonomy and keep personal and business finances separate.
Of course, this short article is meant only to be a broad overview of the topic. There are other factors to consider and a myriad of strategies that can be employed to limit an owner’s personal exposure, which will be the focus of upcoming parts to this series.
If any of the points in this article strike a chord, consider meeting with a business attorney to discuss your particular situation. Despite the cautionary tales described in this article, when it comes down to it, the burden is on the plaintiff to convince the judge to deviate from the status quo and impose personal liability on the owner/director. With an experienced business litigator at your side, your chances of avoiding liability are still pretty good.
1 The same protection entails under certain other business forms as well, (i.e. limited liability company).
2 Also known as “disregarding the corporate fiction.”
3 The term “owner,” as used here, encompasses shareholders, directors, and other controlling parties, as the case may be.
4 Under the same principle, plaintiffs can reach assets of other companies belonging to the owner.
5 8 Fla. Jur 2d Business Relationships §13 (2006); Mullin v. Dzikowski, 257 BR 356 (SD Fla. 2000); Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114 (Fla. 1984); Seminole Boatyard, inc. v. Christoph, 715 So. 2d 987 (1998).
6 For example, where the owner commingles his money with the corporation’s money, or the owner uses corporate property for private purposes. Basically, any evidence that the owner does not respect the corporation as a separate entity could be used to meet the “alter ego” element.
7 Dania Jai-Alai Palace, 450 So. 2d 1114; Hilton Oil Transp. v. Oil Transp. Co., S.A., 659 So. 2d 1141, 1151 (Fla. 3d DCA 1995); Ally v. Naim, 581 So. 2d 961, 962 (Fla. 3d DCA 1991).
8 Kanov v. Bitz, 660 So. 2d 1165 (3d DCA 1995).
9 Undercapitalization of the business and/or failing to maintain liability insurance to cover damages resulting from the company’s negligence or intentional wrongdoing are traditionally looked at to determine these first two elements.