It’s the Law: Corporate shell does not always avoid personal liability

Q: I bought some furniture from a local store. The store delivered the items but some of them were damaged. The store took the items back and promised to replace them but then went out of business. I talked to the owner, but he told me the business was a corporation and it simply could not pay its bills. He said the corporation protected him from personal liability. Is that true?

A: The primary purpose for conducting business as a corporation is to obtain limited liability. Once formed, the corporation is a separate entity from the shareholder owners of the corporation. The corporation is responsible for corporate contracts just as an individual is responsible for his or her contractual obligations.

Under Florida law, a corporation must include the word “Corporation,” “Company”, “Incorporated” or the abbreviation “Corp.,” “Co.,” or “Inc.” to clearly indicate it is a corporation instead of a natural person, partnership or other business entity. This allows people dealing with the corporation to understand they are dealing with a limited liability entity.

The corporation evolved as a limited liability entity to encourage commerce and investment in business. By allowing investors to limit their losses the purchase price of stock, businesses are able to obtain funds needed to start or expand operations without fear of unknown liability. The most a shareholder can lose is the amount of his or her investment.

However, the shareholders cannot use limited liability as protection for wrongful acts. Under limited circumstances, Florida courts have disregarded the corporate form. This is generally referred to as “piercing the corporate veil.” When a court pierces the veil, persons who dominate the corporation and the corporation are treated as one person and liability of the corporation passes through to the dominating persons.

Florida courts do not pierce the corporate veil easily. Because limited liability is an essential part of corporate operations, the courts generally acquire proof of the following:

1. The corporation was controlled by one or more shareholders in a manner that it acted as merely an alter ego for the shareholder’s personal benefit.

2. Wrongful conduct in either formation or operation of the corporation and the wrongful conduct harms a person or entity seeking to recover damages.

In some states, the corporate veil can be pierced where the owners fail to maintain corporate formalities. That means the owners do not keep the corporation’s finances separate from their own, fail to have meetings and otherwise fail to operate the corporation as a separate entity.

That is not enough in Florida. In 1984, the Florida Supreme Court clarified Florida law by holding the corporate veil cannot be pierced unless there is a showing that the corporation was used to commit an illegal, fraudulent or other wrongful act. Corporate officers or shareholders will not be held responsible for acts of the corporation unless it can be shown that they directly participated in the wrongful action.

It is not wrongful conduct for a corporation to pay its sole shareholder and principal employee in the ordinary course of business. That means the corporation can continue paying reasonable salary and benefits, even if the corporation cannot pay its other bills.

Poor business judgment is also not sufficient to pierce the corporate veil. In fact, possibility that a business will fail is a major reason for the creation of a limited liability entity and to allow disregard of the entity because of unanticipated business problems would be directly opposite the goal of encouraging commerce through limiting liability.

Improper conduct sufficient to pierce the corporate veil includes use of a sham corporation to accomplish fraud or an illegal act.

You state the corporation went out of business because it was unable to pay its bills. If you can show nothing more, it is unlikely a court will allow you to pierce the veil. If you can show that the corporation’s principal wrongfully withdrew funds or used the corporation to perpetrate a fraud or sham, you might have luck.

You should discuss the specifics of your case with a qualified attorney. During that discussion, the attorney will further educate you with respect to possible claims and anticipated expenses of pursuit. You can then make an informed decision as to your next step.

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William G. Morris is a lawyer with offices at 247 N. Collier Blvd., Marco Island. The column is not intended to be legal advice for specific circumstances. General questions can be sent by e-mail to wgmorrislaw@earthlink.net or by fax to (239) 642-0722. Read other columns at http://www.wgmorris.com.

© 2007 marconews.com. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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