Companies can offer limited liability | Legal issues
Limited liability companies for shareholders were not favored in 18th century England or the early United States. There was much concern about creditors and it was believed that granting limited liability to shareholders of a corporation was somewhat unethical. During the 19th century, experiments with limited liability in some states led companies to move to states that allowed shareholder protection. Over time, public order creditors could protect themselves if they understood that they had to rely on the assets of the company to pay a debt and not on the shareholders. The concomitant belief that allowing limited shareholder liability would stimulate investment and economic growth helped to make the concept of limited or no liability of corporate shareholders for corporate debts and liabilities the norm.
The result of this process is that shareholders in modern corporations are shielded from liability for corporate debts. The company is a separate legal entity from its owners and those dealing with the company must look to the company alone for payment. This same liability protection applies to other limited liability entities such as LLCs. The personal assets of a shareholder or business owner are protected against claims by creditors of the business.
There are exceptions to the liability protection offered by a corporation or other entity. A shareholder is liable if he physically injures someone by his own actions. A shareholder can also be held liable when he personally guarantees a corporate loan or other debt. In addition, the government can hold certain shareholders liable for the corporation’s failure to pay its tax obligations.
Given that states were originally reluctant to insulate business owners from liability for corporate debt, it should come as no surprise that when a business is used to defraud or harm, the protection can be lost. When an aggrieved person tries to get behind the corporate shell and hold a shareholder accountable, the process is known as piercing the corporate veil.
Where an aggrieved person can establish that a company was formed or used to commit fraud or cause injury to others for something other than a breach of contract or normal business, the aggrieved person may be able to break through the corporate veil against a shareholder or even a policeman. But public policy in Florida makes it difficult to override liability protection since liability protection is the primary reason for incorporation in the first place. Those who deal with the Company are expected to understand that the Company is a separate legal entity and is the responsible party for its debts.
Although Florida court decisions confirm that equity will not allow a corporation to be used for improper conduct, the improper conduct must be bad enough to hold shareholders liable for a corporate obligation.
Business Florida has established three criteria for piercing the corporate veil. First, the shareholder must exercise such control and dominance that the company does not really have an independent existence. Control of the company by a single shareholder, on his own, will never be enough, because the reason for incorporation is to protect the shareholder from liability. If the shareholder could be reached so easily, we would be back in the 18th century mentality that creditors should be protected and not limit the liability of a corporation’s shareholders. Second, the shareholder must abuse the corporate shell in an attempt to avoid liability for fraudulent or improper purposes. Third, the improper purpose or use caused harm to the plaintiff.
The control and dominance of the company by a shareholder when used as a basis for piercing the corporate veil is often reformulated as the alter ego test. The alter ego test is the most often contested issue. If the plaintiff cannot establish dominance and control, there is little hope of reaching the shareholder’s pocket.
The way the shareholder manages the affairs of the company is often the downfall of the shareholder trying to avoid liability. When the company’s bank accounts are used as the shareholder’s personal bank accounts, the criterion may be met. How is it done? It can be established if the plaintiff can prove that the company’s accounts pay for the shareholder’s grocery bill, credit card, car payment and meals and that these expenses are unrelated to the company activities. Failure to hold company meetings, have company bylaws, and keep records of company activity are also evidence of alter ego status for the company.
Many plaintiffs believe that if they can simply prove that the corporate shell is a sham, they will win and the shareholder will have to pay a judgment that otherwise could only be against the company. This is not the case, although many Florida trial judges have agreed with the plaintiffs in these cases. The Florida Supreme Court confirmed that something more was needed in the landmark Dania Jai-alai Palace, Inc. v. Sykes.
In the Sykes case, Sykes was a client of Dania Jai-alai pursuing her injuries after being crushed between two cars in the parking lot. She sued the company that operated a valet parking service on the grounds because the injuries were caused by her agent driving a car. She also sued Dania Jai-alai claiming that Dania owned the company operating the valet. Because Dania had complete ownership and control of the company operating the valet parking service, Sykes argued that the company was Dania’s alter ego and that Dania was liable for the damages.
The Florida Supreme Court explained that liability under the alter ego theory is not based solely on this. The corporation must have been used to commit a wrongful act which equity would not allow to go unpunished. In the case of injuries to Sykes caused by the negligent operation of a motor vehicle by a parking valet, no such wrongdoing existed and Dania was not liable.
Breaking through the corporate veil in Florida can be done, but it is very difficult. Poor business practices alone will not be enough to open the door. In most cases, investors who rely on the structure of the limited liability entity to protect themselves from judgments find this trust well placed.
William G. Morris is the Principal of William G. Morris, PA William G. Morris and his firm have been representing clients in Collier County for over 30 years. Her practice includes litigation and divorce, business law, estate planning, associations and real estate. The information in this column is general in nature and does not constitute legal advice.