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The Limits of Limited Liability Beyond Piercing the Corporate (or LLC) Veil


Stuart Pachman By conducting business as a corporation or a limited liability company, entrepreneurs and investors erect a metaphorical wall protecting their personal fortunes from liability from the torts and contracts of the enterprise. This protection does not necessarily extend to the persons through whom the entities act, the directors, officers, and employees of corporations, and the managers, managing members, and employees of LLCs, all of whom are referred to hereafter collectively as corporate agents.

The concept of limited liability originally enabled large amounts of capital to be aggregated by corporations from numerous individuals for major projects such as railroads and canals. The individual investor, whose relationship to the enterprise consisted only of making an investment and having the right to elect the corporation’s directors, was able to limit his or her risk to what had been paid to purchase shares. Members of LLCs, a form of doing business that developed in the United States about 30 years ago, enjoy virtually the same limited liability as shareholders in corporations.

Being able to limit one’s liability when going into business encourages the creation of new enterprises, small as well as large, and the jobs, commerce, and benefits to the economy that follow. Today, many corporations and LLCs are in reality sole proprietorships or small partnerships made up of one or a few individuals. By filing a certificate of incorporation or certificate of formation in the state capitol, those individuals as shareholders or members obtain the benefit of limited liability. To protect against the abuse of the privilege, the common law developed the concept of piercing the corporate (or LLC) veil. Thus when owners fail to respect the rights and duties of the separate personification of their inanimate creation, the court may demolish the protective wall of limited liability and permit the aggrieved plaintiff to reach the owners’ personal fortunes.

The rules change, however, when a plaintiff seeks to impose personal liability not against an owner, but on a corporate agent through whom the corporation or the LLC conducts its business. The corporate agent’s potential personal liability is distinct and separate from the liability of shareholders or members. The piercing doctrine does not necessarily apply.1

In Milgram v. Comfort Direct Inc.,2, the court said:

A judge is not required to pierce the corporate veil in order to enter judgment against a corporate officer where, as here, that officer personally engages in unlawful activity under [the Consumer Fraud Act].

Consequently, even when shareholders or members have acted in accord with good corporate practice, have adequately capitalized the enterprise, have respected its separate existence, have not used it as a personal pocketbook, have dotted every ‘i’ and crossed every ‘t’ of statutory requirements and formalities— in short, when there is no legal basis to pierce the corporate (or LLC) veil—the shield of limited liability may nonetheless be denied to the human agents through whom the corporation and the LLC act.

STATUTORY LIABILITY

Various federal and state statutes expressly deny limited liability to particular corporate agents for particular acts or omissions made in connection with the enterprise. Perhaps the best known is Section 6672 of the United States Internal Revenue Code,3 which imposes personal liability on the “responsible person” who has willfully failed to pay over taxes withheld from an employee’s wages. Similar provisions are found in the New Jersey Income Tax Act,4 and the New Jersey Sales Tax Act.5 New Jersey’s Consumer Fraud Act is applicable both to the enterprise, and, where liability is established, to the corporate agent who personally participates in the violation of the statute.6

Courts have rigorously imposed personal liability in cases involving securities laws, such as when corporate officers intentionally inflate stock prices, misrepresent revenues, or backdate stock options.7

Other statutes imposing personal liability on corporate agents abound.8

These statutes are not to be treated cavalierly. The New Jersey Appellate Division upheld a defaultjudgment taken under a Virginia statute imposing personal liability on officers of a New Jersey corporation doing business in Virginia without a certificate of authority.9

INTENTIONAL PHYSICAL TORTS

A corporate agent enjoys no limited liability for his or her intentional physical torts. Thus, if a corporate agent assaults the obstreperous person on the other side of the bargaining table while attempting to negotiate a business transaction, he or she is personally responsible for the physical attack notwithstanding the fact that the blow was struck during a heated discussion of price and terms. Where a corporate agent sexually molests or harasses another employee, although the entity may also be liable for failure to take appropriate preventative action or failure to adopt an appropriate policy, the actor is responsible for his or her own act.

INTENTIONAL NON-PHYSICAL TORTS

The corporate agent who commits fraud will not be shielded because he or she utilized the instrumentality of a corporation.10 It does not matter that the corporate agent was acting to benefit the corporation rather than to benefit himself or herself personally.11 The rule of law is stated in Hirsch v. Philly:12

...the officers of a corporation are personally liable to one whose money or property has been misappropriated or converted by them to the uses of the corporation, although they derived no personal benefit therefrom and acted merely as agents of the corporation. The underlying reason for this rule is that an officer should not be permitted to escape the consequences of his individual wrongdoing by saying that he acted on behalf of a corporation in which he was interested. ...13

In short, intentional acts, whether a punch, a pinch, or a prevarication, can result in a corporate agent’s personal liability.

NEGLIGENCE

Direct Involvement—Action
Whether it is the corporate president driving a corporate car to a business meeting, or a corporate employee driving a corporation’s truck to make a delivery, if either collides with another vehicle, the corporation may be responsible on the concept of respondeat superior, but the driver is also liable for his or her own negligence. Thus, when the president/general manager mistakenly pulled the brake rope causing injury to an employee, he was held personally liable.14

OMISSIONS Personal liability may follow from omissions as well as acts. Liability was imposed on a director for failing to prevent other directors from taking trust funds from the corporation.15 Intentional and complete failure of a board of directors to implement reporting requirements or controls, or intentional refusal to monitor an established system or to respond to warning signals, although a difficult case to make out, can result in personal liability.16 A new director was held liable for breaching Indiana’s securities laws, not because he affirmatively inflated stock prices or misrepresented revenues, but because he failed to make inquiries and received no explicit assurances by management or counsel that the transaction he approved conformed with applicable laws.17

INDIRECT INVOLVEMENT

A corporation’s directors or officers generally do not incur personal liability for a corporation’s torts merely because of their official position, but if the director or officer commits the tort, or directs the tortious act to be done, or participates or cooperates in the tort, he or she is personally liable to third persons injured even though liability may also attach to the corporation.18 When the corporate president pulled the rope, there was a direct connection between him and the plaintiff, but there are times when such a direct line to the corporate agent does not exist. To deal with those cases, courts have developed the ‘participation’ theory. A corporate agent incurs the risk of personal liability when he or she personally participates in the wrong not only directly but also indirectly.

Participation runs a spectrum from the proximate to the remote. The corporate agent was personally liable when he was in charge of the structure which collapsed and caused injury.19 By contrast, where there was no evidence that the corporate president “gave any particular direction” or “in any way supervised, participated, or cooperated in” the acts leading to the physical injury, he was not held liable because the plaintiff failed to show that the president knew or should have known of the danger and failed to warn the victim.20

To justify the imposition of personal liability, the court must decide whether the corporate agent was in a “sufficiently direct or close” relationship with the industrial operation “that it may be fairly said that [he or she] did participate or cooperate” in the activity that resulted in the plaintiff’s injury.21 Compare Wicks v. Milzoco Builders, Inc.,22 where a claim against the corporation officers was permitted to proceed because the homeownerplaintiffs alleged that the officers had ordered the housing development to be built at a site knowing that its location created an unreasonable risk of a drainage problem, with Strawn v. Canuso,23 where, although the corporation failed in its duty to disclose the existence of a landfill, corporate officers were not held personally liable because of lack of evidence implicating them. Had there been a showing that the defendant officers knew of the existence of the landfill and had affirmatively directed employees not to disclose that fact to the buyer, the personal claim against those officers might have succeeded.24

CONTRACTS

The corporate agent who wrongfully induces a vendor to sell goods to his or her insolvent corporation is personally liable to that vendor.25 The more difficult case is where the corporation’s contract is negligently performed by the corporation’s employees.

In Saltiel v. GSI Consultants, Inc.,26 turf grass specifications to reconstruct an athletic field were allegedly negligently prepared by a corporation resulting in improper drainage that required reconstruction of the field at substantial cost. The plaintiff sought to hold personally liable the corporation’s employees who prepared the specifications. The Appellate Division held that the individuals who were proximately involved in preparing the specifications were liable on the participation theory. The Supreme Court, attempting to harmonize the various, sometimes conflicting precedents, reversed, refusing to extend the participation theory, where physical injury results from a tort, to a contract case involving only economic damages. The individual employees in Saltiel, even if they were negligent, were protected by the corporate shield because the plaintiff’s only damage was that it did not get the benefit of its bargain, its contractual expectancy. If the allegedly defective design had caused physical injury the result might have been different.

The distinction between economic loss and physical injury was also made on the common law claim asserted in New Mea Const. Corp. v. Harper.27 There, when a new house was not built to the owner’s satisfaction, the homeowner sued both the building corporation and its principal for negligence and careless workmanship. The court declined to find the principal personally liable on common law principles because the damage was of a nature more normally associated with a contract action. Significantly, however, the trial court on remand was directed to determine if the corporation’s principal met the test for liability under the Consumer Fraud Act because inferior material had been substituted for that prescribed by the contract.

One may speculate whether the result in New Mea on the common law issue would have been different if the proofs had shown that the individual principal had said to the homeowner: “Don’t worry, I know what I am doing and I will build the house right.” Would that have been deemed just a sales pitch or a tortious inducement to the plaintiff to contract with the corporation? Should a representation of that nature be treated as a personal guaranty for which the individual should be personally liable?

In Saltiel, the Court noted that there was no showing the plaintiff had an expectation the individual defendants would be personally liable under the contract; the Court repeatedly referred to the need for the plaintiff to “establish an independent duty of care” on the part of the corporate agents, citing a Connecticut decision where the corporate officer had held himself out to be a skilled builder.

In New Mea, the court lamented the fact that the “boundary line between tort and contract actions is not capable of clear demarcation.” This is often the case with professional services. At one time, ‘professionals’ could not practice in the form of limited liability entities. The concept of an inanimate entity with limited liability interposed between physician and patient or between lawyer and client, for example, was seen as an anathema. Because of the tax advantages available to corporations at the time, the Professional Service Corporation Act,28 was adopted in 1962. It was revised in 1969 into its present form, and some professions are now also authorized to use the LLC form. One of the core distinctions between business corporations and professional corporations is that the individual professional always remains personally liable for malpractice in the rendering of his or her services.29

The point at which a corporate agent may be held personally liable on a corporation’s (or LLC’s) service contracts, where no physical injury is involved, is not altogether clear. Courts have ruled that a real estate appraiser for a corporation in one case,30 and an employee managing an investment account for a bank in another,31 were subject to personal liability. Cases such as these may be thought of as involving services that approach, but are not necessarily encompassed within, the personal liability for malpractice imposed under the Professional Service Corporation Act.

Although the boundary between tort and contract claims remains elusive,32 what is clear is that the cloak of limited liability does not always stretch to cover individuals acting on behalf of corporations and LLCs. The corporate agent is exposed to personal risk, and must act with due care.

ENDNOTES
  1. Donsco, Inc. v. Casper Corp., 587 F.2d 602, 606 (3rd Cir. 1978). Regarding LLCs, the Supreme Court of Connecticut, in Weber v. U.S. Sterling Securities, Inc., 924 A.2d 816 (Conn. 2007), held that the limited liability afforded to the members of a Delaware limited liability company does not protect them from personal liability based on their individual conduct.
  2. Docket No. A-0360-07T2 (App. Div. 2008).
  3. 26 U.S.C. § 6672.
  4. N.J.S. 54A:9-6(q).
  5. N.J.S. 54:328-2(w).
  6. N.J.S. 56:8-1(d). See Milgram v. Comfort Direct, Inc., supra, and Lanza v. Secret Gardens Landscaping, Inc. unpublished, Docket No. A-2613-07T22613- 07T2 (App. Div. 2008). (Corporation president who prepared the contract that violated the statute and inspected the work as it was being performed was also liable). Lanza relied in part 15 New Jersey State Bar Association Business Law Section on New Mea Const. Corp. v. Harper, 203 N.J. Super. 486, 502- 503 (App. Div. 1985).
  7. Darquea v. Jarden Corp., Fed. Sec. L. Rptr. ¶ 94, 345 (S.D.N.Y. 2007); SEC v. Todd, Fed. Sec. L. Rptr. ¶ 94, 343 (S.D. Cal. 2007); In re Zoran Corp., Fed. Sec. L. Rptr. ¶ 94, 338 (N.D. Cal. 2007). The 10th Circuit extended personal liability to a non-employee consultant who drafted periodic reports for the corporation that contained material misstatements and omissions. SEC v. Wolfson, 539 F.3d 1249 (10th Cir. 2008). Corporate officers may incur personal liability under provisions of the Sarbanes- Oxley Act of 2002, and see SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008), imposing personal liability on an underwriter’s executives, and SEC v. Delphi Corp., Fed. Sec. L. Rep. ¶ 94, 877 (E.D. Mich. 2008), imposing liability on senior officers.
  8. See, for example, the workers’ compensation law at N.J.S. 34:15-79, the Federal Age Discrimination Employment Act. See also the interpretation of N.J.S. 34:11-4a, given in Mulford v. Computer Leasing, Inc., 334 N.J. Super. 385, 398-399 (Law Div. 1999), as to New Jersey corporate officers’ liability for wages, and Reliance v. The Lott Group, 370 N.J. Super. 563 (App. Div. 2004); certif. den. 182 N.J. 149 (2004), imposing liability on a consultant for violation of the Construction Trust Fund Act. For other examples of statutes where Congress and state legislatures have expressly (or impliedly) limited liability, see Pachman, Title 14A Corporations (Gann Law Books 2009 Ed.), Chapter 6, comment 18a.
  9. Root Jewelers v. JDR Contracting, 233 N.J. Super. 125 (App. Div. 1989).
  10. Commercial Ins. Co. of Newark v. Apgar, 111 N.J. Super. 108, 123 (Law Div. 1970).
  11. In Donsco, Inc., Note 1, supra, the corporation was held liable for acts of unfair competition. The corporate agent who had authorized and approved the false advertising was also personally liable.
  12. 4 N.J. 408, 416 (1950).
  13. The rule was more recently reaffirmed in Metuchen Sav. Bank v. Pierini, 377 N.J. Super. 154, 161-162 (App. Div. 2005).
  14. Duffy v. Bates, 91 N.J.L. 243 (E & A 1918).
  15. Francis v. United Jersey Bank, 87 N.J. 15 (1981).
  16. In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). See Stone v. Ritter, 911 A.2d 362 (Del. 2006), discussing a “Caremark claim.” See also In re World Health Alternatives, Inc., 385 B.R. 576 (Bankr. D. Del. 2008), involving allegations as to the oversight duties of corporate officers.
  17. Lean v. Reed, 876 N.E.2d 1104 (Ind. 2007).
  18. Chas. Bloom & Co. v. Echo Jewelers, 279 N.J. Super. 372, 381-382 (App. Div. 1995).
  19. Tompkins v. Burlington Island, etc., Co., 102 N.J.L. 411 (E & A 1926).
  20. Sensale v. Applikon Dyeing & Printing Corp., 12 N.J. Super. 171 (App. Div. 1951).
  21. Evans v. Rohrbach, 35 N.J. Super. 260, 264 (App. Div. 1955), certif. denied 19 N.J. 362 (1955). In that case the plaintiff sued 21 corporate directors, officers, and employees. None were found to have had the “remotest connection” with the plant operation that resulted in the injury, and thus none could be charged with having “ought to have known of the danger.” One may speculate, however, whether the safety engineer, who had not been named a defendant, might have been held personally liable.
  22. 470 A.2d 86 (Pa. 1983).
  23. 271 N.J. Super. 88, 109 (App. Div. 1994), aff’d 140 N.J. 43 (1995).
  24. See Van Natta Mech. Corp. v. DiStaulo, 277 N.J. Super. 175, 191-192 (App. Div. 1994), where an action was permitted to proceed against the corporate officer who allegedly “directed his company to refuse to deal with” the plaintiff.
  25. Van Dam Egg Co. v. Allendale Farms, Inc., 199 N.J. Super. 452 (App. Div. 1985); see also M. Hayes & Associates Realty Co., L.L.C. v. Molier, 2008 La. App. LEXIS 385 (La. Ct. App. 2008). In In re Morrison, 555 F.3d 473 (5th Cir. 2009), not only did the president (and principal shareholder) of a corporation have personal liability for obtaining a contract for work for his corporation by submitting knowingly false information to the other party, but his liability was held to be non-dischargeable in his personal bankruptcy.
  26. 170 N.J. 297 (2002).
  27. 203 N.J. Super. 486 (App. Div. 1985).
  28. N.J.S. 14A:17-1 et seq.
  29. N.J.S. 14A:17-8.
  30. Sunset Financial Resources, Inc. v. Redevelopment Group V, LLC, 2006 U.S. Dist. LEXIS 90248 (D. N.J. 2006).
  31. Erlich v. Nat’l Bank of Princeton, 2008 N.J. Super. 264 (Law Div. 1984).
  32. See Cardillo v. Bolger, unpublished Docket No. A-1117-07T2 (App. Div. 2009), making irrelevant any distinction between intentional tort and contract liability where statutory violations are concerned.
Stuart L. Pachman is a partner (member) of Brach Eichler L.L.C. in Roseland, where he is in general practice with an emphasis on business law. He is a director emeritus and former chair of the Business Law Section, and is the author of Title 14A Corporations, published by Gann Law Books, and numerous articles on business law topics.

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