When Business Owners Become Personally Liable for Business Debts
One of the primary benefits of forming a corporation, limited liability company, or limited partnership is that the potential liability of the owners of the business for the debts of the business is limited. Under most corporate formation statutes, the owners of these limited-liability entities have no personal liability for the debts of the entities, unless they have personally and expressly agreed to guarantee those debts, or unless a state or federal law makes them liable.
Withholding Taxes: Under both Colorado state law and federal law, corporate officers responsible for tax compliance may be held personally liable for income tax, FICA, and similar taxes which are withheld from an employee’s wages to be paid over to the applicable governmental agency.
Statutory Trusts: Colorado laws provide that funds paid by the owner or project developer for a contractor are held in trust for the benefit of subcontractors working on the job. Corporate officers can be held personally liable for breach of this statutory trust if the funds are not properly paid to the subcontractor and are diverted for other purposes.
Piercing the Corporate Veil: In addition to these statutes, courts around the country have held business owners liable for debts of a business under a variety of circumstances. While the individual facts of these cases vary, the unifying theme is that the business owner treated the business assets as his personal assets, without paying due regard to the corporate shield the owner created. Where creditors have been harmed by this mis-use of assets, the “veil” of the corporation has been pierced to impose personal liability on the business owners for the debts of the business. This veil piercing may occur whether the business owner is one or more individuals, or another corporation.
In organizing and operating their businesses, business owners should be aware that a significant combination of the following factors may result in the imposition of personal liability for business debts:
- funds flow freely between the owner and the business, without proper accounting and documentation
- books and records of the business are not maintained in the ordinary course of business
- personal debts of the owner are paid by the business, or vice versa
- assets titled in the name of the owner are used by the business, or vice versa, without appropriate documentation or compensation
- no directors or shareholders’ meetings are held, or no minutes of such meetings are maintained
- owner represents to third parties that the assets of the business are the owner’s personal assets
- the business is inadequately capitalized
- the owner owns all or a majority of the stock of the business
Courts have also held parent corporations liable for the debts of subsidiary corporations, under similar theories, considering the preceding factors and the following additional factors:
- the parent and subsidiary corporations have the same officers and directors
- the parent finances the operations of the subsidiary
- the parent pays salaries, expenses, or losses of the subsidiary
- the parent refers to the subsidiary as a “division” or “branch”
- the subsidiary has substantially no business except with the parent, or no assets except those acquired from the parent
- the directors or executives of the subsidiary fail to act independently in the interests of the subsidiary
- the formal legal requirements of the subsidiary as a separate and independent corporation are disregarded
Piercing the corporate veil claims typically arise when a business has failed, and the creditors are looking for another source for recovery of their unpaid claims. While these claims may be asserted against billion dollar publicly held companies, most frequently these claims are brought against owners of closely-held businesses who are intimately involved in their businesses’ daily operations. Business owners should carefully document their transactions with their businesses, to avoid the appearance that personal assets have been commingled with business ones, and should otherwise maintain proper books and records for the business to limit the risk of personal liability for business debts.
Tort Claims: Corporate officers may also be personally liable for tortious acts, such as negligence, misrepresentation, or fraud, even when those acts are committed on behalf of the corporation, and within the scope of the officer’s employment.