Small Business Beware
Two important lessons may be gleaned from the recent case of Underwood v. Miller, M2019-00269-COA-R3-CV: 1) if you do business as a corporate entity, act like it, and 2) be sure to sign contracts on behalf of the corporate entity, and not in your individual capacity.
In Underwood, a judgment was taken against an LLC for $709,500.00 for a breach of contract. The LLC didn’t have the funds to pay, so the creditor pursued the owner of the LLC in her individual capacity.
Fortunately for the owner, she had not signed the contracts individually, but rather signed them on behalf of the LLC. The creditor dismissed her in her individual capacity from the lawsuit. But the creditor wasn’t done.
The next attempt to collect the funds came in the form of a lawsuit to pierce the corporate veil. Generally stated, corporations – Inc.’s and LLC’s – are treated as distinct entities, separate from shareholders and officers. The corporation acts as a veil, protecting its shareholders from personal liability for the corporation’s debts. However, the corporate veil may be pierced by showing that the entity is a “sham or a dummy” corporation. From the Underwood case:
Factors to be considered in determining whether to disregard the corporate veil include not only whether the entity has been used to work a fraud or injustice in contravention of public policy, but also: 1) whether there was a failure to collect paid in capital; 2) whether the corporation was grossly undercapitalized; 3) the nonissuance of stock certificates; 4) the sole ownership of stock by one individual; 5) the use of the same office or business location; 6) the employment of the same employees or attorney; 7) the use of the corporation as an instrumentality or business conduit for an individual or another corporation; 8) the diversion of corporate assets by or to a stockholder or other entity to the detriment of creditors, or manipulation of assets and liabilities in another; 9) the use of the corporation as a subterfuge in illegal transactions; 10) the formation and use of the corporation to transfer to it the existing liability of another person or entity; and 11) the failure to maintain arms length relationships among related entities.
These factors are not exhaustive and no single one is dispositive of the issue. In Underwood, the Court ultimately found that the LLC was a separate entity and that the owner had operated it as such – a $709,500.00 win for the owner. The creditor certainly wishes they had made use of a personal guaranty by the owner, but that’s a conversation for a different day.
If you do business as a corporation, take a moment to reflect on the language from the Underwood case. It may save you some money.
LEGAL JARGON DISCLAIMER: The foregoing is not legal advice. Even if you construe it that way, it’s probably only worth what you paid for it. I am an attorney but am not yours.
Whether you are a Haven client or not, I’m always available to discuss.