Business Owners, Like Drivers on the Passes, Can Get Lulled into a False Sense of Security
About a month ago I became that person I hate. I put on studded snow tires, and now I’m partly responsible for chewing up the roads that my property taxes never seem to repair, and making it miserable to sit on a bike saddle. The snow was coming hard and early in the passes, we planned on spending a lot of winter time in our Chelan home, and I had a hunch there was going to be a lot more of the white stuff. It was a good hunch. In the past month I’ve made a dozen trips across the passes, the Chelan roads have been almost continuously covered in snow, and I’ve made half a dozen side trips up into the mountains to ski or snowshoe.
Also this past month I’ve been gobsmacked at how many IDIOTIC drivers there are on the road in these conditions. Idiotic doesn’t begin to describe it, considering the lives and limbs of others they are putting at risk. But to be fair, I think many of them are not simply being reckless; I think they are operating under a false sense of security. Ah yes, the 4 Wheel Drive. The basic concept is that when the drive is engaged, the axel spins and power is delivered to all four wheels, mitigating (not preventing) slipping. What it does not do is give you any greater traction when the drive is not engaged. It does not improve your stopping distance, and when you brake, you’re at the mercy of your tires and the laws of physics. Time and again I see 4x4s racing through the passes, tailgating… and a number of them in the ditch or worse.
Which, for a NERD like me drumming the wheel to Nathaniel Rateliff, taking my sweet time, and getting lost on my thoughts, brings me back to…what else, Business Law!
As a protection against owners “behaving badly”, courts will sometimes disregard the rule of limited liability and “pierce the corporate veil” to hold shareholders, members, directors, and/or officers personally liable for corporate liabilities. Yeah personally, as in the stuff you own outside the business.
This is one of the classic “grey areas” of law, long on case-by-case factual analysis, but short on established principles. It is generally found that courts are more likely to “pierce the veil” and impose personal liability where:
The business is closely-held
The plaintiff is an involuntary creditor (i.e. a tort injury vs. a contractual one such as a supplier)
Owners/officers failed to follow corporate formalities
Owners/officers comingled business assets with personal or outside business assets
The business was not adequately capitalized
The defendant actively participated in the business
There was some element of “bad action” on the part of the owners/officers (deception, fraud, etc.)
While these are common factors, I’ll boil it down to 3 SCENARIOS that you business owners should be aware of where “veil piercing” will be used by the courts:
As a tool of statutory interpretation to bring corporate actors’ behavior into conformity with the “legislative intent” of a statutory program, most commonly in the context of withheld pay, social security or other tax obligations, and unemployment compensation schemes. In other words, sometimes the corporate form will be ignored in order to accomplish the specific legislative goal of a government benefit program that distinguishes between owners and employees. The Washington State Court of Appeals has upheld a judgment for willful withholding of wages of a terminated employee; the judgment was entered against both the employer corporation and two of its corporate officers. Durand v. HIMC Corp., No. 37088-3-II (Wash. Ct. App. Aug. 25, 2009).
To “fix” what appears to be fraudulent or deceptive conduct that does not meet the strict elements of common law fraud. This is commonly called “constructive fraud”. If a court is convinced that a shareholder or other equity investor has, by words, actions or sometimes even inactions, led a counter-party to a contract to believe that an obligation is a personal liability or an extra-company obligation (like a separate LLC or holding company) rather than simply that entity’s corporate obligation, then courts sometimes impose liability on the individual shareholder(s) or member(s).
To promote accepted “bankruptcy values.” Bankruptcy law attempts to achieve an orderly disposition of debtor assets through corporate reorganization or liquidation. One way that bankruptcy law achieves these goals is by preventing shareholders from transferring corporate assets to themselves or “favored” creditors ahead of other creditors when the “writing is on the wall”. But even outside of bankruptcy (and sometimes in the context of bankruptcy proceedings as well), courts may apply these same “bankruptcy values” to eliminate opportunism by companies in financial distress by disregarding the corporate form and going after recently distributed funds or other assets.
The vast majority, if not all of the piercing cases, can be explained as an effort to accomplish one of these three goals. I frequently work with business owners to help minimize their corporate and personal risk. This starts with a conversation and thorough understanding of their business to map out where the potential landmines lay. We then take a 4-pronged approach to risk management, reviewing and where appropriate making changes to the: 1) entity structure (which may include separating out distinct business lines or assets); 2) insurance portfolio; 3) employment agreements, policies and practices; and 4) third party agreements.
The takeaway is this: Be prepared for snow and icy conditions. Four wheel drive is absolutely helpful. Having the right tires may be even more helpful. But in any case, having a false sense of security can be even more dangerous than the limitations of your equipment.