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Dec
10 • 2008
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The Corporate Veil of Protection – An Imperfect Shield

Radio ads, email marketing, and seminars tout the magic of incorporating as a impenetrable fortress from liability, but it’s important to understand exactly how incorporating can protect the owners of a business.  It’s not magic or complicated – when properly formed, a corporation can protect its owners from the day-to-day operations of a business.

 While it is commonly known that under some circumstances a shareholder can be held liable in the event the corporate veil is pierced (see, Piercing the Corporate Veil: A Rare and Drastic Result), there are other situations where the officers and directors of a corporation can be held personally liable for corporate activities.  This is especially important where a single person (or a small group of people) wear all of the hats as officers, directors, and shareholders.  In this article, we will explain the limits of corporate liability protection.

1.         First and foremost, you can’t hide behind a corporation for your own wrong doing.  Corporate officers and directors are not liable for corporate activities in which they did not materially participate.  However, officers and directors of a corporation are always liable for their own wrong doing even when the corporation is also liable.  This is the case whether the corporate officer participates in the wrong or merely authorizes or directs that it be done.  Examples include: ordering a resident of a property to disconnect exterior lighting that the resident installed to protect herself from criminal activity following rape in unit (Frances T. v. Village Green Owners Association); stealing trade secrets from a former employer (PMC, Inc. v. Kadisha); president and majority shareholder of cement subcontractor personally liable for shoddy construction after personally bidding and making all decisions with respect to the job (Michaelis v. Benavides).

2.         Never under any circumstances should you fail to remit federal withholding taxes to the IRS.  Employers are required to withhold income taxes and FICA taxes from employee wages and hold them in trust for the government.  When bills are piling up and a small business is juggling its cash, do not even think about using these trust funds to pay other bills, because Federal statutes provide that the responsible financial officer of a corporation (even a non-shareholder) can be personally liable for withholding taxes. Officers (and other employees) who are “responsible” for the corporation’s payroll or financial affairs may be personally liable for willfully failing to collect and pay required federal taxes – e.g., federal withholding or employment taxes (IRC Sec. 6672).  Even worse, the officer who finds himself in the government’s cross hairs over this issue can face a 100% penalty.  Who is a “responsible officer”?  To be liable for failing to pay withholding taxes, the person must have significant decision making authority over the corporation’s tax matters, even if there is no bad motive. 

3.         California takes a page from the federal government’s playbook with respect to state taxes and unemployment insurance contributions – an officer, major stockholder or other person who has charge of a corporation’s affairs and who willfully fails to pay required contributions to the State Unemployment Fund may be personally liable for the requisite amount, together with interest and penalties (Unemp. Ins. Code Sec 1735).  The lesson is extremely simple – state and federal taxes that are withheld from your employees’ wages are not a source of cash to use to pay other bills.

4.         If you damage the environment, nothing will protect you.  Under CERCLA – the so-called environmental “superfund”, corporate officers who have authority and control over the disposal of hazardous wastes can be held personally liable as “owners and operators” of any corporate facility.  Many courts have held corporate officers or directors who own an interest and actively participate in the management or operation of a company can be held personally liable under CERCLA without piercing the corporate veil (corporate officers liable for $1 million and punitive damages due to failure to comply with EPA order to clean up fluids that leaked into the soil (US v. Carolina Transformer).

5.         In many states, the officers are liable for wage claims.  Although there is some controversy in California (see, Bradstreet v. Wong), Cal. Lab Code Sec. 558 (a) imposes liability for unpaid wages on an employer “or other person acting on behalf of an employer”, including officers.  For New York’s take on this rule, see, Why in the World Would Anyone Incorporate in New York.

Using a corporation to limit the liability of a business owner is an important aspect of running a business.  It is important to keep in mind that while corporate directors and officers do not incur personal liability for torts of a corporation merely by reason of their capacity as officer or director, the officer or director will be personally liable if he or she participates in the wrongdoing or authorizes that it be done.  Further, in the context of taxes, damage to the environment, and certain wage claims, a corporate officer should keep in mind that statutes have been enacted to limit personal protection otherwise afforded by the corporate form.