As a legal precept, officers and/or shareholders of a corporation cannot be liable to third parties for the acts of the corporation, which is an entity distinct from its stockholders/officers, even where one individual owns all of the corporation’s stock. In limited circumstances, however, a court will find that it is appropriate to disregard the corporation, so as to hold a shareholder or officer liable for the corporation's acts or obligations. As the U.S. Supreme Court succinctly stated, “The limited liability sought to be obtained through organization of a corporation may be denied where the sacrifice is essential to the end that some accepted public policy may be defended or upheld.”Anderson v. Abbott, 321 U.S. 349 (1944). When this happens it is commonly referred to as “piercing the corporate veil.”
Many courts have devoted time and opinions to the collective jurisprudence regarding the circumstances in which piercing the corporate veil is appropriate. In general, these bases can be divided into broad categories such as (1) fraud or artifice, such as when corporations are formed to evade law or contract; (2) independent act, in which the individual acts of officers/shareholders are not attributable to the corporation or not binding upon the corporation; (3) “alter ego” theory, such as when a company is merely a cover for an individual or an agent or adjunct of another corporation; and (4) where there has been an unjust injury or loss to the plaintiff.
For example, piercing the corporate veil has been found appropriate where third parties dealing with the corporation cannot distinguish between the corporation and its officer personally, such as where the corporation is named for the officer. Personal liability has been found where a sole proprietor who has recently incorporated his business fails to inform prior customers that they are now doing business with a corporate entity. Officers have been held personally liable where they are not careful to make clear whether they are acting in a personal or a representative capacity.
Green v. Ziegelman: A Cautionary Tale
A recent case, Green v. Ziegelman, demonstrates the potential for personal liability of a sole owner who fails to properly segregate his/her actions from the corporation. Green involved a dispute in which a corporation was held to be the alter ego of the sole owner architect, resulting in the court piercing the corporate veil and finding the architect, Norman Ziegelman, personally liable.
Plaintiffs Sanford Green, Jack R. Hendrickson, and Thomas Esper, along with defendant Ziegelman, were all officers of plaintiff Libwag, LLC, which was formed to undertake a real estate development project. Ziegelman was the sole shareholder of both an architectural corporation, Norman H. Ziegelman Architects, Inc. or NZA, and a general contractor, Continental, both of which contracted with Libwag in connection with the development. A dispute eventually arose concerning the development project and the Libwag operating agreement.
Following an arbitration, the arbitrators ruled, among other things, that NZA had breached the architecture agreement and owed the plaintiffs $156,313; and that Ziegelman had breached the operating agreement and his membership interest must be reduced. The award was confirmed by a court and reduced to judgment.
After efforts to collect judgment from NZA failed, the plaintiffs eventually moved the trial court to pierce NZA’s corporate veil. The trial court granted the motion, despite the fact that the plaintiffs had made no prior attempt to hold Ziegelman personally liable for breach of the architectural agreement, nor sought to pierce the corporate veil during the arbitration or confirmation proceedings. The court of appeals reversed, ruling that the plaintiffs could not use a proceeding supplemental to the judgment to have another judgment entered holding Ziegelman personally liable, in the absence of an arbitration award granting such relief. Green v. Ziegelman, 282 Mich.App. 292, 767 N.W.2d 660 (2009).
Following this loss, Plaintiffs filed a lawsuit against Ziegelman and NZA, asking the trial court to pierce the corporate veil and to find the architect personally liable for NZA’s debt. The defendants moved for summary judgment, based on the theory that the lawsuit was barred by res judicata, but the motion was denied. Trial proceeded, during which it was established that Ziegelman had told the plaintiffs that NZA had successfully undertaken multiple large projects. Based on this, the plaintiffs made Ziegelman a partner of Libwag and signed a $1.4 million architectural agreement with NZA. Ziegelman subsequently tried to gain control of Libwag and, when Ziegelman failed in his attempts to take over Libwag, NZA stopped performing under the architectural agreement.
The trial court found that Ziegelman abused the corporate form by using NZA as a “mere instrumentality or as his alter ego.” For example, the court found that when it entered into the architectural services contract NZA was “grossly undercapitalized,” as NZA had no assets, only $400 in accounts receivable, and—contrary to Ziegelman’s representations—had performed no architectural work since 1989.
Moreover, the court found Ziegelman had not observed the “required corporate formalities.” For example, Ziegelman personally loaned NZA more than $600,000 without NZA executing a promissory note and the loan had never been repaid. NZA had also paid Ziegelman’s personal expenses, including his car lease, travel, and cell phone expenses.
Lastly, the court found that, in order to avoid paying on the judgment, Ziegelman purchased all NZA’s assets for a nominal amount and fraudulently transferred the assets to a new entity.
Based on the foregoing, the trial court held Ziegelman personally liable for NZA’s arbitration award liability. The court further found that Ziegelman used NZA to “commit a fraud or illegality,” which resulted in an unjust loss to the plaintiffs.
On appeal, the Michigan Court of Appeals affirmed both the trial court’s denial of summary judgment for defendants and its holding in favor of piercing the corporate veil. Green v. Ziegelman, 310 Mich. App. 436 (2015). In affirming the ruling below that NZA was Ziegelman’s alter ego and that the corporate veil should be pierced, the Court of Appeals noted that a claim for piercing the corporate veil has three elements: (1) the entity was the mere instrumentality of the owner, (2) the owner used the entity to commit a fraud or wrong (3) resulting in an unjust loss or injury to the claimant. The court noted that “it is not necessary to prove that the owner caused the entity to directly harm the complainant; it is sufficient that the owner exercised his or her control over the entity in such a manner as to wrong the complainant. If, considering the totality of the equities, the trial court would be consummating a wrong by honoring an entity's separate existence, the court may disregard the entity's separate existence.” Faced with an arbitration award against NZA, Ziegelman purchased all of the corporation’s assets for a small sum, transferred those assets to a new corporation, and then liquidated NZA. Both the trial and appellate courts found this behavior evidence in support of imposing personal liability on the architect.
The Green case is a good reminder that the corporate form is not a complete shield from liability. In a recent decision, the Illinois Court of Appeals, faced with similar facts, also ruled that the corporate veil could be pierced and the principals subjected to personal liability. However, that court also found two other grounds for liability not mentioned by the Green court: that the principals had violated the Uniform Fraudulent Transfer Act and also breached a fiduciary duty, imposed upon the principals of a bankrupt corporation and owed to the corporation’s creditors. See A.G. Cullen Const., Inc. v. Burnham Partners, LLC, 29 N.E.3d 579 (Ill. App. Ct. 1st Dist. 2015).
Although it is seemingly obvious that one should not commit fraud, it is easy for lines to become blurred without any ill-intent on the part of a company’s officer or sole proprietor. Principals must remember to observe corporate formalities, to keep corporate and personal property and expenses separate, and to make it clear during transactions that it is the company—not an individual—making the deal.
Regardless of how many safeguards a party has in place, however, a party may find itself concerned about the potential for personal liability in a given project or dispute. In such cases, a party should contact an attorney without undue delay.