November 1, 2010
Separating Limited Liability from Individual Liability in Corporations and LLCs
When we delve into limited liability in my business associations courses, the discussion often turns to the scope of that limited liability and how it should be applied. We talk about how hard it can be to pierce the corporate veil (and LLC veil), especially where the shareholders/members respect the formalities of the respective entity.
Students are sometimes troubled by the idea that an entity not paying its bills could have a primary owner who has ample financial resources who still escapes liability. We discuss the options, before the default, that were available to help avoid such an outcome. For example, I note that lenders and other creditors can always ask for a personal guarantee if they aren't comfortable accepting the risk of the entity's ability to pay. (Less comforting is the third-party tort victim.)
I try to make clear that, although a shareholder will not be held liable to creditors in most instances solely by virtue of their status as shareholders, a shareholder can be liable by virtue of their status as individuals. The classic example is the shareholder and employee of a local company, Bread, Inc., who drives his bread truck into a pedestrian causing severe injuries. The company may be liable for his actions an an employee and the driver may be liable directly because of his actions as the driver, not by virtue of being a shareholder.
A couple recent cases provide good reminders of exactly this point. In a recent U.S. District Court of Maryland decision, a group of employees sued their employer and the president of the company individually for violation of the Fair Labor Standards Act (FLSA) and state wage law violations. Pearson v. Professional 50 States Protection, LLC, Civil Action No. RDB-09-3232, slip op. (D. Md. Oct. 26, 2010) (pdf here). The company president sought summary judgment on his liability, claiming that the only way he could be held liable was if the court pierced the LLC veil (and that such a claim was not adequately pleaded). The court disagreed, explaining that the FLSA holds all employers liable and that an employer could include the entity and the individual. ("There is substantial authority for courts to hold liable as employers individuals with varying amounts of equity and control over the entities and activities before the courts in FLSA cases.") Furthermore, the court noted that "an officer who is liable as an employer under the FLSA is liable in her individual capacity."
Similarly, a recent Connecticut LLC case also explained that an LLC member may be liable individually in tort for personal involvement in a tort even though the LLC may also be liable. Sturm v. Harb Dev., LLC, 298 Conn. 124 (2010) (pdf here). In that case, the plaintiffs sued a construction LLC and a member individually for substandard construction of their home. The court again explained, "[A] director or officer who commits the tort or who directs the tortious act done, or participates or operates therein, is liable to third persons injured thereby, even though liability may also attach to the corporation for the tort.” For a good and more detailed description of this case and other LLC liability issues, see here.
Now that LLCs are the entity of choice, I like using LLC cases for this discussion. Of course, from time to time this can make the discussion even more murky because courts don't often carefully distinguish the entity types. Case in point: the Sturm case discussed above. The court repeatedly referenced the LLC as the "corporation." The court explained that in Connecticut, "A limited liability company is analogous to a corporation for purposes of piercing the corporate veil." Still, I'd much prefer if, after this determination is made, the court would refer to the entity as the "LLC" or the "company." A little precision on this point would be much appreciated in the classroom. I suspect it might help in practice, too.
When I taught that course, I always emphasized that people are always liable for their individual actions - no liability shield protects from individual conduct.
Posted by: Cassondra Joseph | Nov 6, 2010 5:43:54 AM
I think that's a fair point, but it's not exactly helpful without context. When a person acts for the entity, they are shielded. The problem is recognizing the difference between individual conduct and the same person acting for the entity. It's not always easy to see the difference, at least on the margins.
Posted by: Josh Fershee | Nov 8, 2010 7:56:07 PM