Ohio Practical Business Lawyer & Attorney : Teri Rasmussen : Lane Alton & Horst Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

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What could be worse than having a judgment taken against your business?  Having the holder of that judgment going after your home and other personal assets.  If they are not careful, business owners can unexpectantly and unpleasantly discover that they are being held personally liable and responsible for what they thought were obligations of the company only.  This can happen when, in the press of everyday busy-ness, shortcuts are taken and the distinction between the company itself and its owner(s) becomes blurred.  Lawyers call this "piercing the corporate veil" and it can have disastrous effects.

Everybody understands the basic rule that generally speaking, the most important reason for setting a business up as a corporation or limited liability company in the first place is to protect its owners, shareholders, members, officers and directors (and their respective assets) from the consequences of any financial or legal misfortune of the business.  The corollary to this principle -- that individuals will remain liable for their own wrongful acts done as individuals even if a business is also involved -- is also an accepted tenet of everyday life.  Conceptually, the idea of "piercing the corporate veil" grew out of the desire to prevent individuals from escaping the consequences of their individually wrongful acts by using a corporate entity for criminal or fraudulent purposes.

Historical Background.  Historically, the limited liability now taken for granted, which use of a corporate or limited liability company business structure allows, is a relatively recent development.  In the early 1800's, there were very strict limits on the ability of a business owner to obtain limited liability; incorporation of a particular business typically required a special act of the state legislature.  To the extent general incorporation statutes existed, they usually imposed substantial limitations on their use by emphasizing significant minimum paid-in capital requirements, limited permissible purposes and limited duration.

In time, and especially following the Industrial Revolution in the last century, more businesses began to require substantial expenditures and infusions of capital well beyond the means of the typical entrepreneur.  Investors willing to provide these sums of money were, in the absence of limited liability, far less anxious to invest in businesses they neither operated nor were in a position to monitor closely.  As a result, state legislatures eventually removed virtually all of the restrictive limitations on the ability of corporations to organize and operate and the ability to avoid personal liability for debts of one's company became an accepted economic tenet of business life. 

By allowing people to participate in the ownership of businesses without risking their entire personal net worth, granting limited liability encouraged investment and the growth of businesses.  Thus, traditionally, the benefit of limited liability has been linked with the passive involvement by those granted the benefit.  The idea was that people could trade involvement in the management of the business for the security of having no personal liability for the obligations of the business beyond their investment. 

The Problem and Its Consequences.  Today, with the possible exception of businesses fortunate enough to have attracted venture capital, the distinction between passive investors and operating managment is often far less clear.  Typically, in a small or medium privately held owner-operated business, most or all of the owners are likely to have active roles in the day to day management of the company.  Unfortunately, this trend can be a trap for the harried unwary business owner who assumes that observing formalities imposed by Ohio law for operating his or her business is merely optional or "just not that big a deal".

Does this ever really happen?  Yes.  In a surprising number of cases, people suing a business have argued, and the court has agreed, that business owners displaying carelessness in following proper corporate procedures, or lax practices in separating the financial affairs of the business from their own, are personally liable for everything from environmental claims to breach of contract.

Consider the situation of a general building contractor, known as Bachinski Builders, Inc. whose sole shareholder was the president's wife.  Barbee Concrete Construction was a subcontractor hired by Bachinski Builders, Inc. to do concrete work for a residential subdivision being built by Bachinski Builders.  Upon completion of the residential development, Barbee Construction was not paid for all of its work.  After filing suit for breach of contract to recover the unpaid amounts, Barbee Construction amended its Complaint to include a claim seeking to recover against the president of the general contractor personally.  (Barbee Concrete Construction v. Bachinski Builders, et al.).  Among the transgressions important to the Court in deciding to impose personal liability on the president were:

• President testified that he alone made all decisions, including how corporate monies were to be spent and distributed

• President was unable to name any members of the company's board or say whether it had ever even met

• No corporate records could be produced

• A series of payments totaling more than $32,500.00 were made to one of the president's son, allegedly as compensation for work as a construction supervisor, but when questioned about specific payments, the president was unable to explain the amounts or what work was done to earn specific payments

• Payments totaling more than $56,000.00 were made to two other sons supposedly as repayment of loans made, but there was no documentation supporting the existence of the loans.

In still another case, a nursery rewholesaling business owner ran afoul of the "piercing the corporate veil" doctrine when sued by a nursery supplier in a breach of contract action.  (Willoway Nurseries v. Curdes).  Thomas and Rosemary Curdes had taken appropriate legal steps to set up their business, but later became thoroughly undisciplined in maintaining any separate existence for their company. 

Initially, appropriate incorporation documents were filed with the Ohio Secretary of State, shares were issued and paid for, Mr. and Mrs. Curdes were designated as the company's shareholders, officers and directors, and the first shareholders' and first directors' meeting were held.  Unfortunately, the Curdes' business began experiencing difficulties almost immediately.  Plans to make their existing lawn care and landscaping sole proprietorship a subsidiary of the newly formed corporation were never completed.  Instead the Curdes continued to use the sole proprietorship's checking account for both businesses.  In addition, in imposing personal liability on the Curdes, the Court found that:

• although salaries had  been paid to the Curdes, records and accounts for the new company were inaccurate and badly in arrears

• plants in the new company's inventory were used for the old landscaping business without any corresponding record of payment

• revenues generated by the new company were used to buy equipment for the old landscaping business and pay its employees

• no corporate formalities had been observed since the initial incorporation activities

• no corporate or state tax returns had been filed

• when the new company eventually ceased operations, the Curdes simply took the company's assets to their own home, viewing them as their own property

Belvedere Sets Ohio Standard.  In Ohio, the leading case describing the circumstances in which "piercing the corporate veil" is appropriate is Belvedere Condominium Unit Owners' Association v. R.E. Roark Companies, Inc., 67 Ohio St.3d 274 (1993).  This case involved a dispute between a Cincinnati condominium unit owner's association and a Columbus real estate developer (and its majority shareholder).  The association (whose board was controlled by employees of companies owned by the real estate developer's shareholders) and the real estate developer had entered into a lease with provisions highly favorable to the real estate developer as lessee and at an allegedly under-market rent.

After finding no fiduciary duty existed between the developer and the condo association, the Ohio Supreme Court nevertheless held the developer liable under a strict liability statute for failure to disclose to prospective purchasers relevant financial information concerning the condominium development.  The question then was whether the majority shareholder of the developer could be held individually liable for this violation by the developer.  In answering this question, the Ohio Supreme Court indicated that it intended to strike "the correct balance between the principle of limited shareholder liability and the reality that the corporate fiction is sometimes used by shareholders to protect themselves from liability for their own misdeeds." 

The Ohio Supreme Court set out the following guidelines for when individual shareholders could be held liable notwithstanding the corporate form of their business:

1. control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will or existence of its own, i.e. there was no separation between the business affairs of the company and the personal affairs of the owner

2. control over the corporation by those to be held liable was exercised in such a way as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and

3. injury or unjust loss resulted to the plaintiff from such control and wrong.

The Court also hastened to add that "mere control over a corporation is not in itself a sufficient basis for shareholder liability."  In analyzing the situation before it, the Ohio Supreme Court found it persuasive that the individual shareholder did not use his influence and control to injure or defraud the association.  Accordingly, it concluded that it was not appropriate to hold the shareholder individually liable.

Practical Applications.  What does this mean on a practical level?  The most important prong of the standard is the first which tests whether the owner and the corporation or LLC are distinguishable from one another.  Among the telltale factors considered by Ohio courts are 

• grossly inadequate capitalization

• failure to observe corporate formalities

• insolvency of the business entity at the time the debt was incurred

• owner acting in ways holding himself out as personally responsible for the company's obligations

• diversion of company funds or property for personal use

• company used as a mere façade for other operations of the owner

Thus, in the recent case of Kelley v. McComas, 2007 U.S. Dist. LEXIS (S.D. Ohio 2007), while the Court felt it was a "close question" whether the corporate veil should be pierced, the Court refused to impose personal liability on the company's owners based upon the fact that corporate meetings were held and that the company was the holder of the liquor permit, filed corporate tax returns, had employees, and was no more insolvent now than when the incident in question occurred. 

So what's the best way to avoid accidental personal liability?

1. Keep good corporate records.  If there is more than one shareholder or owner, have corporate meetings on a regular basis (monthly or quarterly) and keep minutes of those meetings

2. Make sure you keep some sort of record of revenue coming in, and expenses being paid by, the company.  If you bill clients or customers, make sure they make their check payable to the company, rather than you personally. 

3. Don't pay company bills from personal funds.  If the business is running short of money, deposit a personal check in the company banking account instead of paying even such essentials as employee paychecks or utilities from your own funds.  Make sure to have your bookeeper or accountant keep track of these "loans" to the company.  And while it probably goes without saying, make sure you DO have separate personal and company accounts. 

4. Don't pay personal bills from company funds.  Be sensible about which expenses the business is paying for you.  Car payments may (or may not, depending on the circumstances) be appropriate, but expensive vacation trips to the Carribean even if you did have that one business meeting, are likely to be pushing it.

5. Make sure you've completed ALL of the legal steps in Ohio for proper legal formation of the business.  For example, if a corporation, simply filing Articles of Incorporation with the Secretary of State without also attending to electing directors and officers and issuing shares of stock is not sufficient.

6. Use signage, business order forms, invoices, and business stationary with the company's name and address prominently featured when doing business with customers and clients.

While these guidelines are relevant to all privately held companies, individuals who are the sole owner of thier business should pay particular attention to adhering to them.

In general, the best way to stay out of trouble is to simply remember that the company IS NOT you, but has its own distinct identity and needs to be treated as a separate independent entity. 

• To learn how courts in another state look at the issue, read John Waller's post from earlier this year on "More on Piercing the Corporate Veil in Indiana and the UFTA" in his Indiana Commercial Foreclosure Law blog.

UPDATE: The Ohio Supreme Court heard oral argument in Dombroski v. Wellpoint, Inc., Case No. 2007-2162, on June 4, 2008 in which the certifed question related to the proper interpretation of Belevedere's second prong in a case involving a tort plaintiff and the parent corporation against whom veil piercing was sought.  For more on this, read my posts here and here.  In these posts, I also include links to the Ohio Supreme Court website where you can see the streaming video of the oral argument.