Piercing the Corporate Veil in Texas
It’s a worst-case scenario for any executive. Your company engages in some sort of malfeasance and – rather than go after the organization – lawyers are nipping at your heels and naming you personally in huge lawsuits. Suddenly, your own assets and livelihood are at risk.
But how can you avoid becoming personally liable for the obligations of a corporation or limited liability company? Continue reading below to learn about the standard the courts will apply and how to avoid running afoul of it.
As you probably already know, one of the primary benefits of forming a registered legal entity, like a limited liability company (LLC) or a corporation, is the protection provided by the legal doctrines of limited liability and separate legal personality. Simply put, directors and officers are not liable for the debts, obligations, or other liabilities incurred by the organization for which they work.
The concept of “piercing the corporate veil” comes into play when that general rule is set aside and a director, officer, or manager is held liable for the obligations incurred by the company.
Relevant Statutory Provisions
Several statutory provisions in the Business Organizations Code offer critical guidance on the limited liability of officers, directors, and managers, and when personal liability can be imposed.
BOC Section 101.114 – General immunity
In Texas, the general immunity of individuals against the debts, obligations, and liabilities of the organizations for which they work is found in Business Organizations Code Section 101.114 and reads as follows:
Except as and to the extent the company agreement specifically provides otherwise, a member or manager is not liable for a debt, obligation, or liability of a limited liability company, including a debt, obligation, or liability under a judgment, decree, or order of a court.
BOC Section 21.223 – Additional protection
The protection provided by a corporation is further enhanced by Section 21.223 of the BOC which states:
(a) A holder of shares, an owner of any beneficial interest in shares, or a subscriber for shares whose subscription has been accepted, or any affiliate of such a holder, owner, or subscriber or of the corporation, may not be held liable to the corporation or its obligees with respect to:
(1) the shares, other than the obligation to pay to the corporation the full amount of consideration, fixed in compliance with Sections 21.157-21.162, for which the shares were or are to be issued;
(2) any contractual obligation of the corporation or any matter relating to or arising from the obligation on the basis that the holder, beneficial owner, subscriber, or affiliate is or was the alter ego of the corporation or on the basis of actual or constructive fraud, a sham to perpetrate a fraud, or other similar theory; or
(3) any obligation of the corporation on the basis of the failure of the corporation to observe any corporate formality, including the failure to:
(A) comply with this code or the certificate of formation or bylaws of the corporation; or
(B) observe any requirement prescribed by this code or the certificate of formation or bylaws of the corporation for acts to be taken by the corporation or its directors or shareholders.
(b) Subsection (a)(2) does not prevent or limit the liability of a holder, beneficial owner, subscriber, or affiliate if the obligee demonstrates that the holder, beneficial owner, subscriber, or affiliate caused the corporation to be used for the purpose of perpetrating and did perpetrate an actual fraud on the obligee primarily for the direct personal benefit of the holder, beneficial owner, subscriber, or affiliate.
Note: Section 21.223 is extended to limited liability companies by virtue of Section 101.002.
(Partially) Eliminating the alter ego avenue of personal liability
This section, enacted in 2006, is notable insofar as it does away with several common law strategies for piercing the corporate veil in Texas. In particular, the “alter ego” theory mentioned in the section refers to cases in which the corporation (or LLC) and the individual controlling it are so intertwined as to effectively be the same entity.
In those cases, courts would – depending on several contextual factors – sometimes pierce the corporate veil and hold an individual liable for the obligations of the business. But, thanks to Section 21.223, showing that a corporation or alter ego is a mere alter ego of a person is no longer sufficient to impose liability on the person.
That doesn’t mean that whether a corporation is an alter ego of a person is irrelevant. In fact, it may be considered by a court when determining whether an actual fraud was perpetrated. It simply means that a finding that a corporation or LLC was an alter ego of a person is not sufficient to hold the person liable for the debts of the company.
This passage from Metroplex Mailing Services, LLC v. RR Donnelley & Sons Co., 410 SW 3d 889 is conclusive:
To pierce the veil, it is not enough to show that the LLC was an alter-ego or a “sham” company. Evidence that a company was used as an alter ego does not, by itself create an issue regarding whether it was used to commit an actual fraud on the plaintiff for the defendant’s personal benefit. See Shaw v. Maddox, 73 S.W.3d 472, 481 (Tex.App.-Dallas 2002, no pet.). To recover against a member of an LLC individually, the plaintiff must show dishonesty of purpose or intent to deceive. See Menetti v. Chavers, 974 S.W.2d 168, 174 (Tex.App.-San Antonio 1998, no pet).
An Example of Fraudulent Purpose
To determine what sorts of behavior can result in the loss of the protection of personal liability, we must look to the caselaw for instances where a court either found – or didn’t find – fraud sufficient to ground personal liability. In this next case (which was overturned on other grounds on appeal), the trial court and the appellate court reaffirmed the standard for fraudulent conduct.
Latham v. Burger, 320 S.W.3d 602 (2010)
In Latham v. Burger, the plaintiff, David Burgher, sued Ronald Latham and Latham Roofing Inc. for breach of contract and violation of Deceptive Trade Practices Act (DTPA). Burgher had hired Latham Roofing Inc to repair a tile roof for $4500.00. The work was performed but, three years later, Burgher noticed a leak. Burgher hired Latham Roofing for $695 to address the leak. Three months later, when Burgher noticed another leak, he hired a different company and paid them $3429.00 to finally fix the leak.
When Burgher’s lawyer sent a demand letter to Latham Roofing Inc., Latham dissolved the company. Burgher sued both the company and Latham. At trial, the jury found that the company had breached the contract and violated the DTPA. Importantly, it found that Latham should be individually liable for Burgher’s damages.
Latham appealed on several grounds. While he was ultimately successful on an issue involving damages, he failed to convince the Court of Appeals of Texas that the trial judge had improperly instructed the jury on the definition of fraud. At trial, Latham’s counsel wanted the judge to instruct the jury that fraud could only be found if the elements of the tort of fraud in Texas were made out. The trial judge rejected that argument and instructed the jury that “the term ‘actual fraud’ means ‘involving dishonest or purpose or intent to deceive’.” [sic]
The appellate court ruled that, as it had found in Dick’s Last Resort of West End, Inc. v. Market/Ross, Ltd., 273 S.W.3d 905, 908 (Tex.App.-Dallas, 2008 pet. denied), “the trial court properly instructed the jury that actual fraud means conduct involving either dishonesty of purpose or intent to deceive.”
Ways to Protect Against Personal Liability
From the foregoing cases and provisions, it should be clear that directors, officers, and managers of limited liability companies and corporations should seek to avoid perpetrating frauds for their direct personal benefit or the benefit of a beneficial owner, subscriber, or affiliate.
While you should certainly receive qualified, independent legal advice before taking any action that could reasonably be construed as dishonest or deceitful, denuding a corporation or LLC of its assets when doing so will have the effect of reducing or eliminating the company’s ability to pay its existing or apprehended liabilities can be a very bad idea. Again, it depends on the circumstances, and you should obtain legal advice about your unique situation, but this is often actionable.
One of the best ways to avoid running afoul of the actual fraud rule is to conduct yourself, and ensure your company conducts itself, forthrightly and honestly. The actual fraud rule is concerned with purpose and intent, and it’s not meant to catch in its net behavior that’s merely unfortunate or the product of an honest mistake. But dishonest behavior is another story altogether.
This article represents one author’s viewpoint and is not a substitute for legal advice.