Court Rules on Personal Liability Against Corporate Owner
A corporation has an existence separate and distinct from that of its individual officers, directors and stockholders. The general rule is that individual owners of a corporation are insulated from personal liability for corporate debts, and that individuals may incorporate for the purpose of limiting their liability.
In certain circumstances however, owners may be liable for some underlying corporate obligations. In an appropriate case, a court will disregard the corporate entity or “pierce the veil” of the corporate entity and hold a corporate officer or shareholder personally liable for corporate debt. In the recent case of East Hampton Union Free School District v. Sandpebble Builders, Inc., the court addressed the issue of piercing the corporate veil and imposing personal liability against the corporation’s president and principal owner.
In June 2006 the East Hampton Union Free School District negotiated a construction management agreement with Sandpebble Builders, Inc. The agreement was negotiated in principle and was subject to signature by the construction manager’s owner and president, Victor Canseco. Although Mr. Canseco indicated that he would sign the contract, he later refused and additional negotiations were held, but again, Mr. Canseco refused to sign the agreement. This sequence of re-negotiation, agreement in principle, and refusal to execute was repeated twice more until, by letter dated September 15, 2006, the construction manager terminated negotiations, and stated that it was “ready, willing and able to perform”, but only under the terms of an abandoned 2002 agreement between the school district and the construction manager, which contained more favorable terms. The school district contracted with a different construction manager and sued Sandpebble Builders, Inc. and Victor Canseco, personally for breach of contract.
In support of the school district’s direct claim against Mr. Canseco, the district argued that Mr. Canseco was the president and owner of Sandpebble, that he exercised “complete dominion and control” over Sandpebble, and that Mr. Canseco used such power to commit a wrong against the school district. According to the school district, Mr. Canseco never intended to perform the work as negotiated under the contracts. Rather, Mr. Canseco engaged in bad faith and unfair negotiating tactics by repeated demands for new terms, after having reached an agreement in principle, which were designed to delay progress of the project in order to pressure the district to offer more favorable terms.
Mr. Canseco moved to dismiss the claims against him personally on the ground that in his dealings with the district he acted solely in his capacity as president and principal owner of Sandpebble. Additionally, Mr. Canseco argued that the allegations contained in the complaint were insufficient to maintain an action against him personally. The trial court denied Mr. Canseco’s motion to dismiss and he appealed.
The appellate court reversed the trial court, and dismissed the school district’s direct claims against Mr. Canseco. In so doing, the appellate court relied heavily on prior case law, which states, “The general rule, of course, is that a corporation exists independently of its owners, who are not personally liable for its obligations, and that individuals may incorporate for the express purpose of limiting their liability. The concept of piercing the corporate veil is an exception to this general rule, permitting, in certain circumstances, the imposition of personal liability on owners for the obligations of their corporation. A plaintiff seeking to pierce the corporate veil must demonstrate that a court in equity should intervene because the owners of the corporation exercised complete domination over it in the transaction at issue and, in doing so, abused the privilege of doing business in the corporate form, thereby perpetrating a wrong that resulted in injury to the plaintiff.”
According to the court, the factors to be considered in determining whether the owner has “abused the privilege of doing business in the corporate form” include whether there was a failure to adhere to corporate formalities, inadequate capitalization of the corporation, personal and corporate commingling of accounts, and use of corporate funds for personal use. Although the school district alleged in its complaint that Mr. Canseco exercised “domination and control” over the corporation, it did not allege the factors necessary to find that Mr. Canseco “abused the privilege of doing business in the corporate form.” Accordingly, the appellate court granted Mr. Canseco’s motion to dismiss the claims against him personally.
The analysis of whether a corporate principal can be held personally liable requires a detailed review of the relevant facts and the allegations contained in the complaint. However, even after a thorough review of the facts and allegations, judges and juries can still arrive at different conclusions. In this case, three of the five appellate judges agreed that the claims against Mr. Canseco should be dismissed, while two appellate judges would have let the claims remain.
The majority of the judges held that an allegation in the complaint of “domination and control” is not standing alone, sufficient to state a cause of action for personal liability against the corporate owner. The two dissenting judges, however, held that the complaint states a cause of action against Mr. Canseco under the “piercing the corporate veil” theory because the complaint alleges Mr. Canseco’s bad faith conduct, consisting of his “repeated negotiations of contract terms with the school district, to which he would orally agree on multiple occasions while never intending to execute written contract documents, all in a deliberate effort to delay the construction project as a means of leveraging a greater percentage of completion from the school district.”
An appeal of this decision to New York’s highest court remains possible, and would finally determine whether Mr. Canseco can be sued personally for corporate debt under the “piercing the corporate veil” theory.
If you would like more information regarding this topic please contact Alexander A. Miuccio at