By: Alexander A. Miuccio Published: April 2014

Court Rejects Personal Liability Against Corporate Owner

A corporation has an existence separate and apart from that of its individual officers, directors and shareholders. The general rule is that individual owners of a corporation are insulated from personal liability for corporate debts, and that individuals may incorporate a business for the very purpose of limiting their personal liability.

In certain circumstances, however, corporate owners may be personally liable for corporate debt. In the recent case of PGC Construction Corp. v Fudge, a building owner attempted to hold a sole shareholder, officer and director of a construction company personally liable for the company’s obligations under a construction contract.

Background

PGC Construction was retained by the Fudges to construct a second floor addition and other improvements to their home for a fixed price, with progress payments to be made during the job. About halfway through the job, the homeowners terminated PGC for cause, claiming that PGC failed to adequately protect the home from rain, resulting in damage to the first floor. PGC filed a mechanic’s lien on the property, claiming that $67,493 was still owed to it for labor and materials. PCG ultimately sued to foreclose the mechanic’s lien, and the Fudges counterclaimed against PGC for the damages to the first floor, defective work and the cost to complete the project.

The homeowners’ counterclaim also included a suit against PGC’s sole shareholder, Peter Gmelch, claiming that PGC was under the sole control of Gmelch, was undercapitalized, did not hold regular corporate meetings, commingled corporate funds with Gmelch and otherwise failed to observe corporate formalities. As to the claim that PGC was undercapitalized, the homeowners argued that during the time that PGC was working on their home, they were informed by the HVAC contractor that PGC had bounced checks it had issued to him on prior construction jobs. They also claimed that an electrical subcontractor informed them that he agreed to work on their home “so that Gmelch would pay him the amounts that he owed in connection with the work that the electrical contractor had performed on a prior project.” They also argued that as the sole shareholder, officer and director of PGC, Gmelch is personally liable for wrongfully filing a “frivolous and willfully exaggerated” mechanic’s lien against their property.

Gmelch moved to dismiss the claims against him personally, arguing that the claims as to the underfunding and lack of corporate formalities are false, and that there is no legal basis for holding him personally liable. The homeowners opposed the motion, claiming that the evidence submitted by Gmelch was insufficient to establish that PGC was sufficiently capitalized, holds regular corporate meetings, does not commingle funds and otherwise follows corporate formalities.

Decision

The court dismissed all claims of personal liability against Gmelch. In doing so, the court noted that a business can be incorporated for the very purpose of avoiding personal liability. Nevertheless, a court may impose personal liability on its shareholders to prevent fraud or illegality, or to achieve equity. The court further noted that courts hold shareholders personally liable for the debts of the corporation when the shareholder exercised complete domination of the corporation with respect to the transaction at issue and abused the privilege of doing business in the corporate form to perpetrate a wrong or an injustice.

After discussing the high burden a party faces when it wishes to impose personal liability, the court held that the homeowners failed to state any particular facts as to how Gmelch abused the privilege of doing business in a corporate form to commit a wrong against them. The court also rejected the hearsay and conclusory statements of the homeowners regarding PGC’s dealings with other contractors.  

Comment

The very purpose of doing business in the corporate form is to avoid personal liability for corporate debts. As this case demonstrates, the burden to hold a shareholder personally liable for the debts of the corporation is high. However, that burden is not insurmountable. A prudent contractor would be well advised to follow corporate formalities and make sure that corporate funds are not commingled for personal use.

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