By: Alexander A. Miuccio Published: May 2011

Court Allows Claim For Personal Liability Against Corporate Owner

Real estate developers form corporate entities to conduct business to primarily protect them from personal liability on high-risk ventures, such as the construction of a major real estate project. A corporate form of doing business normally insulates corporate shareholders from any debts or liabilities of the corporation.

But courts will not allow an individual owner to escape personal liability by hiding behind the corporate shield when he creates a corporate entity for the purpose of evading payments to contractors and subcontractors. This issue was addressed in the recent case of Puma Sidewalk Corp. v. GDY Properties, Inc.

Background 

Ron Herscho formed a number of corporate entities that were engaged in the business of developing and selling real estate. He is the principal shareholder and officer of each of the companies. GDY Properties, Inc. was one of the entities formed by Mr. Herscho. GDY Properties, Inc. contracted with Puma Sidewalk Corporation to supply labor and concrete for a project to be developed on property in which Mr. Herscho had an interest. The contractor supplied labor and concrete valued at $270,400, none of which was paid.

The concrete contractor sued GDY Properties, Inc., and other corporate entities formed by Mr. Herscho, and also sued Mr. Herscho personally for fraud. The basis of the contractor’s claims against Mr. Herscho was that he intentionally created more than thirty corporate entities that had no assets, other than the property to be developed, for the purpose of evading payment for services provided by contractors and subcontractors on properties in which he had an interest. GDY Properties counterclaimed against the concrete contractor for defective workmanship, claiming damages of $250,000.

Mr. Herscho made a motion for summary judgment, seeking to have the claims against him dismissed. According to Mr. Herscho, since he did not personally contract with Puma Sidewalk Corporation, he could not be held personally liable for the debts of GDY Properties.

Decision

The court denied Mr. Herscho's motion for summary judgment. In so ruling, the court first noted that simple allegations that an individual dominates a corporation are inadequate to establish personal liability, since that could be said about virtually any single-person corporation. Rather, the court noted that the party seeking to "pierce the corporate veil" to establish personal liability must also establish that the owner, through his domination, abused the privilege of doing business in the corporate form. The factors to be considered in determining whether or not there has been such an abuse include whether there was a failure to adhere to corporate formalities, inadequate capitalization, commingling of assets, and the use of corporate funds for personal use.

In this case, the court noted that Mr. Herscho failed to produce any corporate records, failed to show in any meaningful way that the entities he formed were operated separate and apart from one another, and acknowledged that funds from multiple entities were intermingled without any distinction between or among corporate or limited liability companies. Whether or not this conduct was such as to constitute a conspiracy to defraud the contractor, or to warrant piercing the corporate veil was a factual question, which required a trial.

The court dismissed the counterclaim for defective workmanship since no evidence was produced to substantiate this claim.

Comment

The corporate form is a legitimate means of avoiding personal liability, and a corporation may be organized for the very purpose of avoiding personal liability. However, a court may pierce the corporate veil or disregard the corporate form where the corporate owner commits a fraud by means of a corporate vehicle. As this case demonstrates, if a corporation is formed as a "dummy" by the individual stockholders for the purpose of evading payment to contractors and subcontractors for services provided by them, the stockholders will be held personally liable for these corporate debts.

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