Maintaining and Piercing Limited Liability: Alter Ego, Successor Liability, and Contempt

One of the most common benefits of organizing or incorporating your business venture into an entity (such as a corporation or a limited liability company) is that the law can limit your personal liability for the business’s liabilities to the amount of your investment in that entity.2 This is called limited liability. What this means in practical terms is that, if a creditor successfully sues your entity for an unpaid debt or other liability, that judgment creditor3, while able to lay claim to your business’s assets will not be able to obtain your personal assets simply because you are an owner or officer of the entity. Those assets are shielded behind what is often referred to as the corporate veil4 and inaccessible to the judgment creditor—so long as you have not taken steps to reduce or eliminate the effectiveness of the corporate veil.

Because of this advantage, the corporate form is open to abuse. Some have attempted to use their entity as a shell to stash away their liabilities while draining the assets and profits out of the company for their own personal use. Others have used an entity to hold the business obligations before transferring its business, management, and unencumbered assets to a newly organized entity, free of these obligations. Then, there are others still that may refuse to obey a court’s order directing the entity to do something on the belief that the individual is not the entity and, therefore, not liable for the entity’s inaction. Are such people still protected by limited liability? Is there ever additional recourse for the creditor? If so, is there a way to decrease your exposure to the risks of operating a legitimate business?

This section discuses three legal theories under which business owners and officers may be held liable for the acts (or inaction) of the business entity notwithstanding the typical protections of the corporate veil: (1) Alter Ego; (2) Successor Liability; and (3) Contempt.

Alter Ego
The first potential exception to limited liability is where the entity is nothing more than the alter ego of the owner.5 If a party successfully obtains a judgment that the entity is the alter ego of the owner, the complaining party will then be permitted to pierce the corporate veil6 and satisfy the judgment against the owner, personally. Under Utah law7, courts evaluate the alter ego theory of liability8 under the two-pronged

Norman test:

there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, viz., the corporation is, in fact, the alter ego of one or a few individuals; and (2) the observance of the corporate form would sanction a fraud, promote injustice, or an inequitable result would follow.

Lowry, 2012 UT 39, ¶ 14 (quoting Norman v. Murray First Thrift & Loan Co., 596 P.2d 1028, 1030 (Utah 1979)).

What does this mean? And how do courts evaluate these two prongs? Utah courts look to the following nonexclusive factors in deciding whether the Norman test is met:9

(1) undercapitalization of a one-man corporation; (2) failure to observe corporate formalities; (3) nonpayment of dividends;

siphoning of corporate funds by the dominant stockholder;
nonfunctioning of other officers or directors; (6) absence of corporate records; (7) the use of the corporation as a facade for operations of the dominant stockholder or stockholders; and (8) the use of the corporate entity in promoting injustice or fraud.

Lowry, 2012 UT 39, ¶¶ 16, 20 (quoting Colman v. Colman, 743 P.2d

782, 786 (Utah Ct.App.1987)).

Defending against (or proving) that someone has used a business as their alter ego generally requires significant fact discovery and an factually intensive analysis. This can be very expensive. As such, it is important that business owners keep the above Colman factors in mind as you run your business.

Successor Liability
As your business develops, your company may acquire assets from another company. But, what about the liabilities of the transferring company? Does acquiring assets from another company put your business at risk for those liabilities? What happens if another entity owes you money and begins transferring its assets to another entity before shuttering its doors along with its unpaid debts?

Generally, where a “company sells or otherwise transfers all its assets to another company, the latter is not responsible for the debts and liabilities of the transferor.”10 As always, however, there are exceptions to this rule. The transferee (purchaser) is liable for the debts and liabilities of the transferor (seller) if:

the purchaser expressly or impliedly agrees to assume such debts; (2) the transaction amounts to a consolidation or merger of the seller and purchaser; (3) the purchasing corporation is merely a continuation of the selling corporation; or (4) the transaction is entered into fraudulently in order to escape liability for such debts.11

Decius v. Action Collection Serv., Inc., 2004 UT App 484, ¶ 8, 105 P.3d 956.

The first exception needs no explanation. The second, or “de facto merger,” occurs where the business operation and management continue and require that the purchaser pay for the asset with its own stock. Id. In contrast, the third “mere continuation” factor analyzes not whether the business operations continue, but whether the corporate entity continues; i.e. that there exists a common identity of stock, directors, and stockholders and the existence of only one corporation at the completion of the transfer. Id. The fourth factor asks whether or not the asset transfer was colored with fraud to escape the seller’s debts.

Similar to alter ego, successor liability is a factually intensive analysis. And, depending on the precise case, the relevant law and its application may not be completely settled.12 If you find yourself in a situation where you are merging with another company or buying substantial assets of another entity, you will want to consult an attorney.

Contempt
To this point, the discussion has contemplated a dispute between two parties. What happens when the court orders an entity to comply with an order or a rule? Does that obligation fall on the officers of the company, personally? Can the court hold a person in contempt13 because the entity the person works for failed to follow the order?

Some unfortunate parties have incorrectly believed that if a court orders their entity to do something, they, as officers of the company, are not personally at risk if the entity does not comply. This is not the case. In fact, the Supreme Court of the United States has long-held that “[a] command to the corporation is in effect a command to those who are officially responsible for the conduct of its affairs.” Wilson v. United States, 221 U.S. 361, 376 (1911). Indeed, if those responsible for the entity “prevent compliance or fail to take appropriate action within their power for the performance of the corporate duty, they, no less than the corporation itself, are guilty of disobedience, and may be punished for contempt.”14 Id.; see also, Whole Living, Inc. v. Tolman, 2:03-CV-272 TS, 2004 WL 2733614 (D. Utah Nov. 29, 2004) (stating that a corporate officer who fails to take appropriate action within his or her power to see that the entity complies with a court’s orders “may appropriately be held jointly liable for the contempt”) (citations omitted) (attached hereto as Ex. 3). The Tenth Circuit reiterated this statement of the law many times. See e.g., F.T.C. v. Kuykendall, 371 F.3d 745, 759 (10th Cir. 2004) (quoting Wilson and reemphasizing that “an individual who is responsible for insuring that a corporation complies with a court order cannot escape liability merely by removing himself from the day-to-day operations of the corporation and washing his hands of responsibility”); see also, United States v. Voss, 82 F.3d 1521, 1525 (10th Cir. 1996) (with discussion from other jurisdictions).

Utah follows the federal approach. It is now well-established that “[a]n officer or any other agent of a corporation may be personally as responsible as the corporation itself for tortious acts when participating in the wrongdoing ” d’Elia v. Rice Dev., Inc., 2006 UT App 416,

¶¶ 39, 43, 147 P.3d 515 holding modified on other grounds by Jones & Trevor Mktg., Inc. v. Lowry, 2012 UT 39, 284 P.3d 630 (further holding that the “imposition of personal liability on corporate officers who participate in a corporation’s tortious acts also applies to limited liability members or managers”) (citations omitted); 15 see also, Bennett v. Huish, 2007 UT App 19, ¶48, 155 P.3d 917 (“[A] corporate officer or director can incur personal liability for his own acts even though the action is done in furtherance of the corporate business.”).16

The takeaway here is rather straightforward: If the court orders your business entity to do something and it is within your responsibility to comply—do it. Otherwise, the court may hold you personally responsible.

SUMMARY:
The protection of limited liability has its limits. To protect yourself:

Manage the business as a separate entity from yourself to protect against someone piercing the corporate veil;
When selling or buying substantial assets from another company, hire an attorney that will ensure that the transaction is appropriately structured to avoid unwanted liability;
If a court orders your entity to do something and you are in a position of responsibility to comply with that order, do it.