A key reason you might form a corporation or limited liability company (LLC) is to protect your personal assets from any business debts. Under New York law a corporation or LLC is treated as a separate “person” from its owners. In general, that means a debt owed by the business is not the personal responsibility of a shareholder or, in the case of an LLC, a member.
But, this is not an absolute rule. New York courts may “disregard the corporate form”--otherwise known as “piercing the corporate veil”--in certain limited circumstances. In piercing the corporate veil, a court may assign the corporation or LLC's liability to an individual owner. This does not mean there is a separate debt owed by the owner; rather, he or she is held personally responsible for a debt owed by the business.
AZTE, Inc. v. Auto Collection, Inc.
Here is a recent example from a New York appeals court decision. This was a fairly straightforward breach of contract case. The plaintiff paid the defendants—a corporation and its principal shareholder—for some merchandise. The defendants failed to deliver the merchandise. The plaintiffs sued to recover their payments. Brooklyn Supreme Court, trying the case without a jury, ruled for the plaintiffs and ordered damages in excess of $500,000.
Of note here, the Supreme Court held the shareholder personally liable for the business debt, thus piercing the corporate veil. The Appellate Division, Second Department, upheld the Supreme Court's decision in an opinion dated January 28th of this year. The Second Department held the evidence produced at trial justified holding the shareholder liable.
The New York Court of Appeals has established a two-part test for piercing the corporate veil. First, the owners must exercise “complete domination of the corporation in respect to the transaction attacked.” And, second, this domination must have been “ used to commit a fraud or wrong against the plaintiff which resulted in the plaintiff's injury.” In the present case, the Second Department said the owner not only had “domination and control” of the corporation in general—he owned 90% of the outstanding shares—but he also controlled the specific transaction at issue. The evidence further proved a fraud was committed against the plaintiff because they paid for merchandise that was never received. Based on all these factors, the Second Department said piercing the corporate veil was an appropriate legal remedy.
Again, it's important to emphasize that piercing the corporate veil does not create additional liability. The plaintiff does not recover a higher damage award by adding the business owner as a defendant. The Second Department's decision simply means the plaintiff may go after the owner's personal property—as well as the corporation's assets—in order to satisfy the judgment.
Protecting Your Business
Piercing the corporate veil is still an exception to the rule protecting corporate owners from personal liability. But, it is important to understand that limited liability protection is not an absolute. That is why when dealing with any contract matter, you should engage an experienced New York business attorney who can advise you on the best way to protect yourself from potential litigation. Contact our office right away if you would like to speak with an attorney.