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When Liability isn’t Limited – Avoiding Individual Liability as an Owner of a Corporation or LLC

04.13.2021

By Allegra S. Melton, Associate Attorney

I. Introduction

Generally, an owner of a construction corporation or limited liability company will not be held liable for the debts, obligations, or liabilities of the company. This means that an owner’s personal assets are not on the hook for any of the obligations of the entity. For this reason, many individuals choose to establish their business as a corporation or LLC. However, there are several instances in which Texas courts have determined that an owner is liable for the actions of the entity. Those instances typically turn on the degree of separation present between the actions of the owner and the actions of the entity. Following are some specific examples of individual liability among owners or members of corporations and LLCs. Please note, these instances give a general overview and are not exhaustive.

II. An individual will not be held liable for a corporation’s contractual obligations unless the owner fraudulently uses the corporation to gain a personal benefit.

Generally, a corporate officer’s acts on the corporation’s behalf are deemed to be acts of the corporation. See Leitch v. Hornsby, 935 S.W.2d 114, 117–18 (Tex.1996). Still, the longstanding rule in Texas is that “[a] corporation’s employee is personally liable for tortious acts which he directs or participates in during his employment.” Leyendecker & Assocs., Inc. v. Wechter, 683 S.W.2d 369, 375 (Tex.1984). The law is well-settled that a corporate agent can be held individually liable for fraudulent statements or knowing misrepresentations even when they are made in the capacity of a representative of the corporation. See, e.g., Commercial Escrow Co. v. Rockport Rebel, Inc., 778 S.W.2d 532, 541 (Tex. App.- Corpus Christi 1989, writ denied). In fact, this Court has stated:

“A corporate officer who knowingly participates in tortious or fraudulent acts may be held individually liable to third persons even though he performed the act as an agent of the corporation. It is not necessary that the ‘corporate veil’ be pierced in order to impose personal liability, as long as it is shown that the corporate officer knowingly participated in the wrongdoing.”

Id. at 541. A popular way that plaintiffs seek to pierce the veil is under an alter ego theory.

The Alter Ego Theory

The Texas Supreme Court has described the basis for piercing the corporate veil under an alter ego theory as follows: “Under the alter ego theory, courts disregard the corporate entity when there exists such unity between the corporation and individual that the corporation ceases to be separate and when holding only the corporation liable would promote injustice.” Mancorp, Inc. v. Culpepper, 802 S.W.2d 226, 228 (Tex. 1990). The total dealings between the shareholder and the corporation are relevant in determining whether there is an alter ego relationship. Id. The supreme court has held that the evidence may include “the degree to which corporate formalities and individual property have been kept separately, the amount of financial interest, ownership and control the individual maintains over the corporation, and whether the corporation has been used for personal purposes.” Id.

In 2010, the Texas legislature reacted to the opinion in Castleberry by amending the Texas Business Corporation Act (“TBCA”). The amendments to the TBCA provided that a shareholder or affiliate may not be held liable for a contractual obligation of the corporation, or any matter relating to or arising from the contractual obligation, unless the shareholder or affiliate used the corporation to perpetrate an actual fraud for the direct personal benefit of the shareholder or affiliate. Tex. Bus. Corp. Act. Art. 2.21A(2) (expired eff. Jan 1. 2010). This has been carried forward in the corporate provisions of the Business Organizations Codes (“BOC”). Tex. Bus. Orgs. Code § 21.223(a)(2) and (b).

The statutory actual fraud standard applicable in a veil-piercing case does not protect corporate shareholders/officers from liability for their own torts, even though such torts may have occurred while acting on behalf of the corporation in the context of a contractual transaction between the corporation and the plaintiff. Sanchez v. Mulvaney, 274 S.W.3d 708, 712 (Tex. App. – San Antonio 2008, no pet.).

There has been some disagreement among litigants as to how “actual fraud” should be defined when a veil piercing issue is submitted to the jury. See, e.g., Latham v. Burgher, 320 S.W.3d 602, 606-07 (Tex. App. – Dallas 2010, no pet.) (holding “dishonesty of purpose or intent to deceive” was sufficient definition of “actual fraud” for veil-piercing purposes and trial court did not err in refusing to submit instruction based on common law fraud); Dick’s Last Resort of the West End, Inc. v. Market/Ross, Ltd., 273 S.W.3d 905, 909-10 (Tex. App. – Dallas 2008, pet. denied) (rejecting argument that actual fraud instruction should include elements of tort of common law fraud); McCarthy v. Wani Venture, A.S., 251 S.W.3d 573, 584-85 (Tex. App. – Houston [1st Dist.] 2007, pet. denied) (stating that actual fraud can be concealment or failure to disclose material facts and holding trial court did not abuse its discretion in defining actual fraud based on such theory rather than requiring finding of material misrepresentation); In re Arnette (Ward Family Found. v. Arnette), 2011 WL 2292314 (Bankr. N.D. Tex. June 7, 2011) (discussing actual fraud standard under Section 21.223 of BOC and stating that actual fraud for purposes of statute is not the same as common law tort of fraud and simply requires proof of dishonesty of purpose or intent to deceive).

In Mancorp, Mancorp, Inc. sued John C. Culpepper, Jr. and Culpepper Properties, Inc. for breach of construction contract. Mancorp, 802 S.W.2d at 227. Mancorp alleged it had performed the contract by completing the work on First Bank Galleria building in Bryan, Texas, and that it was owed the unpaid balance under the contract. Id. Mancorp sought judgment against Culpepper Properties, Inc. and against John C. Culpepper, Jr. under an alter ego theory. Id. Considering all the evidence, the supreme court determined John. C. Culpepper, Jr. was liable for the debts. See Id. at 228. Among this evidence was testimony that throughout the dealings Culpepper lead Mancorp to believe it was dealing with Culpepper as an individual, Culpepper’s representation to Mancorp that he personally backed the project, and payment of corporate debts with Culpepper’s personal checks. Id.

Further, the Court reasoned that failure to pierce the corporate veil would result in an injustice. Id. at 229. “Where a corporate entity is owned or controlled by an individual who operates the company in a manner indistinguishable from his personal affairs and in a manner calculated to mislead those dealing with him to their detriment,” the corporate fiction may be disregarded to prevent injustice. Id. (citing Loomis Land & Cattle Co. v. Wood, 699 S.W.2d 594, 597 (Tex. App. – Texarkana 1985, writ ref’d n.r.e.). Accordingly, to avoid personal liability for the debts of the corporation, an owner needs to ensure that he/she separates their personal actions from the actions of the corporation. The best way to ensure this separation is by making payments from the corporation’s bank account, executing contracts as the corporate representative – not as an individual – and representing that all dealings made by the owner are made on behalf of the corporation.

III. Texas courts apply the same standards of liability to owners of a limited liability company.

A member of a limited liability company may be named as a party in an action by or against the limited liability company only if the action is brought to enforce the member’s right against or liability to the company. Tex. Bus. Orgs. Code Ann. § 101.113. Except as and to the extent the company agreement specifically provides otherwise, a member or manager is not liable for a debt, obligation, or liability of a limited liability company, including a debt, obligation, or liability under a judgment, decree, or order of a court. Tex. Bus. Orgs. Code Ann. § 101.114. In particular, a member of a limited liability company is legally distinct from the company itself, and generally, members are not individually liable for the debts of a limited liability company. Sanchez v. Mulvaney, 274 S.W.3d 708 (Tex. App. San Antonio 2008); McCarthy v. Wani Venture, A.S., 251 S.W.3d 573 (Tex. App. Houston 1st Dist. 2007).

Texas law protects members of a limited liability company from being held liable for the company’s obligations, but not the members’ own obligations. In re White-Robinson, 777 F.3d 792 (5th Cir. 2015) (applying Texas law). For example, The Supreme Court of Texas held an owner and operator of limited liability company, which operated a pipe manufacturing facility that caused groundwater contamination, could be held personally liable for civil penalties assessed against the company for violations of the Texas Water Code where the penalty provision of the Texas Water Code applied to any “person” who violated the Code, and the penalties were based on the individual actions of the owner and operator. State v. Morello, 547 S.W.3d 881 (Tex. 2018), cert. denied, 139 S. Ct. 575, 202 L. Ed. 2d 405 (2018).

The statutory protections from liability afforded to members and managers of a limited liability company give way only when a plaintiff can show that the company was used for the purpose of perpetrating, and did perpetrate, an actual fraud for the member or manager’s direct personal benefit. 15 Tex. Jur. 3d Corporations § 579. Under those circumstances, the court may pierce the corporate veil and hold the member or manager personally liable. Fin & Feather Club v. Leander, 415 S.W.3d 548 (Tex. App. Texarkana 2013) (citations omitted). Although “actual fraud” is not statutorily defined, the term is construed, for purposes of piercing the corporate veil, as involving dishonesty of purpose or intent to deceive. R&M Mixed Beverage Consultants, Inc. v. Safe Harbor Benefits, Inc., 578 S.W.3d 218 (Tex. App. El Paso 2019).

Since the basic question is the same, the same general principles applicable to actions seeking to pierce a corporate veil generally should apply to an action seeking to pierce the veil of a limited liability company, and thus, in particular, claimants seeking to pierce the veil of an limited liability company, for claims based on contractual obligations, must meet the same requirements as they would if the entity were a corporation. Lone Star Air Systems, Ltd. v. Powers, 401 S.W.3d 855 (Tex. App. Houston 14th Dist. 2013); Shook v. Walden, 368 S.W.3d 604 (Tex. App. Austin 2012).

A limited liability company member-owner is not individually liable for a breach of contract, for example, by failing to pay a subcontractor’s supplier, where there is no fraud by the member indicated. Sanchez v. Mulvaney, 274 S.W.3d 708 (Tex. App. San Antonio 2008). In contrast, however, the owners of a limited company may be jointly and severally liable where they commit fraud in the service of the company, and individual liability may be imposed where a member has used the company as a sham to perpetrate an actual fraud on a creditor primarily for the member’s direct personal benefit. McCarthy v. Wani Venture, A.S., 251 S.W.3d 573 (Tex. App. Houston 1st Dist. 2007). Therefore, owners of a limited liability company must take the same measures as owners of a corporation to separate themselves from the entity.

IV. Conclusion

Therefore, the basis for finding individual liability of an owner of a limited liability company and a corporation turns on whether the owner used the entity as a shield to carry out his/her personal business. Specifically, the owner cannot use the entity to perpetuate actual fraud and gain personal benefit. The best way to avoid personal liability is to keep the actions of the entity and the actions of the individual entirely separate. Owners should be sure to open bank accounts for the entities and use those bank accounts to pay the debts of the entities. Additionally, all contracts should be signed on behalf of the entity – not the individual – and an owner should ensure that he/she is consistently representing that he/she is acting on behalf of the entity and not on behalf of himself or herself.

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