Individual Liability For Corporate Debts

By: Jim Busch

Often a creditor may proceed to obtain judgment against a corporation only to find the corporation has little or no assets. Upon closer examination, the creditor may discovery that the assets of the corporation were transferred or sold by individuals controlling the corporation. The individuals controlling the corporation may also ignore the corporate entity in its day to day operation or simply use the corporation to advance their personal interests.

The State of Georgia recognizes that a corporation is a separate legal entity from its shareholders, directors and officers. Thus, the liabilities of a corporation are also separate and distinctly its own and as a general rule, shareholders, directors and officers are not personally liable for the debts of a corporation. In some limited instances, an individual member of a corporation may be held liable for the liabilities of a corporation. The limited nature of this exception is highly fact sensitive. Therefore, while it may be possible to pursue an individual for the debts of a corporation, the circumstances under which this is possible will be dictated by the particular facts of each case.

There are four general ways to impose personal liability on an individual for a corporate debt. The first method is liability imposed on corporate directors and officers. Under the Georgia Corporate Code, directors and officers are required to exercise a certain standard of care with respect to their performance of their duties. Directors and officers are required to perform their duties in a manner he or she believes in good faith to be in the best interests of the corporation and with the care of an ordinarily prudent person in a like position would exercise under similar circumstances.

Thus, when a director or officer fails to properly perform his or her duties, he or she may be individually subject to a derivative action brought by a shareholder or the corporation. In addition, when a corporation becomes insolvent, its directors are bound to manage the remaining assets for the benefit of its creditors and should not in any manner use their power to obtain a preference or advantage to themselves. A violation of this duty exposes the directors to recovery of sums improperly paid out by the corporation.

A second method whereby individual liability can arise from a corporation is in the form of debt incurred prior to incorporation. Because a corporation has no legal existence until it has actually met all formation and organizational requirements, any debts incurred by a corporation prior to incorporation are subject to personal liability.

However, it is important to note that a creditor may be prevented from denying the existence of a corporation when the creditor has treated the purported corporation as a legal entity capable of transacting business. Georgia Courts have held that the doctrine of corporation by estoppel, as described above, is inapplicable to transactions occurring prior to the certificate of incorporation.

It is also important to note that where a creditor extends credit to an individual, and the individual later forms a corporation, the formation of the corporation does not automatically transform the debt from the individual to the corporation. The Georgia Courts have held that this is a factual issue to be decided by the trial court.

The most common known theory of individual liability for corporate debts is the theory of piercing the corporate veil. Under this theory, the Courts allowed creditors to look beyond the corporate entity to impose personal liability upon members of the corporation as the alter ego of the corporation. It should be noted that the ability to pierce the corporate veil is exceedingly difficult. In general terms, this theory is shown by revealing that a parent corporation, corporate officers, directors or stock holders disregarded the corporate entity by commingling and confusing their personal affairs and business with those of the corporation and by treating the corporate property as their own.

The standard used by the Georgia Courts is that it must be shown that the stockholder’s disregard of the corporate entity made the corporation a mere instrumentality for the transaction of its own affairs, that there is such a unity of interest and ownership that separate personalities of the corporation and owners no longer exist and finally that to follow the doctrine of the corporate entity would promote injustice.

The final method to obtain individual liability for corporate debts is based upon fraud. Under the fraud theory, a creditor may be able to maintain an action against members of a corporation when a creditor has been defrauded by false representations. Thus, where an individual makes willful misrepresentations of material facts which are made to induce the creditor to act, and the creditor suffers damage based upon a justifiable reliance then an action for fraud may be appropriate.

A corporation generally provides a protection from individual liability. However, as outlined above, individuals within a corporation can act in such a way as to expose themselves to individual liability for the debts of a corporation.

Mr. Busch is an attorney specializing in commercial and construction litigation for Busch, Reed, Jones & Leeper, P.C. in Marietta, Georgia