Think Your Corporation Shields You From Personal Liability? Are You Sure About That?

By harley erbe


One reason why people set up business entities like corporations and limited liability companies is to shield themselves from personal liability if a legal claim is filed against the business. The general rule in Iowa is that officers, directors, shareholders, or members of a business entity are not personal liable for acts of negligence or other acts of wrongdoing committed by an employee or agent of the business. Only the business itself is normally liable, not any of the individuals associated with it. But there are exceptions to that general rule that allow for personal liability against individuals associated with a business.

In some instances under the "alter ego" theory or "piercing the corporate veil" theory, corporate shareholders can be held liable even for corporate acts that they were not involved in. That can happen in just about any type of case, including car accidents, motorcycle accidents, products liability cases, employment law matters, and construction defect cases. Let's look at the two theories.

Under the alter ego theory, a court will disregard a business entity that is merely an instrumentality or device set up to ensure the avoidance of legal obligations. A business entity is the alter ego of a person if (1) the person influences and governs the entity; (2) a unity of interest and ownership exists such that the business entity and the person cannot be separated; and (3) giving legal effect to the fictional separation between the business entity and the person would sanction a fraud or promote injustice. The "alter ego" theory is similar to and often analyzed together with the "piercing the corporate veil" theory.

Another method of disregarding the corporate entity is “piercing the corporate veil” of a corporation that is a mere shell, serving no legitimate business purpose, and used primarily as an intermediary to perpetuate fraud or promote injustice. Courts will look at several factors in deciding whether the protection from personal liability has been forfeited under the "piercing" theory. First, is the corporation adequately capitalized? Second, did the corporate participants follow corporate formalities? Third, did the corporation keep separate books?  Fourth, were corporate finances kept separate from individual finances, or did the corporation pay individual obligations? Fifth, was the corporation used to promote fraud or illegality? Finally, was the corporation a mere sham? No one factor is determinative, and not all of them have to be present for a court to determine that personal liability for business acts is appropriate.

In certain types of cases (usually not contract or warranty claims though) there's another way to get around a business and directly at the people responsible for any wrongdoing. Business employees and agents are not immune from personal liability for their own wrongful acts. That includes actions that occurred while the agent or employee was acting within an official business capacity. Therefore, regardless of whether a business entity can be disregarded and personal liability imposed under the theories discussed above, business employees and agents cannot escape liability for any negligent or intentionally wrongful conduct that they were personally or directly involved in.

By Harley Erbe

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