Forming an entity, such as a corporation, limited partnership or limited liability company, is an important and commonly used way for an individual to shield himself or herself from personal liability for acts taken on behalf of the entity. However, there are exceptions in which an individual may be held personally liable.
One such way is if an opposing party can successfully pierce the corporate veil. In the typical case of piercing the corporate veil, the plaintiff seeks to hold an individual officer, director or shareholder liable for the actions of the corporation. This is not easily proven, and generally only applies if the plaintiff can prove the owner exercised complete control over the corporation with respect to the transaction at issue and such control was used to commit a fraud or wrong that injured the party seeking to pierce the veil.
Under current statutory law in Texas, a shareholder or owner of any beneficial interest in shares “may not be held liable to the corporation or its obligees with respect to . . . any contractual obligation of the corporation or any matter relating to or arising from the obligation on the basis that the holder . . . is or was the alter ego of the corporation or on the basis of actual or constructive fraud, a sham to perpetrate a fraud, or other similar theory; or any obligation of the corporation on the basis of the failure of the corporation to observe any corporate formality.” Willis v. Donnelly, 199 S.W.3d 262, 272 (Tex. 2006) (quoting Tex. Bus. Org. Code § 21.223(a)). The liability of a shareholder or owner of any beneficial interest in shares of a corporation for an obligation that is limited by Section 21.223 “is exclusive and preempts any other liability imposed for that obligation under common law or otherwise.” Willis, 199 S.W.3d at 272 (quoting Tex. Bus. Org. Code § 21.224).
However, there is a statutory exception which allows the shareholder to be liable if he “caused the corporation to be used for the purpose of perpetrating and did perpetrate an actual fraud on the obligee primarily for the direct personal benefit of the holder.” Willis, 199 S.W.3d at 272 (quoting Tex. Bus. Org. Code § 21.223(b)). Thus, a plaintiff must typically prove actual fraud to hold an individual liable in Texas under a piercing of the corporate veil theory.
However, there is another important statute in Texas that subjects officers and directors to liability if their entity does not pay its franchise taxes when due. Tex. Tax Code § 171.251, et. seq. Specifically, when the corporate privileges of a corporation are forfeited for the failure to file a report or pay a tax or penalty, each director or officer of the corporation is personally liable for each debt of the corporation that is created or incurred in this state after the date on which the report, tax, or penalty is due and before the corporate privileges are revived. Tex. Tax Code § 171.255(a). If a corporation’s charter or certificate of authority and its corporate privileges are forfeited and revived under this chapter, the liability under this section of a director or officer of the corporation is not affected by the revival of the charter or certificate and the corporate privileges. Tex. Tax Code § 171.255(d).
In 2008, the Texas Legislature added Section 171.2515 to the Texas Tax Code, so that it now includes all “taxable entities;” therefore, in addition to corporations, this personal liability likewise extends to officers and directors of most other entities in Texas, including limited partnerships, limited liability companies, limited liability partnerships, professional associations, joint ventures, and holding companies.
Officers and directors are not required to have personally participated in the transaction resulting in the corporate debt to be held personally liable. However, the statute contains a safe harbor for officers and directors. A director or officer is not liable for a debt of the corporation if the director or officer shows: (1) that the debt was created or incurred over the director’s objection or without the director’s knowledge; and (2) that the exercise of reasonable diligence to become acquainted with the affairs of the corporation would not have revealed the intention to create the debt. Tex. Tax Code § 171.255(c).
It is important in determining personal liability to ascertain the date on which the corporate debt is created or incurred. Personal liability attaches only to those directors and officers of the entity at the time the debt is created or incurred because they have abused the corporate privilege by continuing to create and incur debts after the franchise tax is delinquent and are, therefore, culpable. See PACCAR Fin. Corp. v. Potter, 239 S.W.3d 879 (Tex. App. – Dallas 2007, reh’g overruled). Furthermore, courts have held that personal liability under the statute applies only to debts contracted after the forfeiture of the right to do business and does not apply to the renewal of obligations that arose prior to that date.
It therefore should go without saying that any entity operating in the state of Texas must always ensure that its franchise taxes are paid timely. If not, its officers and directors could be held personally liable for the entity’s debts.