Personal and Successor Liability Against a Principal and His Newly Formed Entity for Debt Incurred by the Principal's Previous, Bankrupted Company
In general, a corporation will be treated as an entity that is completely separate from its stockholders. However, in certain instances the separation may be ignored where there is a "unity of interest" of the stockholders and the corporation and where the stockholders have used the corporate structure in an attempt to avoid legal obligations. Where the stockholder co-mingles funds or runs the corporation as an extension of his own personal interests, this "corporate veil" may be "pierced" by the courts, thereby holding the stockholder liable for obligations incurred by the corporation.
In Woodbridge Hills Association , the court found overwhelming evidence that the Principal treated the original roofing company as "his alter ego." The roofing company paid for his personal expenses, including club memberships, insurance premiums, his family's cellular telephone service, home cable, internet, personal vehicles, and the like. In addition, the Principal routinely made personal loans to the company without any documented promissory notes, simply writing checks to the company, and writing checks back to himself as needed. After receiving notice of a garnishment to collect on the judgment against the original roofing company, the Principal began withdrawing funds from the corporate bank accounts and placed the company into bankruptcy. The court again found the Principal's actions were taken to circumvent the collection efforts of the creditor and to shield himself from personal liability.
Shortly thereafter, the Principal started a new entity engaged in "general contracting" but performing a substantial amount of roofing work. The creditor argued that the new entity could be liable for the obligations incurred by the original roofing company under the theory of "successor liability". The traditional rule of successor liability focused on the nature of the transaction between the "predecessor" and "successor" corporations and imposed successor liability where the acquisition was accomplished by merger, with shares of stock serving as consideration. The traditional rule does not impose liability where the purchase was accomplished by an exchange of cash for assets, unless one of five narrow exceptions applies:
- Where there is an express or implied assumption of liability;
- Where the transaction amounts to a consolidation or merger;
- Where the transaction was fraudulent;
- Where some of the elements of a purchase in good faith were lacking, or where the transfer was without consideration and the creditors of the transferor were not provided for; or
- Where the transferee corporation was a mere continuation or reincarnation of the old corporation.
Similarly, the "mere continuation" doctrine forces a successor corporation to accept the predecessor's liability with the benefits of continuity where there is a continuity of enterprise between the successor and the predecessor corporations. To establish liability under the "mere continuation" doctrine, the creditor must establish:
- There is a continuation of the seller corporation, so that there is a continuity of management, personnel, physical location, assets, and general business operations of the predecessor corporation;
- The predecessor corporation ceases its ordinary business operations, liquidates, and dissolves as soon as legally and practically possible; and
- The purchasing corporation assumes those liabilities and obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations of the selling corporation.
The court ultimately found liability against the new "successor" company citing that: (i) the Principal was the sole member and officer of both companies; (ii) invoices indicated that the Principal ran both corporations from home; (iii) the new entity utilizes several assets of the old entity, including vehicles purchased from the bankruptcy trustee and transferred to the new entity; (iv) both companies used the same computer; (v) the new entity maintained the same vehicle insurance policy as the old company; and (vi) the Principal simply transferred his builder's license from the old entity to the new entity.
While an "unpublished" Court of Appeals' opinion, this is one of the few Michigan appellate decisions finding liability under theories of piercing the corporate veil and successor liability, especially involving a construction company. Whether you are trying to collect against an alleged "uncollectable" company or trying to protect your own business interests, this case illustrates the importance of consulting with an attorney to maximize your chances of success.