Where are the Loopholes in Corporate Liability Limitations?

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My good friend and attorney colleague, Steven A. O’Rourke http://www.calcorplaw.com is a very sharp corporate and business lawyer. He is a guy that other attorneys go to when they want to debate the law. But he is also a guy that entrepreneurs and business owners should go to when they are concerned that they are thorough and accurate because Steve strives to be both. We often kick around concepts that affect the entrepreneurial community and below, I want to share another piece of work that Steve produced as a result of a recent conversation that we had.

Beginning of Contributor Comments:

You can reduce exposure to legal liability by learning the differences and interplay of the different legal regimes that apply to shareholders, directors and officers, respectively. When a prospective client asks me to create a corporation for which he would be (an) owner, an officer and (a) director, he usually states his purpose as wanting “personal immunity” As a matter of professionalism, I always assure the client knows the general law before I start preparing documents.

Shareholders are said to be “immune” from corporate liabilities. The California corporate statute says nothing about that; neither does the Delaware code. Indeed, for its first 60 years, the California constitution expressly provided that shareholders were liable for their pro-rata share. So, there is no structural reason why shareholders ought to be immune. Rather, each state has a presumed intention generally to immunize shareholders.

Lawyers refer to “piercing the corporate veil” (imposing corporate liability on shareholders) as an “equitable remedy”, which means that courts may pierce the veil whenever justice requires. There is no prescribed test, so “expert” articles listing the “factors” must be read with caution.

Takeaway #1: “A shareholder who has no other involvement can assume, but can never assure, shareholder immunity.”

Shareholder immunity, even if not pierced, is somewhat a misnomer because any shareholder who acts in an additional role opens himself to liability for actions in that other role.

Shareholders who are also directors are not immune from the liabilities imposed on directors. Corporate law in most states allow corporations to eliminate some, not all, bases for director liability for failing to meet the director’s fiduciary duty standard. Even when the corporate charter (some states call it the “Articles”, some say “Certificate”) or bylaws recite that the “liability of directors to the corporation are eliminated to the fullest extent permitted by law”, bear in mind that the law has many exceptions regarding the “fullest” extent. A charter’s “elimination” of liability applies only to the director’s liability “to the corporation”, not to 3rd parties such as employees, customers, suppliers, banks etc. And not for legal remedies other than payment of money. And state laws also preserve director liability for many acts.

For example, California prohibits elimination of liability for “intentional misconduct”, “absence of good faith”, “improper personal benefit”, “reckless disregard”, and a “pattern of inattention”. Consider the ease with which a director can be accused of failing to act in “good faith” or with necessary continuing “attention”.

Takeaway #2: a Director ought to seek legal advice on how to prevent, eliminate, reduce, indemnify, insure, waive or contract-away director’s liabilities.

In California, Delaware and most other states, officers have the same fiduciary duties as directors but the corporation’s charter cannot reduce or eliminate the scope of officer’s liability for breaches.

Takeaway #3: Officers ought to also seek legal advice to control liability.

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Joel’s thoughts:

1. The liability of management, whether directors or officers, is serious and must be well understood. The responsibility is far reaching as I have discussed before. See: http://tinyurl.com/crxjqw.

2. Anyone who plays ball in the corporate arena takes risk. Know the risks so that you can properly assess the required returns. Always know the facts. Play smart. And,

3. If you have any questions on these complex issues call a securities attorney. And try to become friends with a guy like Steve O’Rourke. He would be a good guy to call and get to know.

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Often dubbed a Growth Architect by his clients, Joel Block advises companies on explosive growth strategies by driving revenue and sales. Well known in the capital markets, Joel is a successful entrepreneur, speaker, advisor and faculty member of the iLearningGlobal community.