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Obligations of the Corporate Status

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James Irving
BKK Business Law Newsletter
November 2015

One of the principal reasons business owners form a corporation (or an LLC) is to shield the owners’ personal assets from attack by creditors of the business. However, the corporate shield is not absolute; while judges are loath to pierce it, they will – and may have an obligation to – if the owners of the entity fail to comply with corporate formalities and/or treat its assets as their own. Atron and Karen Rowe learned this difficult lesson when Judge James C. Cacheris entered judgment against them individually upon Plaintiff’s Motion for Summary Judgment in Heitech Services v. Front Rowe, Inc. The case arose in the United States District Court for the Eastern District of Virginia. 

In 1997, the Rowes, husband and wife, formed Front Rowe, Inc. (“FRI”), an information technology company operating in Fairfax, Virginia. In the regular course of business, Front Rowe entered into a contract with Heitech Services, Inc. FRI allegedly breached the contract and Heitech sued for damages. In December 2014, judgment was entered in favor of Heitech and against FRI in the amount of $450,421, but the court deferred a ruling on the Plaintiff’s request to pierce the corporate veil until June 5, 2015, when the Court issued its final ruling. In it, Judge Cacheris found it appropriate to “pierce the corporate veil and hold the individual defendants liable” for FRI’s contractual obligation to Heitech. 

The June ruling contained the court’s findings that, among other things, the Rowe’s commingled their personal funds with FRI’s, “regularly siphoned business assets into their personal accounts,” and took money out of the company account to pay their basic living expenses. Evidence also showed that FRI was undercapitalized during this period, that FRI was not making payments on its invoices when due and that the company was not observing the business formalities prescribed by law. 

The Rowes’ absence of any apparent effort to comply with the requirements of proper corporate governance seems to make Front Rowe an easy case, which it may be, but that conclusion may obscure the risk that every company exposes itself to when it fails to adhere scrupulously to the niceties of corporate formality. At the most obvious level, co-mingling personal and corporate assets courts a degree of legal risk that no rational businessperson should accept. It’s equally true that prudent management requires careful maintenance of reasonable capitalization and attentiveness to the corporate formalities required by statute - such as conducting annual meetings, electing officers and directors annually and maintaining compliance with SCC filing requirements. 

Corporate status and the liability shield it provides is a common law development of ancient pedigree. It persists because lawgivers continue to recognize that immunity from personal liability facilitates commerce which benefits our society as a whole. It’s a mistake, however, to assume that this freedom comes without responsibilities.