When Can a Texas Court Hold an Owner Personally Liable? Piercing the Veil

The starting point: the shield is the rule

A corporation's shareholders and an LLC's members are not liable for the entity's debts. Section 101.114 says so for LLC members and managers, including judgments against the company, except as the company agreement specifically provides otherwise. 'Piercing the veil' is the name for the exceptional case in which a court disregards the entity and holds an owner liable anyway. In Texas that exception has been narrowed by statute more than in most states, and the first question in any veil case is whether the claim against the company sounds in contract or in tort, because the statute governs one and not the other.

Contract claims: the actual-fraud requirement

Section 21.223(a) provides that a holder, owner or subscriber of shares, or an affiliate, may not be held liable to the corporation or its obligees for 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. Subsection (a)(3) adds that failing to observe corporate formalities, including the Code's requirements, the certificate of formation or the bylaws, is not a basis for liability either.

Section 21.223(b) states the one exception for contract claims. The limitation does not apply if the obligee demonstrates that the holder 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. Both elements must be proven: an actual fraud on this creditor, and a direct personal benefit to this owner. Section 21.224 then makes the statutory liability exclusive: it preempts any other liability imposed for that obligation under common law or otherwise.

'Actual fraud' in this context means dishonesty of purpose or intent to deceive, not the looser 'constructive fraud' of unfairness or a breach of duty. Undercapitalizing the company, commingling funds and running it informally are not actual fraud by themselves. Using the company to take a deposit the owner never intended to earn, moving the company's receivables to himself to defeat a known creditor, or lying about the company's assets to induce the contract can be.

LLCs

Section 101.002 applies sections 21.223 through 21.226 to LLCs, their members, owners, assignees, affiliates and subscribers, reading 'shares' to include membership interests, 'shareholder' to include members and assignees, 'directors' to include managers or managing members, and 'bylaws' to include the company agreement. The protection is the same and so is the exception. A creditor of a Texas LLC must prove actual fraud for the member's direct personal benefit to reach him on a contract debt, and the LLC's lack of meetings, minutes or separate stationery is irrelevant.

Tort claims

Section 21.223 speaks to contractual obligations and matters relating to them. Where the claim against the company is in tort, for example a negligence or fraud claim that does not arise from a contract with the plaintiff, Texas courts continue to apply the common-law veil-piercing analysis, which asks whether the entity was in fact the owner's alter ego or was used as a sham to perpetrate a fraud, considering factors such as the degree to which the entity's finances and property were kept separate from the owner's, whether the entity was undercapitalized for its business, and whether the owner treated the entity's assets as his own. The line between contract and tort is contested in these cases, because a plaintiff who can frame the claim in tort escapes the actual-fraud requirement, and a defendant who can tie it to the contract invokes section 21.224's preemption.

The ways around the veil that are not veil piercing

Most owners who end up personally liable get there without any piercing, and creditors should look here first.

• Personal guaranty. Section 21.225 preserves liability of an owner who expressly assumes or agrees to be personally liable for the obligation. A signed guaranty on a lease, loan or supply agreement is the most common route; see personal guaranties on commercial leases.
• The owner's own conduct. A person who personally commits fraud, converts property or makes a negligent misrepresentation is liable for his own tort regardless of the entity; see when officers and directors are personally liable in Texas.
• Statutes imposing liability. Section 21.225 also preserves liability under the Code or another statute. Examples include the Texas Construction Trust Fund Act for misapplied construction payments, and section 101.206's duty of a member who knowingly received an unlawful distribution to return it.
• Fraudulent transfers. When the company's assets were moved to the owner or a new entity to defeat creditors, the Texas Uniform Fraudulent Transfer Act (Business and Commerce Code chapter 24) allows the creditor to avoid the transfer and recover the asset or its value from the transferee, without piercing anything; see recovering business assets through constructive trusts and tracing.
• Successor liability. A new company that is a mere continuation of the old one, with the same owners, business and assets, can be reached under successor doctrines in limited circumstances.

Example

Suppose a Dallas remodeling LLC takes a $60,000 deposit from a homeowner, performs almost nothing, and shuts down. The homeowner obtains a judgment against the LLC and finds no assets. Reaching the sole member on the contract requires proof under section 21.223(b) that the member caused the LLC to be used to perpetrate an actual fraud on the homeowner primarily for his direct personal benefit. If bank records show the deposit was transferred to the member's personal account the week it arrived, that the member had already decided to close the business, and that he told the homeowner the project was 'scheduled' while taking other deposits the same way, a jury could find actual fraud for his direct benefit. If instead the LLC spent the deposit on subcontractors for other jobs and failed because of poor management, the veil almost certainly holds, and the homeowner's better route is the Construction Trust Fund Act, which imposes personal liability on those who misapply construction funds, or a fraudulent transfer claim if assets were moved out.

What a creditor must prove, and how

1. An obligation of the entity. Usually a judgment, though the veil claim can be pleaded in the same suit.
2. Classification. Contract or tort, which decides whether section 21.223 governs.
3. For contract claims, actual fraud on you. Specific misrepresentations or concealment, with intent, aimed at you, on which you relied.
4. Direct personal benefit to the owner. Tracing: bank records showing the money or asset reached the owner, not merely the company.
5. For tort claims, the alter ego factors. Commingling, undercapitalization, the owner's use of company property as his own, and the absence of any real separation.

Veil piercing is a question for the fact finder and is pleaded as a basis for liability on the underlying claim, not as a stand-alone cause of action. Post-judgment discovery into the company's and the owner's finances is how the tracing evidence is usually obtained; the tools are in how to collect a judgment against a business in Texas.

For owners: what actually protects you

Not the formalities, since section 21.223(a)(3) says their absence is not a basis for liability. What protects an owner is the absence of actual fraud: dealing honestly with the people the company contracts with, keeping the company's money in the company's account and the owner's in his own, documenting any distributions and loans, and not moving assets out when a creditor appears. Personal guaranties, not veil piercing, are how most Dallas business owners end up personally liable, and reading before signing is the real defense.

Which court

District court, ordinarily. An action seeking to hold an owner or governing person liable for an organization's obligation, other than under a written contract he signed in another capacity, is within the Texas Business Court's concurrent jurisdiction when more than $5 million is in controversy (Government Code section 25A.004(b)(6)). Veil claims also appear in federal court when the underlying case is there on diversity or a federal question.

When to involve a litigator

Before the lawsuit against the company is filed, not after the judgment proves uncollectible. The fraud evidence and the tracing are gathered in discovery, the pleading must allege the veil theory and the fraudulent transfer alternative, and the contract-versus-tort framing is decided at the outset. Tina Wysk represents creditors seeking to reach owners and owners defending against it, in Dallas state and federal courts.