When Are Officers and Directors Personally Liable in Texas?

The default: the entity answers, not the person

A corporation or LLC exists so that the people who run and own it are not personally responsible for its obligations. Texas law states this directly. Section 101.114 of the Business Organizations Code provides that a member or manager of an LLC is not liable for a debt, obligation or liability of the company, including one arising from a judgment. For corporations, section 21.223 provides that a shareholder or affiliate is not liable for any contractual obligation of the corporation on the basis of alter ego, actual or constructive fraud, sham to perpetrate a fraud or a similar theory, nor for failure to observe corporate formalities. Section 101.002 applies those corporate provisions to LLCs and their members and managers.

Section 21.224 makes that limitation exclusive: it preempts any other liability for the obligation under common law or otherwise. A creditor cannot get around it by calling the claim something else. The protection is for the company's obligations, and the rest of this article is about what it does not cover.

Situation 1: the person's own tort

The entity shield covers the company's obligations. It does not cover an individual's own wrongful acts. An officer who makes a fraudulent statement to a customer, a manager who converts a vendor's property, a director who defames a competitor, is personally liable for that tort, even though it was committed in the course of the company's business and for its benefit. The company may be liable too, as the principal, but the agent's own liability is direct. This is why fraud suits against companies almost always name the individual who spoke.

The point is often misunderstood by owners who believe the LLC protects them from anything. It protects them from the LLC's debts. It does not protect them from a judgment for fraud they committed personally. The defense of a fraud claim against an individual is covered in how to defend a business fraud claim.

Situation 2: fiduciary duties to the company and its owners

Directors and officers owe the corporation duties of care, loyalty and obedience; LLC managers and managing members owe duties the company agreement defines, within the limits of section 101.401, and the common law fills gaps. Breach of those duties is a personal liability to the company, enforced by the company or derivatively by its owners. Two doctrines limit it.

The business judgment rule

Texas courts do not second-guess honest business decisions that turn out badly. In Sneed v. Webre (Tex. 2015) the Texas Supreme Court reaffirmed that the business judgment rule protects corporate officers and directors from liability for acts within the honest exercise of their business judgment and discretion, and that it bars claims for negligence, unwise decisions or honest mistakes. It does not protect fraud, self-dealing, ultra vires acts, or decisions made in bad faith. A director who approved an acquisition that lost money after reasonable deliberation is protected; a director who approved a contract with his own company at an inflated price is not.

Exculpation in the certificate of formation

Section 7.001 of the Business Organizations Code allows a corporation's certificate of formation, or an LLC's certificate or company agreement, to limit or eliminate a governing person's liability to the organization or its owners for monetary damages for acts or omissions in that capacity. Many Texas companies include such a clause. But section 7.001(c) lists what the clause cannot cover: a breach of the duty of loyalty; an act or omission not in good faith that constitutes a breach of duty, or that involves intentional misconduct or a knowing violation of law; a transaction from which the person received an improper benefit; and an act or omission for which liability is expressly provided by statute. In practice the clause eliminates liability for ordinary negligence and leaves intact exactly the claims that business disputes are about: disloyalty, self-dealing and bad faith. The duties themselves are covered in what fiduciary duties partners and LLC managers owe in Texas.

Situation 3: statutes that name the individual

Section 21.225 says the limitation of liability does not apply where the person is otherwise liable under the Business Organizations Code or another statute. Several Texas statutes impose personal liability on the people who control a company's money.

• The Construction Trust Fund Act. Under section 162.002 of the Property Code, an officer, director or agent of a contractor, subcontractor or owner who receives construction payments, or who has control or direction of them, is a trustee of those funds. Misapplication of trust funds is a personal liability of that individual, and in some cases a crime. The statute is explained in the Texas Construction Trust Fund Act.
• Trust-fund taxes. Section 111.016 of the Tax Code makes an individual who controls or supervises the collection of sales tax or other collected taxes, or the accounting for and paying over of them, personally liable as a responsible individual if they willfully fail to pay them over. The definition expressly includes officers, managers, directors and employees. Federal law imposes a parallel trust-fund recovery penalty on responsible persons for withheld payroll taxes.
• Other statutes. Securities statutes impose liability on control persons and on individuals who make or aid violations. Wage statutes can reach individuals in some circumstances. Each statute has its own definition of who is liable and for what, and the certificate of formation cannot waive liability a statute expressly imposes.

Situation 4: piercing the veil

Veil piercing is the exception people think of first and the one that applies least often. For contractual obligations of a corporation or LLC, section 21.223(b) permits liability only where the claimant proves that the owner or affiliate caused the entity to be used to perpetrate, and did perpetrate, an actual fraud on the claimant primarily for the direct personal benefit of that owner or affiliate. Undercapitalization, commingling and ignoring formalities are not enough on their own. For tort claims, the statute's text covers contractual obligations, and courts continue to apply the common-law standards, but the actual-fraud requirement dominates in practice. Section 21.225 preserves liability where the person expressly assumed the obligation or agreed to be personally liable for it, which is the ordinary route creditors use: a personal guaranty. The doctrine is covered in when a Texas court holds an owner personally liable.

Example

Suppose a Dallas commercial roofing company, an LLC, fails with unpaid subcontractors, an unpaid supplier and a customer who was told the job was "fully permitted" when it was not. Its managing member faces four different questions. The supplier's contract claim against him fails under sections 101.114 and 21.223 unless he signed a guaranty or the supplier can prove actual fraud for his personal benefit. The subcontractors' claim that he paid himself from the owner's progress payments before paying them is a Construction Trust Fund Act claim against him personally, because he controlled the trust funds. The customer's fraud claim about the permit is against him personally if he made the statement knowing it was false, regardless of the entity. And if the company collected sales tax on materials and he directed that it be used for payroll, the Comptroller's claim under section 111.016 is his too. The entity protects him from exactly one of the four.

Indemnification and insurance

Chapter 8 of the Business Organizations Code governs when a company may, and in some cases must, indemnify its governing persons for liabilities incurred in that role, and permits it to buy directors and officers insurance. Indemnification is generally unavailable for liability to the company itself for willful misconduct or improper personal benefit, and D&O policies exclude adjudicated fraud and personal profit while typically advancing defense costs until then. An officer named personally should give notice under any D&O policy and review the company agreement's indemnification terms in the first week.

For owners deciding whether to sue the individuals

Naming the people behind the company is justified when there is a personal tort, a fiduciary breach, a statute that reaches them, or a guaranty. It is not justified merely because the company cannot pay, and a veil-piercing count without facts showing actual fraud for personal benefit invites early dismissal and, under some fee statutes, a fee award against the plaintiff. Facts about who made which statement, who controlled which funds, and who benefited personally should be gathered before the individuals are sued, not after. Tina Wysk represents officers, directors and the companies and owners who sue them in fiduciary duty litigation in Dallas state and federal courts.