Expert: Regan Shinski - 3/11/2010

Question
I have an issue where I purchased a software product and decided I wanted to cancel the subscription because it was not useful to me.  I cancelled it within 45 days as per an unclear provision in their contract.  A year passed and now they are suing saying I have to pay for the entire year.  My company is operating in the red and has been for at least the past 6 months.  There is still no judgment, and I have already begun the process of forming a new corporation with new investors for a reason unrelated to this debt.

However, I did take distributions at some time within the past year, and I am wondering whether they would be able to hold me personally liable for the debt because I did take distributions out of the company after having accrued the debt but before having recorded a judgment, (there is still no judgment).   Will they have an opportunity to say that even though the company is currently in the red that at some point in the past year it was not and that the distributions that were taken by shareholders should be paid back to settle any judgment?

Answer
Gabriel:

This is always a very complicated area of law.  I'm going to say upfront that there is no way I can give you a 100% certain answer.  There are just too many variables including state laws, how your business was set-up, the specific contract for the subscription, and the voracity of the collector.  So I can only speak in general terms.

They would need to break your corporate veil if the contract is in the business name.  Again, depends on a lot as described above.  However, you are automatically on the hook personally if the contract is in your name, under your social security number, or if the language of the contract or application provides that you gave a personal guarantee.  A good rule of thumb would be if you provided your social security number at the time of application.  Often contracts or terms of service, will have an officer personally guarantee for the business, especially for start-up businesses.  It would be better for you if the application/extension of credit was exclusively in the business name and it's tax identification number ONLY.

Even if it is only in the business name and tax id number, they can still sue you personally.  This usually comes down to record-keeping, state laws, and how aggressive the collector is.  Remember, an aggressive collector can sue you personally whether they have a case or not.  It would be up to you to prove you are not liable at that point.  It is not uncommon for an aggressive collector to sue in these cases counting on the officer to bow down and pay out of fear or lack of legal knowledge as it pertains to the case.

If you intermingles funds, completed a lot of personal transactions in the business name, improperly advanced or loaned the business money, didn't file proper business taxes and licensing steps as required by law, or otherwise did not operate a COMPLETELY separate business operation, you POTENTIALLY could be on the hook.  A lot of things would have to fall in place for them to collect the first being a creditor that is determined enough to pursue through those complicated waters.  Many just drop it.

The specific issue of you taking a distribution does not mean they can sue you because of that reason only.  It's kind of a cumulative thing and really depends on the case, the judge and state laws.  The distribution does need to be legal, recorded, and allowed in previously filed or created corporate by-laws in most states.  It really does not matter if the company is or was in the red.  The issue is liability not the solvency of the business.  If liability is there a judgement can be made against you whether your company is like Microsoft or millions in debt.  

If you are concerned about them breaking the corporate veil, you should consult an attorney familiar with the laws in your jurisdiction and one that can personally review the relevant documents in your case.

Good luck.  I hope this helps.

Regan