Personal Liability of Corporate Officers and Directors

The reason people form corporations is to keep business obligations away from personal assets. That protection is real, and it holds in most situations. But it has specific, well-defined holes, and officers fall into them regularly, usually while trying to keep a struggling company alive. An executive who prioritized payroll over the payroll tax deposit, or who kept operating while directing which creditors got paid, can end up personally liable for amounts the company itself could never pay.

The Law Offices of Albert Goodwin defends officers, directors, and controlling members in New York City against claims that seek to reach them personally, and advises executives on limiting that exposure while they still can.

Trust Fund Taxes: The Largest and Most Common Exposure

Money withheld from employee paychecks for income tax and the employee share of employment taxes does not belong to the company. It is held in trust for the government. When a company withholds those amounts and fails to remit them, the government does not simply become an unsecured creditor. It looks for a person.

Under Internal Revenue Code section 6672, any person responsible for collecting, accounting for, and paying over withheld taxes who willfully fails to do so is personally liable for a penalty equal to the full amount of the unpaid trust fund taxes. Two elements matter:

• Responsible person is a functional test, not a title. Courts look at authority over financial affairs, check signing authority, the ability to decide which creditors get paid, involvement in day to day management, hiring and firing authority, and stock ownership. A controller with signing authority can be a responsible person. So can an officer who never touched the books but had the authority to direct payment.
• Willfulness does not require an intent to defraud. It generally means knowing the taxes were unpaid and using available funds to pay other creditors instead. This is the element that surprises executives, because paying employees, landlords, and vendors to keep the business alive is precisely the conduct that establishes it.

Assessment follows an interview and a determination, and there is a window to protest before the penalty is assessed and collection begins. That window is the best opportunity to establish that you lacked authority, that funds were encumbered, or that another person made the decisions. Multiple responsible persons can each be assessed the full amount, with the government collecting only once in total, and contribution rights among them exist but are cumbersome.

New York Trust Fund and Sales Tax

New York applies parallel rules, and its sales tax provision is broader than most executives realize. Under Tax Law section 1133, persons required to collect sales tax, defined to include certain officers, directors, and employees of a corporation who are under a duty to act for the corporation, are personally liable for the tax. For limited liability companies, members can face liability under rules that are stricter still, though relief provisions exist for certain minority members who did not participate in management. Withholding tax carries its own responsible person liability under the Tax Law.

A New York sales tax assessment against an officer is frequently larger than the federal exposure for a retail, restaurant, or hospitality business, and the Department of Taxation and Finance pursues these assessments aggressively. Responding at the audit and conciliation stage, rather than after a warrant is filed, materially changes the outcome.

Unpaid Wages

Executives can be personally liable for employee wages through three separate routes.

Individual employer status. The Fair Labor Standards Act and the New York Labor Law define employer broadly, and courts apply an economic reality analysis considering whether the individual had power to hire and fire, supervised and controlled work schedules or conditions of employment, determined the rate and method of payment, and maintained employment records. An officer with operational control over pay practices can be a joint employer and jointly liable for unpaid overtime, minimum wage, liquidated damages, and attorney fees. Corporate formalities do not defeat this.

Business Corporation Law section 630. The ten largest shareholders of a New York corporation whose stock is not publicly traded are jointly and severally liable for unpaid wages and salaries owed to the corporation's employees. This liability runs to shareholders rather than to officers as such, but founders and senior executives are frequently both. The statute contains notice requirements and time limits that must be satisfied by the employee, and those requirements are a genuine defense when they are not met.

Limited Liability Company Law section 609. A parallel provision makes the ten members with the largest ownership interests in a New York LLC personally liable for wages and salaries owed to the LLC's employees, again subject to notice and timing conditions.

See unpaid overtime claims and final paycheck claims.

Breach of Fiduciary Duty

Officers owe the corporation duties of care and loyalty. Claims arise from self-dealing, taking a corporate opportunity, competing while still employed, approving transactions with an undisclosed personal interest, and, less often, decisions that are challenged as uninformed. The business judgment rule protects informed, disinterested, good faith decisions, and it is a strong protection, which is why plaintiffs work to plead around it by alleging interest, bad faith, or a failure to inform.

Two New York doctrines deserve specific attention because they are unusually harsh:

• The faithless servant doctrine. An employee who is disloyal may be required to forfeit compensation earned during the period of disloyalty, without regard to whether the employer suffered actual damages and without offsetting the value of services properly rendered. For a highly paid executive, this can exceed the value of the underlying claim, and it is often asserted as a counterclaim to a severance or bonus suit.
• Corporate opportunity. Pursuing a business opportunity in the company's line of business, without first presenting it, can require disgorgement of the profits, and the analysis does not turn on whether the company could have afforded to take it.

See breach of fiduciary duty and shareholder derivative actions.

Veil Piercing and Alter Ego

Creditors seeking to reach owners personally must show complete domination of the entity with respect to the transaction at issue, and that the domination was used to commit a wrong causing injury. New York courts do not pierce lightly, but the factors are the familiar ones: commingled funds, undercapitalization, disregard of formalities, use of corporate assets for personal purposes, and the absence of separate books. Executives who are also owners should assume that every personal expense run through the company will be exhibited in the complaint. See piercing the corporate veil.

Guaranties and Signature Exposure

The most straightforward personal liability is contractual. Officers sign leases, credit agreements, equipment leases, and vendor credit applications, and many of those documents contain a personal guaranty. Signing without a title, or on a signature line that is not clearly designated as representative, can create individual liability on the contract itself. Where a guaranty exists, whether it was limited in amount or duration, whether the underlying obligation was materially modified, and whether the guarantor gave notice of revocation are the questions that matter. See personal guaranty defense.

Other Statutory Exposure

• Discrimination and harassment. Individual liability exists under the New York State and New York City Human Rights Laws, including on an aiding and abetting theory, and it does not require that the individual be the employer. See individual liability of supervisors and managers.
• Environmental and safety statutes, which impose liability on individuals who had authority over the conduct at issue.
• Fraudulent conveyance claims against officers who directed transfers out of an insolvent company.
• Unpaid benefit contributions, where an individual exercised control over plan assets and can be treated as a fiduciary under federal benefits law.

Protecting Yourself

The practical measures are unglamorous and effective. Confirm that payroll taxes are actually being deposited, in writing, and escalate in writing if they are not, because the documentary record of your objection is what separates a responsible person from a liable one. Do not sign anything personally without knowing that you are. Keep entity funds and personal funds strictly separate. Ensure the D&O policy exists and covers you, and that an adequate tail is purchased on any sale or wind-down. Get an indemnification agreement, not just bylaw language. And when a company begins to fail, get advice before deciding which creditors to pay, because those decisions are the ones that create personal liability later. See indemnification and D&O coverage.

You can contact us by phone at 212-233-1233 or by email at [email protected].