Gaps in the “Corporate Veil” Create Personal Liability When You Ignore Franchise Taxes
“There was a Door to which I found no key; There was a Veil through which I could not see;”
from Rubaiyat of Omar Khayyam (translated by Edward Fitzgerald)
The concept that the owners of a corporation or limited liability company do not have personal liability for the obligations of the entity is an axiom of corporate law. By forming a legal entity for the conduct of business, the business’s owners are insulated from individual liability for the debts and obligations of the business. This separation of liability is known as the “corporate veil.”
Once the corporate veil is in place, a business owner can rest assured that any attempt by a creditor to hold the owner individually liable for the business’s debts will fail—except when it doesn’t.
An often-overlooked exception to the limited liability of a business’s owners can be found in the Texas Tax Code. In short, an owner that acts as a director or officer can be on the hook for the business’s liabilities if the company ignores its obligation to pay franchise taxes.
Chapter 171 of the Texas Tax Code requires corporations, limited liability companies, limited partnerships and certain other business entities to file and pay an annual franchise tax. If a business entity fails to file its franchise tax report or pay its franchise tax, its charter and right to conduct business in Texas is subject to forfeiture.
Watch out. The Texas Tax Code imposes individual liability on each director or officer of a corporation, or manager or member of a limited liability company, for any business debts that are incurred after the date on which the tax was originally due. The personal liability continues even if the entity subsequently files its delinquent reports, pays its delinquent franchise taxes, and has its corporate privileges reinstated. This means the directors, officers and managers remain personally liable for all debts of the business that were incurred during the period between the date the franchise taxes were originally due and the date the corporate privileges were reinstated.
The statute carves out two narrow exceptions to individual liability. First, if the debt was incurred over the objection of the officer, director or manager. The second is if the debt was incurred without the knowledge of the officer, director or manager, and the exercise of reasonable diligence to become acquainted with the affairs of the business would not have revealed the intention to incur the debt.
So, what does this mean for you?
If you are a creditor of a corporation, limited liability company, or other tax paying business entity that continued to engage in business after the forfeiture of its charter, you might have recourse for collection of your accounts against the individual officers, directors or managers—even if the company is subsequently reinstated or has been dissolved or discharged in bankruptcy.
It is surprising how often this is the case and how often it is not adequately explored by creditors trying to collect on a claim against a business entity.
Additionally, a business owner who also serves as an officer, director, or manager must make sure that the business entity continues to file and pay franchise taxes until it is formally dissolved in accordance with the Texas Business Organizations Code. Walking away without following the legal formalities puts officers, directors and managers at risk of personal liability for any debts incurred after the date that the franchise tax report is due.