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Article of Interest

Self-Inflicted Veil Piercing:  Corporate Forfeiture and the Dangers of Personal Liability
By: Vincent Circelli

Most lawyers and clients are familiar with the “bedrock principle of corporate law” that an “individual can incorporate a business and thereby normally shield himself from personal liability” for the debts of the corporation.  Willis v. Donnelly, 199 S.W.2d 262, 271 (Tex. 2006).  The ability to avoid personal liability “is an essential reason that entrepreneurs” shoulder the risks of starting and running their businesses in Texas.  Id.

The Texas Legislature and Texas Supreme Court have repeatedly bolstered this bedrock principle, and have greatly limited the circumstances in which a plaintiff may “pierce the corporate veil” to hold a business owner personally liable for corporate debt.  See, e.g., TEX. BUS. ORGS. CODE § 21.223 (requiring “actual fraud…for the direct personal benefit” of the business owner); SSP Partners v. Gladstrong Inv. (USA) Corp., 275 S.W.3d 444, 455 (Tex. 2008).

However, many are unaware of the automatic, irreversible personal liability that can arise outside the traditional veil piercing formula, based on obscure provisions buried in the Texas Tax Code.  Both the provision and the personal liability that comes with it are completely avoidable (by filing simple franchise paperwork and taxes with the Texas Comptroller annually) yet thousands of Texas companies suffer from self-inflicted veil-piercing every year.

Corporate entities “chartered or doing business in Texas” must (1) pay an annual franchise tax; and/or (2) file an annual report.  Failure to pay the tax or file the report results in the mandatory forfeiture of the corporate charter by the Texas Comptroller.  TEX. TAX CODE § 171.251.

The Texas Tax Code states that when “the corporate privileges of a corporation are forfeited,” officers and directors are liable for the corporation’s debt.  TEX. TAX CODE § 171.255. Specifically, the Code states that when “corporate privileges of a corporation are forfeited...each director or officer of the corporation is liable for each debt of the corporation that is created or incurred in this state after the date on which the report, tax, or penalty is due and before the corporate privileges are revived.”  Id. at 171.255.  The period of liability thus begins “when the report, tax or penalty is due,” and not when the corporate charter is eventually forfeited.

The liability of a director or officer under the Tax Code “is in the same manner and to the same extent as if the director or officer were a partner and the corporation were a partnership.”  Id.  The equivalent liability of partners in a general partnership means that all officers/directors “are liable jointly and severally for a debt or obligation” of the corporation.  TEX. BUS. ORGS. CODE § 152.304 (defining liability for partners in a general partnership).

Importantly, “liability...is not affected by the revival of the charter or ... corporate privileges.” TEX. TAX. CODE 171.255.  Therefore if liability arises during the period between the tax or report being due and the revival of the corporate charter, that personal liability will remain in place even if the corporate charter is revived.  Id.

No case law has “engrafted upon section 171.255(a) an appendage holding that officers and directors are never personally liable whenever it may appear that a post-forfeiture debt has some connection to a pre-forfeiture event, cause, or circumstance.”  Cain v. Texas, 882 S.W.2d 515, 518 (Tex. App.—Austin 1994, no writ).  In fact, Texas courts have held that “[s]ervices rendered on a contract after the corporation failed to file its franchise-tax report on the due date resulted in the directors’ personal liability under the plain and ordinary meaning of the words in Section 171.255... .”  Id. at 518 n.4 (quoting Dae Won Choe v. Chancellor, Inc., 823 S.W.2d 740 (Tex. App.—Dallas 1992, no writ)).

While Section 171 refers to “corporations,” these forfeiture provisions apply to all “taxable entities” in Texas.  The Tax Code states “[t]he comptroller may, for the same reasons and using the same procedures the comptroller uses in relation to the forfeiture of the corporate privileges of a corporation, forfeit the right of a taxable entity to transact business in this state... .  The provisions of this subchapter, including Section 171.255, that apply to the forfeiture of corporate privileges apply to the forfeiture of a taxable entity’s right to transact business in this state.”  TEX. TAX CODE § 171.2515 (emphasis added).  The term “taxable entity” includes a “limited liability partnership, corporation, banking corporation, savings and loan association, limited liability company, business trust, professional association, business association, joint venture, joint stock company, holding company, or other legal entity.”  TEX. TAX CODE § 171.0002.

In addition to creating personal liabilities on officers and directors, a forfeited charter means “the corporation shall be denied the right to sue or defend in a court of this state” TEX. TAX CODE § 171.255

Don’t allow self-inflicted veil piercing to happen to your clients.  Advise your clients to stay on top of their Texas franchise filings.  For litigators, the first time you see a petition or answer, check your opponent’s corporate status.  The threat of personal liability can create enormous leverage in prosecuting or defending a lawsuit.  The Texas Secretary of State lists the current status of taxable entities at direct.sos.state.tx.us (fee required).  The Texas Comptroller likewise lists status information at ourcpa.cpa.state.tx.us/coa/Index.html (free).

Vincent Circelli is a commercial-litigation associate with Haynes & Boone, LLP, in Fort Worth. He serves as Vice President of the Tarrant County Young Lawyers Association.