Twin Cities Business Litigation Blog : Minneapolis Business Litigation Lawyer & Attorney : Gavin P. Craig Law Firm : St. Paul, Twin Cities, Minnesota MN

I always enjoy reading the blog posts of Max Kennerly. His latest post concerns the misconception of some people that if they create an LLC (or corporation) to conduct their personal business, they are somehow exempt from personal liability. If it were only this easy, everyone would do it and we wouldn't need insurance.

I want to expand on the ideas presented by Max. Creating a corporate or LLC does create a limitation of liability for the owners for contracts entered into in the name of the company. The owners are usually agents of the company, and can enter into contracts on behalf of the company. (But not always.) Unless there is some agreement limiting authority, officers of any LLC can enter into contracts for the company. Sometimes owners claim that one owner didn't have the authority, but that is an issue between them, not the party that relied on the contract.

This concept is very different than trying to pierce the corporate veil and impose liability on the owners. The first problem is that piercing the corporate veil (of limited liability) is hard to do. If you succeed, great, but the case is much more complicated. On the other hand, naming an owner as the agent of the corporation, for the owners wrongful acts is a perfectly legitimate claim. An agent is liable for their own wrongful actions, even if they act in the name of the company. I've also seen people try to create trusts to try to avoid liability. That doesn't work either.

What happens when an owner enters into a contract in the name of the company, and then causes the company to breach the contract. Is the owner personally liable? (I am distinguishing this from the case where the owners tortiously injures someone.) Can the owner be personally liable for causing the LLC or corporation to breach its' obligations? Yes! The agent is, remember, liable for its own tortious acts. An agent is a third party - not a party to the contract. So the wrongful interference with the corporations obligations under a contract is tortious interference with the contract. So the agent owner can be personally liable for contracts as well as running people over with the corporate car.

This does not mean that every corporate or LLC owner is liable for every breach of contract of any company. The concept is limited to actions by the owner/agent that interfere with the companies performance in such a way as to show tortious interference. Most breach of contract actions are based on problems other than tortious interference. But the risk remains for the owner/agent, when they act wrongfully they can be personally responsible for the damages.

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I am one of those strange attorneys that thinks cases involving agency are interesting. An agent is a person (including a company) that acts for another. Simple, right! An officer is usually - not always - an agent for the company. What does it mean to be an agent? I am glad you asked.

                                                                   What is an Agent?

The agency is created by contract - written or verbal. The contract determines the scope of the agency. If an agent has the power to bind the principal to a specific contract to purchase, the agency could be limited to that one agreement. Or the agency could be open ended. The officer of an LLC at least has the appearance of having the authority to enter into any contract as agent for the LLC. Agency is one of the simplest legal principles; the principle is based on contract law, and yet there are numerous disputes every year.

                         But He Didn't Have the Authority! He was No Longer the Agent!

The Delaware Business Litigation Report blog discusses a recent case that has many of the issues relating to Agency. In this case, the Plaintiff contracted with a Virginia LLC to provide certain services. Burden was the general manager of the LLC. Two days before the LLC signed the contract (by Burton) with the Plaintiff, the LLC amended its Operating Agreement to remove Burton as the general manager. The reason for the change was not related to the contract with the Plaintiff. When the Plaintiff was not paid, it sued. The LLC's defense was that Burton did not have the authority to bind the LLC. In other words, the Burton was no long an agent for the LLC when he signed the contract!

                                                      Defense Problems!

The defense has a several serious problems with this defense. First, since Burton was dealing with the Plaintiff as the general manager, how would the Plaintiff know that Burton no longer had the authority to bind the LLC? Burton apparently never mentioned it. Moreover, Burton continued to act as though he were still the general manager.

An agent can act for a principal when the agent has express authority (Contract,) Implied authority (as an officer of the corporation or LLC, a partner, or by the actions of the principal,) or apparent authority (when the agent holds himself out as having the authority and the principal allows the representation.) I am summarizing and these points are a little more complicated that I have outlined.

In this case, Burton had the authority before the contract was signed, and Burton continued to hold himself out as having the authority, with the knowledge of the principal, even after the authority was removed. So Burton appeared to have the authority to bind the LLC to contracts as an agent with either express or apparent authority.

                                              What about the Ex-Agent?

One funny thing that the case does not mention is that the LLC, owned in part by Burton, is effectively arguing a position that Burton is personally liable as a principal to the contract. The case does not appear to address this point.

I discussed a similar legal point in an earlier post where I urged owners of corporations to disclose that the contracting entity is a corporation. Failure to disclose that you are an agent for a principal (the LLC or the Corporation,) or the failure to disclose that a prior agent can not longer bind the company can lead to unfortunate results.

                                            Verbal Contracts and Agency!

This leads me to my final point. Verbal contracts are perfectly valid, and enforceable so long as they do not violate the Statute of Frauds. A verbal contract with an agent would not violate the Statute of Frauds. However, the always interesting Rush Nigut's Blog has an interesting post on the verbal agreements - with the simple but good advise: Don't do it!

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After many years practicing law I am convinced that small business owners - and especially contractors - have no idea how to use a corporation or LLC to avoid personal liability for the debts of the business. For simplicity I will use the corporation as an example. But the same rules apply to any form of business that shields the owners and officers from personal liability.

When a person incorporates their business, it takes more than just filing a form with the Secretary of State. When a business is incorporated, it can't be a secret to those that do business with the new corporation. In other words, the new corporation needs to disclose the fact that the business (the party that is contracting with others) is incorporated on its letterhead, business cards, invoices and checks.

If the business does not disclosed in a meaningful way that it is a corporation, the owners and officers have probably lost the very advantage they tried to create. Several times in the last few years I have represented a client that had a claim against a business that was incorporated, but never disclosed that fact to the contracting party I represented. We sued the owners and officers directly, along with the corporation and an identically named company as an assumed name of the owners. The businesses in question used letterhead that did not disclose their corporate status, and their contracts likewise were silent as to their corporate status.

The legal theory is simple: an officer of a corporation is an agent for the corporation. Agents have two very important obligations with respect to other parties they are dealing with. The agent must disclose that they are an agent, and disclose the identity of the principal. How does the agent do this? By using letterhead and other information that clearly identifies the real contracting party is the corporation. There are a number of cases on point, and the decisions are universally the same. The agent to an undisclosed corporation is responsible for the debt or obligation. By failing to disclose, the agent become the principal to the transaction, and personally responsible.  In a 1985 case the defendants truly got lucky when the court decided that the principal corporation was disclosed because the defendants used some checks with a corporate designation.      

I always hear the argument from the opposing counsel in these cases that the defendant didn't need to disclose because all the plaintiff had to do was check with the secretary of state. Unfortunately, it is not the obligation of the contracting party to figure out who they are contracting with; it is the obligation of the agent to disclose. This has been the law for decades. So until the law changes, business owners better disclose. Don't look for a change anytime soon, this rule has been in the Restatement's for years.   A Cargill Elevator case from the 1920's is a fun example of what can happen.  This case is still good law.     

If the agent doesn't disclose the agency and the identity of the principal, which is often the case with small businesses, the agent is personally liable as a principal in the transaction. This is not rocket science; it is the law. So my advice to small business owners is: disclose, disclose and disclose.

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