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Avoiding Shareholder Liability for Corporate Actions Under Michigan Law

Corporations are generally treated as their own “legal persons,” separate and distinct from their individual owners. A primary feature of this separate treatment is that corporations’ debts and obligations belong to the entities themselves – not their individual owners. Courts refer to this legal distinction between the business entity and its owners as the “corporate veil.” Notably, though, this protection is not absolute, and under certain circumstances, courts will allow a corporation’s creditors to “pierce the corporate veil” and hold a corporation’s shareholders personally liable for the corporation’s obligations. Read on for a discussion of when Michigan courts will hold shareholders liable for their corporation’s debts and obligations, and how business owners may avoid such personal liability.

Under Michigan law, as in other states, the “default setting” is that the debts and obligations of a corporation are that of the corporation – and not the corporation’s shareholders.[1] Generally, courts will respect a corporation’s separate form, and not hold the shareholders of a corporation responsible for paying or answering for the debts and obligations of the business entity. See, e.g., Foodland Distributors v. Al-Naimi, 220 Mich. App. 453, 456 (1996) (“Under Michigan law, there is a presumption that the corporate form will be respected”). However, as some courts have said, “the fiction of a distinct corporate entity separate from the stockholders is a convenience introduced in the law to subserve the ends of justice. When this fiction is invoked to subvert justice, it is ignored by the courts.” Id. at 275. (internal citations omitted). In other words, courts do not allow creditors to reach the personal assets of a corporation’s shareholders, or “pierce the corporate veil,” until they do. In Michigan, while there is no rigid or “mechanical” test courts apply for determining whether to hold shareholder’s personally liable for the acts of a corporation, courts will generally “pierce the corporate veil” upon a showing that:

  1. The corporate entity was a mere instrumentality of the shareholder sought to be held personally liable;
  2. The corporate entity was used to commit a fraud or wrong; and
  3. The plaintiff or creditor suffered an unjust loss or injury as result.

As an initial note, the more that the power to control and influence the decisions of a corporation is placed in a single person, or small group, the more likely a court will find that the corporation is a “mere instrumentality” of such person(s). See, e.g., Thomas v. Khrawesh, 738 Fed Appx 870 (6th Cir. 2018) (noting that the shareholder was the President and owned 100% of shares in the corporation). This means that for corporations with either a single owner or very few owners, who may also be directors and/or officers of the corporation, such owners should take especially high care when managing their corporation, as they are generally at an increased risk of being held personally liable for the corporation’s acts and obligations.

With the above context in mind, business owners can take proactive measures to mitigate any potential risk of being held personally liable for their corporation’s debts and obligations, including:

  • Always observing the corporate formalities when conducting corporate affairs, including:
    • Holding shareholder meetings and Board of Director meetings whenever required under the Corporation’s Bylaws or the Michigan Business Corporation Act;
    • Keeping and maintaining minutes of all Board of Directors and shareholder’s meetings, corporate Bylaws, and other corporate records;
  • Avoiding paying their personal debts with corporate funds, or otherwise making purchases personal purchases with corporate funds;
  • Avoiding placing corporate funds in accounts that also contain their personal funds, and vice versa;
  • Avoiding placing corporate funds in accounts held in their name personally, and vice versa;
  • Avoiding using corporate assets as collateral for their personal debts and obligations;
  • Avoiding taking out loans for the corporation’s business or affairs in their name personally;
  • Avoiding the corporation loaning money to them personally, or the business owner personally loaning money to the corporation. If a corporation does loan money to a shareholder, or vice versa, such loans should always be well documented, on terms objectively fair to the corporation, repaid timely and according to their terms, and the corporation should not give preferential treatment to repaying such loans, relative to debts owed to other creditors.
  • Avoiding the corporation assuming any of their personal debts or obligations, especially without any consideration to the corporation

Again, there is no single act or practice guaranteeing that a court does not pierce the corporate veil. However, based on factual circumstances identified by courts to justify piercing the corporate veil in the past, implementing the above practices will mitigate the risk of a shareholder being held personally liable for the corporation’s debts or obligations.

For any questions, on establishing and maintaining corporate records and formalities, contact the business and corporate attorneys at Fahey Schultz Burzych Rhodes PLC.

[1] While this article is focused on shareholders’ personal liability for acts and obligations of corporations, the same law generally applies to hold members of limited liability companies personally liable for the acts and obligations of the company. Therefore, the above guidance generally applies to members and managers of limited liability companies as well.

 

By: Mitchell Zolton and James Budreau

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