liability of corporation vs personal liability


Assume for purposes of answering questions 4-11 that Joe and Marge form a corporation and that each owns 50% of the corporate shares. Marge is the president and Chief Financial Officer and Joe is the

Secretary. Both are on the board of directors.

Six months after the corporation is started, there was a cash flow problem and it is necessary for

Joe to lend $50,000 to the business to enable it to cover its operating expenses. Four months later they hire, Helmut, as Vice President of Sales & Marketing.

During the next few years, the business did well. Vircon, however, never obtained liability insurance. Joe and Marge keep meticulous records of receipts and payments, but did not document certain corporate transactions, such as salaries and shareholder meetings. In one year the corporation paid six of Marge’s monthly mortgage payments because she was having severe personal financial problems and also paid for her daughter’s college tuition for her first semester.

A few months later, Marge wishes to obtain a personal loan from her bank for $100,000, but the bank requires someone to co-sign the note. Marge co-signed the note in the name of the corporation and signs as the president. Later Marge defaults on the note, and the bank sues the corporation for payment.

10. Is Vircon (corporate name) liable to Marge’s bank for the $100,000 personal loan?

ANSWER (only edit/correct this part)

The general rule is that shareholders, board of directors, and corporate officers are not liable for the debt of corporation.  An exception is allowed, however, when such is to prevent abuse of the privilege of corporate status during which courts sometime pierce the corporate veil to expose shareholders and directors/officers to liability.  The factors considered by the courts to determine whether to pierce the corporate veil include; commingling of funds and other assets, unauthorized diversion of corporate funds to use other than the benefit of the corporation and contracting with another with intent to avoid performance by use of a corporate entity as a shield against personal liability.

In this case, Marge knew that she was insolvent at the time she tried to obtain a personal loan from the bank since her 6 month mortgage payments and her daughter’s tuition were paid for by corporation funds.  Therefore, it can be considered that she had the intent to avoid performance by using Vircon as a shield against personal liability. Moreover, she obtained the loan for her personal benefits and not for the benefit of the corporation.   The presence of these facts justify the act of the court in piercing the corporate veil, thereby making Marge personally liable for the $100,000 that she borrowed from bank

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