D. Liability of Directors and Officers to Third Parties

• Library: South Carolina Corporate Practice Manual (SCBar) (2005 Ed.)

D. Liability of Directors and Officers to Third Parties

1. Various Common Law and Statutory Liabilities

There are several distinct situations in which corporate directors and officers may face personal liability to third persons. As discussed above, they may have common law or statutory liability if the articles of incorporation have not been filed, and as discussed below, they and the shareholders may have common law liability for carrying on the business after dissolution. In addition, a number of state and federal statutes impose civil, and frequently criminal, liability on officers and directors who participate in any violation; the existence of the corporation does not shield the wrongdoers from liability. other than general state criminal law,¹⁴ the most significant of these statutes are state and federal securities laws,¹⁵ state unfair trade practices acts,¹⁶ federal antitrust laws, federal environmental laws, and federal and state tax laws.¹⁷ In some cases, for example under the securities laws and unfair trade practices acts, civil or criminal liability may be imposed upon shareholders, directors, or officers who are "controlling persons" even though they do not personally participate in the conduct giving rise to the liability.¹⁸

2. Direct Personal Liability for Torts and on Contracts

The most significant kind of personal liability is that which is the director or officer incurs directly. Directors and officers are as liable as anyone else for their own torts¹⁹ and on any contracts to which they are parties or guarantors.²⁰

The existence of the corporation in no way provides a shield limiting this kind of personal liability. For example, if the president of a corporation negligently causes an automobile accident, his personal liability will be the same if he is driving a company automobile on corporate business or if he is driving his own car on vacation. Likewise, if an officer, director, and shareholder of a real estate development corporation makes fraudulent representations to the purchaser of a lot or participates in the creation of a scheme to defraud prospective purchasers, he will be personally liable for the fraud, even though the corporation will also be liable vicariously.²¹

3. Liability When Corporate Veil Pierced

Shareholders, officers, and directors are not vicariously liable for the debts and liabilities of South Carolina corporations.²² However, South Carolina courts will exercise their equitable powers to pierce the corporate veil and impose personal liability upon individuals who abuse the corporate form to inflict injustice or fundamental unfairness on corporate creditors. Enough South Carolina cases have been decided that South Carolina piercing law is beginning to achieve clarity.²³ Although South Carolina courts continue to articulate a cautious approach, stating that piercing is only appropriate in clear cases and that courts should pierce the corporate veil reluctantly,²⁴ in fact the recent decisions evidence and evolution of the requirements and an increased willingness to pierce.²⁵

A careful study of Hunting v. Elders provides the best insight into the current state of piercing law in South Carolina.²⁶ The Court of Appeals applies the two-prong test articulated in Sturkie v. Sifly:²⁷the veil is only to be pierced if the plaintiff proves that (1) the individual defendants have caused the corporation not to act like a corporation, an entity distinct from its shareholders, and (2) injustice or fundamental unfairness will result unless the acts of the corporation are regarded as the acts of the individuals.

The court is to analyze the first prong first and is supposed to only consider the second prong once it has determined that the first is satisfied.²⁸ The first prong is to be determined by considering eight factors:

(1) whether the corporation was grossly undercapitalized;
(2) failure to observe corporate formalities;
(3) non-payment of dividends;
(4) insolvency of the debtor corporation at the time;
(5) siphoning of funds of the corporation by the dominant stockholder;
(6) non-functioning of other officers or other directors;
(7) absence of corporate records; and
(8) the fact that the corporation was merely a facade for the operations of the dominant stockholder.²⁹

The eight factors need not all be satisfied,³⁰ and it is unclear how many would need to be proven to justify piercing. Nor has it been clear how they are to be weighted.³¹ However, the Court of Appeals in Hunting indicated that developments in federal tax law and state corporate law make items 2, 3, 6, and 7 less significant than formerly.³² Tax considerations have made it common for corporations not to pay dividends. The Statutory Close Corporation Supplement³³ has made it proper to run a corporation with less formality and fewer artificial pretenses than used to be required for all corporations.³⁴ Although the court acknowledged that Mr. Elders maintained the required corporate records,³⁵ the court expanded the breadth of the analysis to include business records, as well, and the court found these records to be lacking, although they included numerous corporate contracts, bank records, tax returns, and annual financial statements prepared contemporaneously by an outside accountant.³⁶ In addition, the record showed that the corporation was not insolvent in either an equity or a balance-sheet sense until the rendition of the tort judgment against it.³⁷ However, the court found that the corporation had made profits that were not accounted for,³⁸ that Mr. Elders took whatever money he desired from the corporation whenever he wanted, and that at his niece did not know she was a shareholder and the corporate secretary.³⁹

One can conclude that a controlling shareholder, director, and officer of a closely-held South Carolina corporation cannot be assured of protection from personal liability when the corporation is used as a conduit for...