Contesting a Corporate lawsuit accusing fraud, or not? Does it set precedent for fraud suit against Officer.
I am the CEO of a C Corp that recently went defunct after failing to reorganize under Ch. 11 proceedings. The corp is being sued by a creditor it owes $3 m to; claims that Corp (doesn't name me personally) comitted negligent fraud in representing collateral for loan (corp assets/receivables). I 've been told not to fight corp. lawsuit -just let them get their judgement, or plaintiff will then have more ''dirt'' should they elect to sue me personally for fraud. If nobody represents the corp. in court, will a judge allow them the fraud allegation, since there was no defense? Or will they simply get their judgement and then have to decide whether to allege fraud against me personally? They already have an entry of default against me personally for the guarantee, , with no mention of fraud, but they haven't filed the judgement - yet. The corp. BK atty advised that they'd have to refile the lawsuit against me and allege fraud, which would look suspicious to the court. He also advised that I should file Ch 7 personally, to make that fraud allegation harder to prove, since they'd be re-suing me, this time with fraud included. I'm worried that if the corp lawsuit isn't defended and fraud is allowed, then they can successfully sue me for it too, making it non-dischargable.
Attorney answers (2)
Douglas Anthony Dube
Reputation Level 10
Answered about 3 years ago.
Business Attorney in San Diego, CA.
Dear CEO:
Your circumstances raise several issues. First, is the corporation still in "active" status with the California Secretary of State (if you don't know, the status can easily be ascertained on the SOS web site)? If the corporation is suspended (typically for failure to pay taxes or fees), then the corporation cannot defend itself in court until it revives its corporate status.
Second, can a default judgment for fraud be obtained if the corporation fails to defend itself? I can't state for certain without more information, but in some circumstances a cause of action for fraud can be obtained by default.
Third, if a judgment for fraud is obtained against the corporation, what is the impact of that on you personally? That really asks whether the creditor can "pierce the corporate veil" to enforce the judgment against you personally. In some circumstances that can be done, but it is a very fact-driven analysis. Did yo follow corporate formalities (have shareholder meetings, keep corporate minutes, etc.); did you keep personal finances separate from corporate finances; was the corporation adequately capitalized (and the mere fact that a corporation fails is not an indication of whether it was adequately capitalized); and a number of other factors are considered. Then, the Court must also determine that an injustice would result if the corporate separateness is recognized - in other words, that it would be an injustice to recognize the form of the corporation under the circumstances. Again, it's a fact-driven analysis. Typically, it is not sufficient to constitute an injustice merely because a creditor cannot be paid by the corporation. Last, to enforce the judgment against you, the creditor would have to show that you had directed the litigation on behalf of the corporation - made the decisions related to the defense. Otherwise, you were not personally present in the litigation and there's a failure of due process. No appellate case has been published in which the fact that a shareholder made the decision for the company not to defend itself led to a default judgment being enforced against the shareholder, but I did recently read a published article in which the author proposed such a result may be feasible.
Last, if a creditor cannot pierce the corporate veil to reach you, then it must file a new claim against you. A judgment for fraud does not automatically lead to non-dischargeability in bankruptcy court. The bankruptcy court usually requires a different level of proof to justify non-dischargeability (because the public policy is to allow a debtor to get a new start). (That was a painful lesson from one of my earliest cases - a firm I worked for 13 years ago obtained a judgment for fraud in State court. The judgment debtor filed for bankruptcy, but in that court we had to file an adversary proceeding and prove the case all over again. We did eventually obtain a ruling that the debt was non-dischargeable, but on different grounds and in a lesser amount than the State court judgment. It was an expensive process for the creditor.)
I hope you find this response helpful.
Douglas Anthony Dube
Reputation Level 10
Answered about 3 years ago.
Business Attorney in San Diego, CA.
Dear CEO:
Your circumstances raise several issues. First, is the corporation still in "active" status with the California Secretary of State (if you don't know, the status can easily be ascertained on the SOS web site)? If the corporation is suspended (typically for failure to pay taxes or fees), then the corporation cannot defend itself in court until it revives its corporate status.
Second, can a default judgment for fraud be obtained if the corporation fails to defend itself? I can't state for certain without more information, but in some circumstances a cause of action for fraud can be obtained by default.
Third, if a judgment for fraud is obtained against the corporation, what is the impact of that on you personally? That really asks whether the creditor can "pierce the corporate veil" to enforce the judgment against you personally. In some circumstances that can be done, but it is a very fact-driven analysis. Did you follow corporate formalities (have shareholder meetings, keep corporate minutes, etc.); did you keep personal finances separate from corporate finances; was the corporation adequately capitalized (and the mere fact that a corporation fails is not an indication of whether it was adequately capitalized); and a number of other factors are considered. Then, the Court must also determine that an injustice would result if the corporate separateness is recognized - in other words, that it would be an injustice to recognize the form of the corporation under the circumstances. Again, it's a fact-driven analysis. Typically, it is not sufficient to constitute an injustice merely because a creditor cannot be paid by the corporation. Last, to enforce the judgment against you, the creditor would have to show that you had directed the litigation on behalf of the corporation - made the decisions related to the defense. Otherwise, you were not personally present in the litigation and there's a failure of due process. No appellate case has been published in which the fact that a shareholder made the decision for the company not to defend itself led to a default judgment being enforced against the shareholder, but I did recently read a published article in which the author proposed such a result may be feasible.
Last, if a creditor cannot pierce the corporate veil to reach you, then it must file a new claim against you. A judgment for fraud does not automatically lead to non-dischargeability in bankruptcy court. The bankruptcy court usually requires a different level of proof to justify non-dischargeability (because the public policy is to allow a debtor to get a new start). (That was a painful lesson from one of my earliest cases - a firm I worked for 13 years ago obtained a judgment for fraud in State court. The judgment debtor filed for bankruptcy, but in that court we had to file an adversary proceeding and prove the case all over again. We did eventually obtain a ruling that the debt was non-dischargeable, but on different grounds and in a lesser amount than the State court judgment. It was an expensive process for the creditor.)
I hope you find this response helpful.
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