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Small Business Owners – Watch Your Capitalization!

We have lately seen a rash of cases where the corporate veil was busted primarily for lack of adequate capitalization. Thus, business owners should take the time to analyze their O&O and make sure that they are now — and continue to be — adequately capitalized for whatever they are doing and whatever agreements they are entering.

The corporate veil is not an unlimited defense… as yet another owner of a sole shareholder corporation has discovered in a recent case, Bogosian v. All American Concessions, 2011 WL 4460362 (E.D.N.Y., Slip Copy, Sept. 26, 2011). So, what did him in? As Forbes reports it was undercapitalization, among other missteps, making the case one of several recent ones in a rash of such cases.

It was the U.S. Open in 2005 and The United States Tennis Association contracted with Restaurant Associates to provide catering services. Restaurant Associates, in turn, subcontracted beverages out to All American Concessions. The sole shareholder of All American Concessions was one Marty Rosen. As a condition of the subcontract with Restaurant Associates, All American Concessions was required to obtain proper insurance.

A class action suit was later filed against all three – the USTA, Restaurant Associates, and All American – leaving Restaurant Associates out $92,000, but with All American declining to participate. Naturally, Restaurant Associates sued All American for indemnification and even sought to “pierce the corporate veil” all the way to Marty Rosen. The veil was pierced and Rosen was on the hook for the $92,000.

There were a couple of problems, and it should be noted that sole shareholder corporations oftentimes invite some of these problems unintentionally. Nevertheless, such invitations tend to leave them with greater exposure to veil-piercing claims.

At the outset, it certainly didn’t help that Rosen failed to maintain all of the standard “corporate formalities” and, therefore, had little documentation to produce during discovery. But the far bigger issue is that All American was undercapitalized. That means it did not have the necessary capital to pay its liabilities. In the end, all would have been fine if Rosen had only purchased the insurance he was required. But, he did not. As a result, that put All American in a tight spot, as well as Rosen himself, once the corporate veil was pierced.

While this case is instructive on many levels, it is a good lesson in the powers of a corporation. True, a corporation protects against “unlimited liability,” but it still requires liability for the appropriate capital for a particular transaction undertaken. Yes, it’s easy to move capital around, but the rule of thumb is to have sufficient capital to cover O&O, operations and obligations. The corporation can be a powerful vehicle, but only with the proper care. Indeed, for greater protection, other measures also may be needed.

Reference: Forbes (September 30, 2011) “Undercapitalization Again: Owner of Sole Shareholder Corporation Gets Aced On Veil Piercing Claim At The U.S. Open

 

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