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Court Holds Corporate Officers Personally Liable for Participation in An Alleged Conversion of Assets

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  • Posted on: Nov 12 2018

As discussed in previous Blog posts (here and here), business owners and entrepreneurs wishing to insulate themselves from personal liability for the acts taken in the name of their business can generally do so by forming a corporation (e.g., C-Corp. or an S-Corp.) or limited liability company (“LLC”). Such protection, however, is not absolute; there are exceptions to the rule. For instance, a creditor or other third party can “pierce the corporate veil” – i.e., go behind the corporate form – to hold an officer, director, or shareholder liable when he/she fails to follow corporate formalities, comingles corporate funds with personal funds, or perpetrates a fraud or other wrongdoing on a third party. TNS Holdings v. MKI Sec. Corp., 92 N.Y.2d 335, 340 (1998) (the corporate veil may be pierced to impose liability for corporate wrongs upon persons who have “misused the corporate form for [their] personal ends.”); Matter of Morris v. New York State Dept. of Taxation & Fin., 82 N.Y.2d 135, 142 (1993) (the corporate veil may be pierced where the owners have “abused the privilege of doing business in the corporate form” by “perpetrat[ing] a wrong or injustice . . . such that a court in equity will intervene.”).

Additionally, an officer, director, member or shareholder can be sued individually when the corporation is accused of committing a tort in which the individual personally participated. Hamlet at Willow Cr. Dev. Co., LLC v. Northeast Land Dev. Corp., 64 A.D.3d 85, 116 (2d Dept. 2009) (“A corporate officer may be liable for torts committed by or for the benefit of the corporation if the officer participated in their commission.”). Notably, tort liability applies regardless of whether the third party can pierce the corporate veil.

A tort is generally defined as an act or omission that gives rise to injury (i.e., the invasion of any legal right) or harm (i.e., a loss that an individual suffers) to another for which the courts will impose liability.

There are three general categories of torts: intentional; negligent; and strict liability. Intentional torts are wrongs that the defendant knew or should have known would result through his/her actions or omissions (such as fraud). Negligent torts occur when the defendant’s actions were taken without reasonable care. Strict liability torts focus on whether a particular result or harm manifested from the actions taken by the defendant.

In the business context, there are numerous types of torts, including, but not limited to, fraudulent misrepresentation, misappropriation, conversion, interference with contractual or business relations, breach of fiduciary duty, negligence, and defamation.

In Starr Indemnity & Liability Co. v Global Warranty Group, LLC, 2018 NY Slip Op. 07346 (2d Dept. Oct. 31, 2018) (here), the Appellate Division, Second Department, recently addressed the foregoing principles, in affirming the denial of a motion to dismiss a conversion claim against corporate officers who participated in the alleged conversion of assets.

Starr involved an alleged diversion of funds belonging to the plaintiff, Starr Indemnity & Liability Company and two related corporations (collectively, “Starr” or “Plaintiff”), by the defendants (five related corporate entities and four individuals who were officers of those corporate entities).

As set forth in the decision appealed from, Starr and Global Warranty Group, LLC and related entities (“GWG”) entered into an administrative services agreement (“ASA”) in June 2012, pursuant to which GWG agreed to be the service provider for Starr’s cellular-telephone service plans. Among other things, GWG served as third-party administrators of extended-service contracts and insurance policies covering mechanical breakdown, accidental damage, loss and theft of various appliances and portable electronics (principally cell phones) insured by Starr.

Under the ASA, Starr bore the sole financial risk and reward of the plans. GWG’s role was limited to interfacing with the dealers who sold the service contracts and insurance plans, collecting the premiums, depositing them into an account maintained for Starr’s benefit, remitting them to Starr, and processing and paying the claims. The ASA required GWG to account for and be liable to Starr for all premiums owed to Starr and to act as a fiduciary for Starr. The ASA provided that all premiums collected by GWG were Starr’s exclusive property and were to be deposited into a premium account maintained by GWG as a fiduciary for Starr’s sole benefit. The ASA also provided that all funds intended for claim disbursement were Starr’s exclusive property and were to be deposited in a claims-disbursement account maintained by GWG as a fiduciary for the sole purpose of paying claims.

At the end of May 2014, GWG owed Starr premiums in the amount of approximately $841,000, but belatedly paid Starr only $356,000. GMG failed to make the premium payment that was due at the end of June 2014 (approximately $650,000), explaining that it was due to late payments by GWG’s dealers. However, in July 2014, GWG revealed to Starr that it was facing serious financial difficulties and that it was on the verge of bankruptcy. At a meeting at Starr’s corporate offices on July 25, 2014, Charles Pipia, one of the individual defendants, admitted to Starr that there was a shortfall of more than $1.6 million in the claims-disbursement account because the funds had been diverted by GWG for other purposes. A subsequent audit by Starr revealed that the shortfall of funds due to Starr exceeded $7 million as of August 1, 2014.

Starr commenced the action shortly thereafter, alleging 20 causes of action, 16 of which were asserted against the individual defendants. The claims fell into four basic categories: conversion, fraud, breach of fiduciary duty and tortious interference. Defendants moved to dismiss, which the motion court granted in part and denied in part.

Defendants Arthur Krantz and Andrew Schenker appealed, arguing, among other things, and relevant to this post, that they could not be held personally liable for the alleged conversion.

The Second Department affirmed, finding that Starr stated a claim of conversion against the individual defendants. In doing so, the Court reiterated the legal principle discussed above, namely: “A corporate officer, although acting for the benefit of a corporation, may be held liable for conversion, if he or she participated in the commission of the tort.”

Takeaway

Although Starr is pithy in its discussion of personal liability of a corporate officer, it nevertheless illustrates the importance of understanding the various bases upon which a plaintiff may seek to hold a corporate officer personally liable for an alleged wrong. In Starr, the alleged wrong was the tort of conversion. But, as noted in the legal analysis preceding the discussion of Starr, there are numerous torts that can be asserted against a corporate officer, director, member or shareholder. Thus, Starr confirms the legal principle that insulation from liability using the corporate form is not absolute.

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