Wednesday, February 22, 2012

Forleo Again Rejected - Officer Not Liable on Contract Entered into During Administrative Dissolution

U.S. District Court Rejects Forleo, Holds Officer Not Personally Liable on Contract Signed While Company Administratively Dissolved
The fact pattern is straightforward – Company is administratively dissolved for failure to file its annual report.  Still it continues in operation and, on its behalf, an officer enters into an agreement with a third party.  Thereafter the Company is reinstated by the Secretary of State.  Eventually Company defaults on the contract, whereupon third party assets that the officer is personally liable on the agreement.  A recent decision of the District Court has rejected that assertion.  eServices, LLC v. Energy Purchasing, Inc., 2012 WL 404957 (E.D. Ky. Feb. 6, 2012).
The argument for officer liability is that from administration dissolution a company is restricted to activities appropriate for its winding up and liquidation.  See, e.g., KRS § 14A.7-020(3).  Actions accomplished by an agent purportedly on behalf of the dissolved company that exceed that limited scope involve purported agency on behalf of a principal who cannot so act.  Not actually acting on behalf of a competent principal, the agent may be held liable on the agreement.  See generally Thomas E. Rutledge, Dissolution of a Limited Liability Company § 9.5, in Limited Liability Companies in Kentucky (UKCLE 2010)
This argument begs a crucial question, mainly the impact of the company’s reinstatement.  The statute provides, inter alia, that reinstatement relates back to and has the effect of nullifying the prior administration dissolution.  See, e.g., KRS § 14A.7-030(3).  The principal’s incapacity having been retroactively cured, the agent was clothed with authority and is therefore not a party to or liable on the agreement.
Because Energy Purchasing was reinstated after Buchart signed the contracts, the corporation is treated as having been in existence when the contracts were signed…
2012 WL 404957,*2
eServices pinned its hopes on the Forleo decision in which, notwithstanding reinstatement, the corporation’s officers were held personally liable on an agreement entered into during the period of administrative dissolution.  Forleo v. American Products of Kentucky, Inc., 2006 WL 2788429 (Ky. App. 2006).  Judge Coffman dissected and discarded any application of Forleo, finding its reasoning unpersuasive, that it conflicts with the operation of the express statutory language and as well conflicts with the published Fairbanks decision.  2012 WL 404957, *2-3; Fairbanks Arctic Blind Co. v. Prather & Assoc., 198 S.W.3d 143 (Ky. App. 2005).
Hopefully this decision will serve as a final nail in the Forleo coffin.
All that said, there are two points in this opinion with which I would quibble.  There is an extensive discussion of limited liability, suggesting that it is the touchstone of the corporate form and must be afforded an officer with respect to obligations undertaken with respect to the corporation.  While limited liability is commonly perceived to be the most important aspect of the corporate form, and its availability has greatly enhanced capital formation for over a century, limited liability is not actually central to the corporate structure.  It is rather a late development with respect to the corporate form, and not all corporations have had this attribute.  Rather, the sine qua non of the corporate form has been continuity of life. 

        Of greater importance is the suggestion that the rule of limited liability somehow impacts upon whether an officer is or is not liable for a contract entered into in the name of the principal.  The rule of limited liability as set forth in the Kentucky Business Corporation Act extends exclusively to the shareholders; it is not this rule that affords either the directors or the officers limited liability from the debts and obligations of the entity.  See KRS § 271B.6-220(2) (referencing shareholders but not directors, officers or agents).  While officers are not personally responsible for the performance on and any default of an agreement entered into on behalf of a corporation, that absence of exposure arises not from the substantive law governing corporations (including the rule that shareholders enjoy limited liability), but rather from the common law of agency.  See, e.g., Restatement (Third) of Agency § 6.01.  As to why directors are not liable for the debts and obligations of a corporation, in that directors are not agents, that is a discussion for another day.

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