Personal Liability and Franchise Tax

One of the primary reasons New York business owners are advised to structure a business as a corporation, is to shield themselves and the officers and directors of the corporation against personal liability from those seeking to collect the judgments or debts of the business. Business owners all too often mistakenly assume that once their corporation is registered with the state, they are free and clear of any and all liability. This is not the case. The truth is business entities require regular and diligent attention in order to maintain an owner's protection against potential liability.  All too often the owners of corporations neglect simple but crucial ongoing obligations, which can result in a piercing of the corporate veil and the imposition of the very personal liability the business structure chosen was designed to avoid.

One of the ongoing obligations of the majority of businesses incorporated in New York State is the payment of franchise taxes under Article 9-A § 209 of the New York State tax law.¹ In conjunction with § 209; Section 203-a of the New York State tax law, provides that a corporation that fails to pay franchise taxes as required for two consecutive years shall be dissolved by proclamation of the New York Secretary of State for failure to pay such tax.
While it is well settled that New York law permits the incorporation of a business for the distinct purpose of avoiding personal liability,² it is also well settled that equity will intervene to pierce the corporate veil and permit the imposition of personal liability against a business owner in order to avoid fraud or injustice.³ The circumstances which lead to personal liability for business owners who have failed to pay franchise taxes and the extent of such liability are issues which courts in New York have struggled with over the last sixty years. Their analysis hinging in large part on whether the actions of the officers and directors of a corporation taken during a period of dissolution constitute a fraud or an injustice with regard to those who have dealt with the corporation during the period the business was dissolved.

Initially many courts followed the analysis in the often cited case Poritzky v. Wachtel, 176 Misc. 633, 27 N.Y.S.2d 316 (Sup. Ct. 1941) when deciding whether personal liability should be found for business owners who transacted business during periods of dissolution. Poritzky involved a corporation to which plaintiff sold meat on account at defendant's order and which had been dissolved by proclamation of the Secretary of State for failure to pay franchise taxes. Despite the dissolution, defendant, who was the corporation's president, continued to order meat in the corporation's name.  The court held that the subsequent reinstatement of the corporation after the payment of its franchise taxes did not operate retroactively to restore the corporate entity and validate ab initio defendant's acts in ordering meat while the corporation was dissolved so as to relieve defendant from individual liability during that period.

Notably, the court in Worldcom, Inc. v. Sandoval, 182 Misc. 2d 1021, 701 N.Y.S.2d 834 (Sup. Ct. 1999) followed Poritzky and granted a motion for summary judgment in favor of the plaintiff-creditor based upon what it saw to be the majority rule at the time that: "the officer may be held personally liable for debts incurred by the continuation of business of the dissolved corporation, regardless of the corporation's subsequent reinstatement."

The Worldcom court noted however that Prentice Corp. v. Martin, 624 F. Supp. 1114 (E.D.N.Y. 1986) (a case the Worldcom court characterized as "strongly criticized and rejected as a proper statement of New York law"), had declined to follow Poritzky, instead holding, based chiefly on the decision in Held v. Crosthwaite, 260 F. 613 (2d Cir. 1919)⁴ and on dictum in Garzo v. Maid of the Mist Steamboat Co., 303 N.Y. 516, 104 N.E.2d 882 (1952),⁵ that a corporate officer should only be liable for a corporate debt incurred between involuntary dissolution and reinstatement if the officer acted fraudulently or in bad faith.
In 2001 the court in Department 56, Inc. v. Bloom, 186 Misc.2d 901, 720 N.Y.S.2d 920 (Sup. Ct. 2001), rejected Poritzky outright holding that "the personal liability of corporate officers or directors for debts incurred during the period of revocation does not survive reinstatement", adding:

"Seductive though it may be, the Poritzky rationale is fallacious, and I respectfully choose not to follow it. Neither Poritzky or the cases adopting its holding explain why such fraud and abuse would be encouraged. In general terms, the Poritzky rationale may be stated as follows: the existence of adverse consequences discourages wrongful conduct; therefore, the absence of adverse consequences encourages wrongful conduct. People, however, are motivated by the expectation of benefits, not by the absence of adverse consequences. In the field of logic, the Poritzky rationale commits the formal fallacy of denying the antecedent. I can conjure up no scenario that would entice a corporate officer to purposefully allow his corporation to be dissolved and I fail to see how, even if he did, there would be any fraud perpetrated on a creditor or any benefit inuring to such corporate officer. Put another way, absent any dissolution a creditor would be dealing with a corporation and relying on the soundness of the corporation's credit and ability to pay. With a period of dissolution later annulled, a creditor would believe it was dealing with a corporation and relying on the soundness of the corporation's credit and ability to pay. In both cases the consequences to the debtor, the corporation and the creditor are identical."Id. at 922-23.

Four years later in 2005 another New York Supreme Court in Lodato v. Greyhawk N. Am., L.L.C., 10 Misc. 3d 418, 807 N.Y.S.2d 818 (Sup. Ct. 2005), analyzed its New York precedents, including Poritzky and Bloom and concluded that a more conditional rule applied, holding:

"Based upon all of the foregoing, the court finds that individual officers or directors of corporations should be shielded from personal liability absent a showing of fraud or misrepresentation and that an officer or director of a corporation that has forfeited its corporate charter for non-payment of taxes and been dissolved by proclamation of the Secretary of State pursuant to the Tax Law is not personally liable for service obligations of the corporation contractually undertaken while the corporation was dissolved, where the officer acted without knowledge of the corporation's dissolution, the dissolution was truly inadvertent and not due to neglect, the corporation quickly rectified the default by seeking reinstatement and there is a subsequent annulment of the dissolution and reinstatement of the corporation." Id. at 427.

Later decisions, including, Nigro v. Dwyer, 438 F. Supp.2d 229 (S.D. N.Y. 2006), have attempted to reconcile the various New York decisions as well as federal decisions not considered in Lodato.⁶ Rejecting (almost entirely) the reasoning of Bloom and relying ultimately on the decision in Held v. Crosthwaite (1919), the court in Nigro reasoned that "[a] variety of factual issues need to be tried concerning the circumstances of the dissolution and reinstatement and [defendant's] behavior during the interim period”including, specifically, his conduct at or about the time the contract was signed and his knowledge of the corporation's status at that time."⁷

Despite the somewhat disjointed nature of the series of opinions cited herein one thing is clear. For corporate business owners in New York, paying franchise taxes in a timely manner to avoid personal liability is a far more predictable and prudent course of action than defending actions taken while a corporation was dissolved in hopes of convincing a court of the corporate owner's; good faith, intentions, exemplary behavior or lack of knowledge, during a period of dissolution.

A franchise tax is one 'upon the right of a corporation to exist and exercise the power granted by its charter.' People ex rel. United States Aluminum Printing Plate Co. v. Knight, 174 N.Y. 475, 67 N.E. 65, 66, 63 L.R.A. 87 (1903).

Bartle v. Home Owners Coop., 309 N.Y. 103, 106, 127 N.E.2d 832 (1955); see Seuter v. Lieberman, 229 A.D.2d 386, 387, 644 N.Y.S.2d 566 (1996); New York Assn. for Retarded Children, Montgomery County Ch. v. Keator, 199 A.D.2d 921, 922, 606 N.Y.S.2d 784) (1993).

See Matter of Morris v. New York State Dept. of Taxation & Fin., 82 N.Y.2d 135, 140, 603 N.Y.S.2d 807, 623 N.E.2d 1157 (1993). 'The decision whether to pierce the corporate veil in a given instance depends on the particular facts and circumstances'  Weinstein v. Willow Lake Corp., 262 A.D.2d 634, 635, 692 N.Y.S.2d 667 (1999).

In Held, the Court refused to impose personal liability on the corporate officers of a New Jersey corporation that was dissolved and later reinstated, since there was no evidence of fraud on the part of the corporate officers.

Garzo held that, where a dissolved corporation 'carries on its affairs and exercises corporate powers as before, it is a de facto corporation as well, and ordinarily no one but the state may question its corporate existence.

In Nigro, plaintiffs sued a corporation's president personally for breach of contract, alleging that he was personally liable because he signed the agreement on behalf of the corporation while the corporation was dissolved.

Nigro v. Dwyer at 237