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Points of Law

Director/Officer Liability and Corporate Alter Ego

OFFICER AND DIRECTOR LIABILITY

The law concerning officer and director liability in tort, while expanding the bases upon which liability may be found requires, generally, a finding of actual participation by the officer or director in the tortuous conduct. That is, generally, a director or officer of a corporation does not incur personal liability for torts of the corporation merely by reason of his or her official position, unless he or she participates in the wrongdoing or authorizes or directs that it be done. PMC v. Kadisha, (2000) 78 Cal.App.4 th 1368, 1378, 1381. Although courts have not set forth a single well-stated standard concerning the imposition of such liability, the California Supreme Court has set forth a two-part test to determine whether an officer or director can be held personally liable for a tort. Specifically, a plaintiff must prove that:

  • The director or officer either
    • Specifically authorized, directed or participated in the allegedly tortious conduct"; or
    • Although he or she specifically knew or reasonably should have known that some hazardous condition or activity under his or her control could injure plaintiff, he or she negligently failed to take or order appropriate action to avoid the harm"; and
  • An ordinarily prudent person, knowing what the director knew at that time, would not have acted similarly under the circumstances.

Frances T. v. Village Green Owners Association, 42 Cal.3d 490, 504 (1986).

Although, most typically, officer or director liability in tort is found in the context of an intentional tort, it should be noted that the above standard applies to both intentional and negligent torts.

Intentional Torts

All persons, regardless of whether they are officers or directors of a corporation, are liable for their participation in an intentional tort. PMC v. Kadisha, supra at 1378, 1381. It has been held that "[t]his rule applies to intentional torts committed by shareholders and those acting in their official capacities as officers and directors of a corporation, even though the corporation is also liable", and it is well-established that corporate officers and directors may be found personally liable for damages caused by their own fraudulent conduct.

A corporate officer or agent is personally liable for damages caused by his fraud or deceit, to the person directly injured thereby. As to third persons dealing with a corporation, the directors are merely agents of the corporation, their liability being the same, and if they assist or participate knowingly or recklessly without knowledge, in obtaining property by fraud or deceit, they are liable to an injured person who relies on their representations.

Provident Land Corp. v. Bartlett , 72 Cal. App. 2d 672, 687-88 (1946); Croeni v. Goldstein, 55 Cal. App. 4th 754, 758 (1994).

Where the acts or omissions involve a question of policy or business judgment, a director can only be held liable with a showing of fraud, bad faith or negligence. Findley v. Garrett, (1952) 109 Cal.App.2d 166, 178. The standard of care for a director is that the director's duties must be performed in "good faith" and in a manner the director believes to be in the best interests of the corporation and with the care, including reasonable inquiry, that an ordinary prudent person in a like position would exercise under similar circumstances. Cal. Corp. Code § 309(a).

Under the above standard, anyone who is found to have participated in an intentional tort will be held liable for the full measure of damages incurred. Id. at 13 81. However, "participation" should not be narrowly construed so as to be limited to commission of an intentional tort. Rather, officers or directors may be found liable for intentional torts committed by the corporation where when the officers or directors had been aware of, or ratified acts of, unfair competition and benefited from the misconduct, or for misappropriation of trade secrets when the corporation not only gained unauthorized access to the secrets but used them on a continuing basis. Id. at 1383-1384, 1387

Similarly, it has been held that an officer or director can be individually liable for conversion to one whose money or property has been misappropriated or converted by him or her to the uses of the corporation, even where he or she derived no personal benefit therefrom and acted merely as an agent of the corporation. Granoll v. Yackle, 196 Cal. App. 2d 253, 257 (1961). As held in that matter, "[t]he underlying reason for this rule is that an officer should not be permitted to escape the consequences of his individual wrongdoing by saying that he acted on behalf of a corporation in which he was interested."

Negligent Torts

Typically, the imposition of liability upon corporate officers or directors for negligent tortuous conduct is significantly less likely. In such a situation, liability will be imposed only where the officer or director participated in the wrong, or authorized or directed that it be done, and the conduct resulted in pecuniary harm or injury to a third person. United States Liab. Ins. Co. v. Haidinger-Hayes, Inc., 1 Cal.3d 586, 594-595. In that matter, the court also noted that directors or officers of a corporation, even where they participate in the wrong or authorize or direct that it be done, are not responsible to third persons for "negligence amounting merely to nonfeasance, to a breach of duty owing to a corporation alone; the act must also constitute a breach of duty owed to the third person." The Haidinger-Hayes, Inc., court also set out the requirement of injury, rather than mere pecuniary harm, for the imposition of tort liability against corporate officers and directors based upon negligent conduct. ( See, also, Self-Insurers Sec. Fund v. Esis, Inc., 204 Cal.App. 3d 1148 (1988), restating the general resistance to holding a corporate officer personally liable in the absence of physical injury, and the rule that officers are not liable to third parties for breach of duties owed to the corporation alone.)

The California Supreme Court further addressed the issue of directors' personal liability for negligence in the matter of Frances T. v. Village Green Owners Ass'n, 42 Cal.3d 490, 504 (1986), finding that the liability of corporate officers or directors does not derive from their corporate positions, per se, but, rather, from their own tortuous conduct. Id. at 503. The court, however, was careful, to restate the traditional limitations on the imposition of officer/director liability: 1) the harm in question cannot be mere economic harm; and 2) the breach of duty must relate to a duty owed to the injured party, rather than a breach of duty owed to the corporation alone. Id. at 505-06. Concerning this second prong, the court clarified the rule by stating:

a distinction must be made between the director's fiduciary duty to the corporation (and its beneficiaries) and the director's ordinary duty to take care not to injure third parties. The former duty is defined by statute, the latter by common law tort principles.

Id. at 506

In that case, involving a condominium board's failure to authorize exterior lighting, allegedly resulting in plaintiff's personal injuries, the court held that only those directors who actually voted for the commission of the tort could be held personally liable.

Lastly, the Court of Appeals, in the matter of Michaelis v. Benavides, 61 Cal. App. 4th 681 (1998), did find in a manner which was contrary to the traditional distinction between pecuniary loss and personal injury for negligence liability. In that case, the court found directors liable in negligence for pecuniary loss relating to improvements to real property by rationalizing that its decision was consistent with the traditional limitations because it was "not unlikely that personal injury could have resulted from the unsafe conditions of the real property." It is unclear to date whether Michaelis is an isolated decision or, rather, signals an expansion of the traditional limitations on officer and director liability.

ALTER EGO DOCTRINE

In California, two conditions must be met before the alter ego doctrine will be invoked. First, there must be such a unity of interest and ownership between the corporation and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist. Second, there must be an inequitable result if the acts in question are treated as those of the corporation alone. ( Automotriz etc. De California v. Resnick (1957) 47 Cal. 2d 792, 796 [306 P.2d 1, 63 A.L.R.2d 1042]; Hennessey's Tavern, Inc. v. American Air Filter Co. (1988) 204 Cal. App. 3d 1351, 1358 [251 Cal. Rptr. 859]; Alberto v. Diversified Group, Inc., supra, 55 F.3d at p. 205;Calvert, supra, 875 F. Supp. at p. 678.)

"Among the factors to be considered in applying the doctrine are commingling of funds and other assets of the two entities, the holding out by one entity that it is liable for the debts of the other, identical equitable ownership in the two entities, use of the same offices and employees, and use of one as a mere shell or conduit for the affairs of the other." (Cal. 3d Roman Catholic Archbishop v. Superior Court, supra, 15 Cal. App. 3d at pp. 406, 411; Associated Vendors, Inc. v. Oakland Meat Co., supra, 550 Cal. App. 2d at pp. 838-839.) Other factors that have been described in the case law include inadequate capitalization, disregard of corporate formalities, lack of segregation of corporate records, and identical directors and officers. (See Tomaselli v. Transamerica Ins. Co. (1994) 25 Cal. App. 4th 1269, 1285 [31 Cal. Rptr. 2d 433]; Associated Vendors, Inc. v. Oakland Meat Co., supra, 550 Cal. App. 2d at pp. 838-839; Alberto v. Diversified Group, Inc., supra, 55 F.3d at p. 205.) No one characteristic governs, but the courts must look at all the circumstances to determine whether the doctrine should be applied. ( Talbot v. Fresno-Pacific Corp. (1960) 181 Cal. App. 2d 425, 432 [5 Cal. Rptr. 361].) Alter ego is an extreme remedy, sparingly used. ( Calvert, supra, 875 F. Supp.)

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