Liability of Officers and Directors in Pennsylvania Corporations
One of the main reasons why individuals and unincorporated associations do incorporate is to gain some measure of insulation from the claims of third persons, whether under contract law or under a tort theory such as for negligence or fraud. However, those who wield executive power in a corporation would do well to remember that despite the limited liability protections of incorporation, officers and directors can nevertheless expose themselves to personal liability if they commit malfeasance or fraud in acting of behalf of the corporation.
The legal theories for imposition of personal liability on corporate officers are nothing new. In fact, they should appeal to common sense. Simply put, Pennsylvania law provides that a corporate officer may be personally liable for fraud if he personally participates in wrongful acts. Punitive damages may also attach to such tortious conduct. In a leading case on the subject, First Realvest, Inc. v. Avery Builders, Inc. , our Superior Court explained that such a “participation theory” is a theory which imposes personal liability on corporate officers or shareholders where they have personally taken part in the tortious conduct of the corporation. On the other hand, the court noted that shareholders, officers, and directors will not be held liable for a corporation’s breach of contract, absent establishment of the participation theory or successful assertion of the equitable doctrine of piercing the corporate veil.
For what specific conduct can an officer, shareholder, or director be held liable? In Kaites v. Com. of Pa., Dept. of Environmental Resources, the Pennsylvania Commonwealth Court reasserted that corporate officers are generally individually liable for their own tortious actions; that is, in order for liability to attach, the officer must actually participate in wrongful acts, and may be held liable for misfeasance but not for simple nonfeasance. Thus, committing an affirmative act of fraud may expose one to liability, but failure to act (when there is otherwise no duty to act) generally will not.
However, in some cases a failure to act may be construed as fraudulent. Generally, as the Superior Court noted in Delahanty v. First Pennsylvania Bank, N.A. , fraud “consists of anything calculated to deceive whether by single act or combination, or by suppression of truth, or suggestion of what is false whether it be by direct falsehood or innuendo, by speech or silence, word of mouth, or look or gesture.” To establish a claim for fraudulent misrepresentation, the plaintiff must allege the following elements: (1) a representation; (2) which is material to the transaction at hand; (3) made falsely, with knowledge of its falsity or recklessness as to whether it is true or false; (4) with the intent of misleading another into relying on it; (5) justifiable reliance on the misrepresentation; and (6) the resulting injury was proximately caused by the reliance. Additionally, “if the misrepresentation is made knowingly or involves a non-privileged failure to disclose, materiality is not a requisite to the action.” Moreover, “the deliberate non-disclosure of a material fact is the same as culpable misrepresentation.” McClellan v. Health Maintenance Organization of Pennsylvania, 604 A.2d 1053, 1060 (Pa. Super. 1991) . Thus, “a misrepresentation is material when it is of such a character that if it had not been made, the [agreement] would not have been entered into.”
In sum, an officer, director, or shareholder acting in her official capacity cannot make a false representation, and must correct another’s mistake if she knows it to be material to the matter at hand, or else she risks being held personally liable for her fraud.
The scenarios in which an officer’s fraud can become an issue are too numerous to count. There are many opportunities for unscrupulous corporate agents to take advantage of both consumers and peers. But well-meaning officers and directors should not hide their heads in the sand for fear of being held liable under a “participation” theory, if they have not personally committed or taken part in any wrongdoing. For the borderline cases, when there has not been affirmative misconduct, many companies provide officers and directors with some insulation against having to defend such claims. Specifically, corporate by-laws often are written to indemnify officers and directors for negligent conduct which falls short of actual malfeasance, so that the corporation itself will pay for the legal defense of an accused officer or director if he or she is ultimately found innocent of, or not liable on, the “charges.” Additionally, officer and director liability insurance is available to protect officers and directors against negligence claims, and it is not unusual for the corporation itself to pick up the tab for this insurance so as to entice qualified individuals to serve as officers or to sit on the board of directors.
This article is not intended to scare. Rather, it is intended to focus your thought on the responsibilities of corporate agents. Officers and directors must have a firm handle on the realities of the situation around them. Their action, or inaction, could have serious consequences for both themselves and their businesses.
The attorneys at Wolf, Baldwin & Associates, P.C. will take the time to advise you of your legal rights. The firm counsels both businesses and individuals regarding a variety of business and civil litigation issues, including fraud and the liability of officers and directors for malfeasance. We will represent persons injured by the fraudulent conduct of corporate agents, and we will represent officers and directors accused of wrongdoing if they are uninsured. Contact us today for a full consultation.
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