Former Shareholder Liability for Prior Use of Corporate Funds for Personal Use – What Standard Should Apply?

In a recent case, the Tennessee Court of Appeals, affirming the holdings of a trial court, held that the phrase “assets used in conducting the business” was ambiguous, with respect to establishing the breadth of assets transferred in a stock transfer agreement, and set forth seemingly new caselaw on the personal liability of former sole shareholders of a closely held corporation for challenged corporate expenditures. The case involved the sale of a closely held corporation among family members where the ownership of certain assets, several personal cars, was contested. The plaintiffs in the case, the corporation and its new sole shareholder, argued that the cars belonged to the corporation, but the defendants, the former sole shareholders and related parties, asserted that the cars were marital property of the former sole shareholders. The corporation alternatively asserted a claim for recovery of the expenditures made on these personal cars.

In its opinion, the Court of Appeals specifically considered the phrase “assets used in conducting the business” (though, the language of the agreement was arguably broader and stated “all assets … used in conducting the business”), often used in purchase agreements, and found it to be ambiguous. It then resolved the issue in favor of the defendants based on evidence that the parties to the agreement did not intend for the personal cars of the former sole shareholders to be considered assets of the business. The cars had never been titled in the corporation’s name, but some of them had been listed on a tax return as depreciable assets. Importantly, though, the parties had treated the cars as marital assets in a simultaneous divorce proceeding where an agreed order was entered declaring them such. The Court of Appeals held that the expenditure of corporate funds on these personal cars did not negate this evidence and merely represented questionable business practices. This holding demonstrates the importance of specifically defining what is – and is not – transferred in a sales agreement.

In what a trial court found to be a case of first impression regarding close corporations, the Court of Appeals also resolved the claim for corporate expenditures for the defendants. While the trial court determined that there was not prior caselaw speaking to this specific liability question, the Court of Appeals relied on caselaw discussing when the corporate veil can be pierced to hold that the defendants should not be held personally liable for the corporate expenditures made while they were the sole shareholders of the closely held corporation.

This case appears to clarify the shareholder liability standard for close corporations, as opposed to public ones, at least with respect to situations where corporate funds were expended for personal use. The corporate veil piercing analysis is undertaken on a case-by-case basis focusing on fraud and injustice, and the use of corporate funds on personal cars did not amount to this in the court’s opinion. Going forward, claims for corporate expenditures against former sole shareholders of a closely held corporation will need to undertake a corporate veil piercing analysis.

To read more about the case, you can view the oral arguments here, and you can read the full opinion here.

Blog post written by Katherine Denney, Law Clerk at Dodson Parker Behm & Capparella PC, edited by attorney Tyler Chance Yarbro