A friend and colleague posed the following question:
Are you aware of situations where selling shareholders who engage in a stock or membership sale of their ownership interests are held liable to creditors of the company before, at or after the sale? What theories other than veil piercing would be asserted to impose liability?
I'm afraid I wasn't able to be much help. I recall from my practices days back in the dark ages (the 1980s) that some creditors tried to use fraudulent conveyance law to recover the allegedly fraudulent transfers from the shareholders. Plus, I suppose in some cases there might be successor liability.
The problem is that, absent veil piercing, there are very few situations--whether in a sale context of not--in which shareholders face liability to creditors.
The following commentary is adapted from my book Corporate Law
Watered stock is one potential claim. If a corporation claimed that it had sold 2,000 shares of stock with a par value of $100 per share, for a total capital of $200,000, the trust fund concept necessitated some mechanism for ensuring that the full value of the purported capital in fact had been paid into the corporation. Suppose Shareholder bought 100 shares of the corporation’s stock. Shareholder should have paid at least $10,000 for her shares. If Shareholder paid less than that amount, her stock was said to be “watered.” If Shareholder actually paid only $4,000, for example, she could be held liable to the firm’s creditors for the $6,000 “water.”
Failure to pay in full for shares probably was rare. Because corporation statutes allowed corporations to issue stock in return for noncash forms of consideration, such as property or services rendered, however, disputes over the valuation of such consideration were not uncommon. Suppose the board accepted an offer from a prospective shareholder to exchange an acre of land for 500 shares of stock having a par value of $100 per share. The corporation later became insolvent and creditors claimed that the acre of land in question was really worth only $20,000. If true, the shareholder’s stock was watered to the tune of $30,000.
Several factors combined to effectively eliminate the watered stock problem. One was the decline of par value as a meaningful concept. Par value always was an arbitrary figure. With the development of secondary trading markets for corporate stock, the market price (and thus the value) of outstanding corporate stock rarely coincided with its par value. As a result, par value simply had no relation whatsoever to the price shares would command on a secondary trading market or the price at which shares subsequently might be issued by the corporation. States began to permit corporations to issue low par value stock (such as shares with par value of a penny) and most states eventually permitted corporations to issue shares having no par value whatsoever. Consequently, today, watered stock is largely a dead issue. Corporations issue no par or low par stock and sell it at the highest price the shares will bring in the primary market. As long as the investor pays something for his shares, the par value requirement will be satisfied.
The trend away from par value was taken to its logical conclusion in the MBCA, under which par value has no legal significance. The MBCA, moreover, goes even further than Delaware law towards eliminating concerns about the propriety and adequacy of consideration for shares. Section 6.21(b) allows the corporation to accept just about any form of consideration: tangible or intangible property, cash, promissory notes, services performed, contracts for future services or other securities of the corporation. Section 6.21(c) then provides that the board must determine whether the consideration is adequate. If the board so determines, their conclusion is conclusive. Once the corporation receives the agreed consideration, the shares are regarded as fully paid and nonassessable.
Improper dividends is the other example that comes to mind, but in Delaware it’s pretty much meaningless. DGCL § 174 provides that if there is a willful or negligent illegal dividend payment the directors under whose administration the payment occurs are jointly and severally liable to the corporation or directly to its creditors in the event of dissolution or insolvency. A director can avoid liability by timely causing his dissent to be noted on the corporation’s books. Section 172 also protects a director who in good faith relies on reports of corporate officers, legal counsel or accountants. The amount for which directors can be held liable is the amount of the dividend that was improperly paid plus prejudgment interest. There is no express provision for holding liable those shareholders who receive the improper dividend, although directors are entitled to contribution from shareholders who knowingly received the illegal dividend. Worse yet, from the creditor’s perspective, standing under § 174 is limited to the corporation (and, presumably, shareholders suing derivatively). Creditors are given standing only where the corporation is insolvent. In effect, creditors are limited to their fraudulent conveyance remedies.
MBCA § 8.33(b) provides that a director who is held liable for an unlawful distribution is entitled to contribution from (1) any other director who voted for or assented to the distribution and also failed to live up to the standards of section 8.30, and (2) from each shareholder who accepted the distribution knowing that it was improper. Although the MBCA imposes a contribution obligation on shareholders who knowingly receive an improper distribution, it does not otherwise impose any liability on shareholders. If a creditor wishes to recover the amount of the unlawful distribution from the shareholders, its remedy lies in the fraudulent conveyance laws, not the MBCA. This is a significant change from the common law rule that all shareholders had corporate law liability for improper distribution.
It is noteworthy that under MBCA § 8.33, the cause of action for an unlawful distribution belongs to the corporation. A shareholder therefore could bring a derivative action against the responsible directors. Because creditors generally have no standing to sue derivatively, however, only rarely will they be able to bring suit under MBCA § 8.33. The MBCA’s distribution rules thus provide creditors with few protections.
