Mike Murtaugh, Esq.
Murtaugh Miller Meyer & Nelson LLP
Irvine, CA

The corporate limitation of liability, and its gaps and limitations, are the subject of laws that are generally well settled among lawyers, but poorly understood by design and environmental professionals. This article is intended to provide a layman's overview of the subject sufficient to enable such individuals to assess how this area of the law can best be used to limit professional risks. First, the basic principle of the corporate shield is explained, and then a discussion is provided of the basic limitations of personal professional negligence liability and the doctrine commonly known as "piercing the corporate veil."

The Corporate Shield

The law has long recognized the importance of, and given great deference to, the corporate protection from personal ownership liability for the obligations of a business enterprise, the principle that a corporation's creditors can pursue only the corporation's assets and insurance, and not the personal assets of the business owners. A concept dating back at least to the early days of the industrial revolution, the so-called corporate veil (in today's terms, read "firewall") enables investors to enjoy the benefits of business ownership while limiting their risks to what they voluntarily choose to invest -- no shareholder of General Motors need fear any personal exposure for even the largest multibillion dollar product liability jury verdict because liability to any and all corporate creditors stops at the corporation. Further, while once upon a time the corporate shield came with a potentially heavy burden of double taxation (first of corporate profits, and then again of individual income), this burden has been greatly reduced by the IRS's creation of the Subchapter S Corporation (a corporate entity that provides shield protection, but which, like a partnership, is not a taxable entity, but rather passes any income directly to the company owners via a K-1 and without taxation), and increasingly individual states are granting (or selling for a modest tax) corporate shield protection through still more user friendly Limited Liability Partnerships (LLP's) and Limited Liability Corporations (LLC's).

Likewise, while general legal principles or particular contracts may impose high-risk duties upon a business enterprise (for example, to produce a defect-free project, or to warrant project components), rarely are such duties imposed upon an enterprise's individual employees. For example, even the CEO and major shareholder of a contracting firm is not personally responsible for the firm's obligations to deliver a specified structure by a specified date -- whatever rights a disgruntled owner might have for poor contractor performance are for the most part against only the contracting firm. Technically, every individual employee, and in fact every member of our society, has a duty to conduct his or her affairs in a reasonable manner so as not to subject others to an unreasonable risk of harm. But as a practical matter this general obligation of societal membership rarely comes into play for non-professional employees. In theory, an employee who causes an accident by negligently running a red light while on company business faces the same legal liability as if the accident had occurred on their day off; but the employer faces the same liability for the accident, and as a practical matter most such situations are simply resolved by automobile insurance. The problematic high risk aspects of most businesses are the result of specific duties imposed upon the business, duties that rarely apply to individual employees as such.

Personal Liability for Professional Negligence

While the corporate shield afforded by corporations, LLP's and LLC's generally protects owners from individual liability to firm creditors, and as a practical matter a business's legal and contract duties rarely apply directly to its affiliated individuals, for design and environmental professionals practicing their profession, these limitations on personal liability are profoundly limited. While design and environmental professionals have no greater personal responsibility as owners or employees for their firm's obligations than do their counterparts in development or contracting firms, as practicing professionals they are far more vulnerable to allegations of personal negligence. With a professional practice, the duty to provide non-negligent services lies not only with the firm, but also with the individual practitioners who personally provide the services. If, for example, a contractor's project manager performs poorly, for the most part the rights of the injured owner are against only the contractor, not against the individual project manager with whom the owner did not contract, and upon whom the law imposes only the most general duties. In contrast, if a design or environmental professional provides services below the applicable standard of practice, malpractice liability lies as much with the malpracticing professional as with their firm. If an engineer signs (and thereby takes professional responsibility for) a substandard set of plans and specifications, then they may well be able to claim indemnification from their employer or their employer's professional liability insurer. But if for any reason this indemnification is not forthcoming (for example, if the employer does not have adequate assets or insurance), then they must face whatever liability the law may impose on their own.

As long as a firm remains healthy and adequately insured, the issue of personal professional liability usually remains academic. If a professional liability claim arises, the individual practitioners accused of negligence are certainly not uninvolved, but the real exposure lies with the firm or its insurer. On the other hand, if a firm fails, or is allowed to go defunct upon the retirement of its key principals, or loses its financial viability such that it can no longer afford adequate liability insurance, then the issue of personal professional liability can become quite real. And while the firm owners may well still be able to assert corporate shield protection concerning the firm's general creditors, any individual who was subjected to allegations of professional malpractice while practicing with the firm is exposed. If, say, a design or environmental professional who practices through a corporate entity decides to wind up all corporate affairs and retire, then the corporate shield can be used to avoid personal ownership liability to the corporation's general creditors, but liability for alleged professional malpractice will go on unabated indefinitely.

Piercing the Corporate Veil

Merely doing business as an entity that can afford corporate shield protection does not guarantee such protection will be afforded. The corporate shield is a privilege, extended only when specified technical requirements are met, and revocable if abused.

The technical requirements vary widely with the form of entity, and to a much lesser extent from state to state; and specific and current legal counseling is well-advised, especially concerning the newly authorized LLP's and LLC's. In general, however, the key in all cases is a respect for the formalities and separateness of the business entity. If the firm owners want creditors to honor the corporate entity, then so must they; and if a firm is really just the "alter ego" of its owner, then it may not shield the owner from firm creditors. Commingling of funds is perhaps the parade example of impropriety in this regard; and business owners who treat firm funds as if they were their own may have difficulty in asserting the corporate shield to protect their personal assets from firm creditors.

Abuse of the corporate shield most often takes the form of attempts to defraud or otherwise mistreat specific firm creditors (for example, borrowing money in the firm name with the intent of thereby avoiding repayment), or more generally to put all firm creditors at unfair risk by operating with obviously inadequate capital or insurance. Those who choose to do business with a corporate entity take a well-recognized credit risk, but not the risk of being cheated; and if the firm is properly (if poorly) run with capitalization or insurance commensurate with its known risks, then firm creditors bear the risk of legitimate business failure.

Mike Murtaugh is a lawyer with personal practice emphasis in the areas of construction and professional liability, and with more than 20 years of experience working with design professionals. A 1973 graduate of The University of California at Los Angeles School of Law, Mr. Murtaugh is a founding partner of the Southern California firm of Murtaugh Miller Meyer & Nelson LLP, located in Irvine, California, and a frequent lecturer on construction law, design professional risk management and professional service contracts.