Shareholder Liability During Periods of Charter Revocation

Patricia McManus and Eric Michaels

This article addresses the issue of shareholder liability during periods when a corporation’s charter has been revoked.  Many state statutes, including New Jersey’s, allow for revocation on administrative bases such as failure to file annual reports or nonpayment of franchise taxes.  N.J.S.A. §14A:4-5(5); N.J.S.A. § 54:11-2.  Often a corporation will not know its charter has been revoked until it requires a good standing certificate as part of a transaction.  Once these issues are identified, corporations typically seek to have the charter reinstated, which in the case of revocations due to failure to file annual reports involves paying various fees and obtaining a certification of the Director of the Division of Taxation, and in the case of revocations due to nonpayment of taxes, involves paying various fees to the Secretary of State.  If the corporation has continued to act in the normal course during the revocation period, and assuming it has not engaged in conduct that would permit piercing of the corporate veil, can shareholders be liable for corporate obligations incurred during the revocation period?

Regarding revocations due to failure to file annual reports, New Jersey law provides that once a charter is reinstated, “[t]he reinstatement relates back to the date of issuance of the proclamation revoking the certificate of incorporation or the certificate of authority and shall validate all actions taken in the interim.”  N.J.S.A. § 14A:4-5(7) (emphasis added).¹   The retroactive aspect of the reinstatement along with the express language as to the effect of the reinstatement on interim actions means that if the corporation ultimately reinstates its charter, any liabilities incurred during the time of revocation will belong to the corporation.  Asbestos Workers Local Union No. 32 v. Shaughnessy, 306 N.J. Super. 1 (App. Div. 1997).  In Asbestos Workers, the defendant corporate officers appealed an order of summary judgment holding them liable for corporate debts that were incurred while the corporation’s charter was revoked for failure to file annual reports.  Id. at 1.  The charter was later reinstated, however, the trial judge held the officers liable for the debts arising under the contracts they signed on behalf of the corporation during the period of revocation.  Id. at 2-3. 

The Appellate Division reversed on two bases.  Id. at 3.  First, the court noted that personal liability was inappropriate where “the contracting party neither relied upon the individual assurances of the officers nor upon their credit.”  Id.  The court held that: 

[h]ere, where the corporation apparently retained its validity, except for the fact that a report sent to a former stockholder and officer had gone astray, imposing individual liability on directors or officers would be intolerable.  The Union made an agreement with what it thought was a viable corporation. Defendants acted on behalf of what they also thought was a viable corporation.  Once the charter was restored, the parties’ expectations again became a reality.  To impose personal liability upon the corporation’s principals on these facts simply makes no sense.

Id. at 4.

Secondly, the court pointed out that N.J.S.A. § 14A:4-5(7) makes reinstatement of the charter retroactive to the date of revocation.  Id.  In light of that clear mandate, the court saw no reason for imposing personal liability, though it did note that the result may be different if there was evidence of fraud or if there was “express reliance upon the individual credit of the officers[.]”  Id. at 5.  Though Asbestos Workers addressed the personal liability of officers, there is nothing to suggest that the holding would not apply to shareholders

While reinstatement will usually validate the actions of individuals during the revocation period, if the corporation’s charter is not reinstated, persons carrying on the corporation’s business during the period of revocation can become liable as general partners.  In Lancellotti v. Maryland Cas. Co., 260 N.J. Super. 579 (App. Div. 1992), the plaintiffs operated a truck repair business, which had its charter revoked for nonpayment of franchise taxes.²   Id. at 582.  Later, an insurance policy insuring the building where the business was conducted was amended to change the insured from the corporation to one of the plaintiffs.  Id.  The building and its contents were destroyed by fire later that year and the insurer denied payment on the basis that the plaintiffs had no insurable interest in the contents and earnings of the business.  Id. 

The court held that the charter revocation dissolved the corporation, and that during the dissolution process, the corporation was prohibited from carrying on business except for certain purposes, such as collecting assets and paying debts.  Id. at 583.  The court held that “‘persons who carry on the business of a corporation…after the charter has expired, or after dissolution, become personally liable as general partners.’”  Id. (quoting Leventhal v. Atl. Rainbow Painting Co., Ltd., 68 N.J. Super. 406, 413 (App. Div. 1961)).  The court noted that it follows that those “persons would also [be] entitled to claim the earnings and assets of that business” and found that at the time of the fire, the earnings and building contents were “part of the enterprise that was taken over and conducted by plaintiffs in their individual capacities” and that the plaintiffs had an insurable interest in the property of the business.  Id. at 583-584. 

So if reinstatement will protect corporate actors from personal liability in most instances, and if failure to reinstate can lead to personal liability, what happens when issues arise during the pendency of the reinstatement process?  As any corporation that has had its charter revoked knows, the reinstatement process, particularly for for-profit corporations, can be very lengthy.  In addition to submitting delinquent annual reports and reinstatement forms and fees, New Jersey also requires that a tax clearance certificate be issued in the case of revocations due to failure to file annual reports.  While the potential for personal liability under these circumstances is not totally clear, a New Jersey court would likely stay or continue proceedings until the completion of the reinstatement process and would then follow the Asbestos Workers court, absent circumstances implicating the fraud or reliance concerns discussed in Asbestos Workers. 

A recent unpublished Appellate Division case, Needle v. Byram Cove, Inc., 2010 WL 2555710 (App. Div. 2010), provides some useful guidance.  In Needle, the plaintiff argued that the defendant corporation did not have standing to sue and that a judgment in its favor should be vacated because its charter was revoked during the litigation and at the time of the entry of the judgment.  Id. at 6.  The court noted that while “a corporation whose charter has been revoked has limited access to our courts to enforce its rights[,]” cases like Lancellotti stand for the proposition that under certain circumstances, such corporations may sue and be sued.  Id. at 9.  The court held that upon reinstatement of a charter, the corporation is “entitled to all its franchises and privileges.”  Id. at 9 (citing N.J.S.A. § 54:11-5). 

While the circumstances present in the Needle case do not involve the potential personal liability of individuals during the period of revocation, the court’s approach is instructive on that issue.  Importantly, the court noted that the corporation had paid the overdue taxes and was actively seeking reinstatement.  Under those circumstances, the court upheld the judgments against the plaintiff and in favor of the defendant corporation, but, in recognition of the corporation’s revoked status, stayed enforcement of the judgment until the charter was reinstated.  Id.  That holding is consistent with approaches of other courts that permitted corporations to reinstate in order to prevent the imposition of individual liability or to prosecute or defend lawsuits,³  and comports with New Jersey’s statute and policy favoring corporate instead of personal liability in these instances.

The process of reinstatement is generally simple and when commenced in a timely manner, will likely result in the continued protection of the corporate shield.  Where however, a corporation has lost its charter, and a claim arises, the corporation faces the expense of defending a claim that personal liability should attach.  In addition, many businesses, particularly closely held companies, do not always adhere to corporate formalities.  Such failures, coupled with a loss of a charter, further increase the cost of defending a claim and divert resources that would be better applied to defending against the underlying claims.  

The best practice for any business is to keep current with all required State filings and to avoid circumstances that can lead to charter revocation. Businesses can take simple steps to maintain compliance, including periodically ordering a status report to check whether the corporation is current in its filings, calendaring the month in which its annual report is to be filed, and updating the name and address of its registered agent.  If revocation occurs, businesses should promptly pursue a cure so that they can become reinstated, which, in New Jersey, will usually protect individual shareholders from personal liability for actions taken during the period of revocation.    

FOOTNOTES:

1. The reinstatement statute applicable in the case of revocations due to nonpayment of taxes, N.J.S.A. § 54:11-5, does not include language validating all actions taken in the interim, however, it has been interpreted to permit reinstatement back to the date of revocation and to validate corporate action taken in the interim.  See J.B. Wolfe, Inc. v. Salkind, 3 N.J. 312, 320 (N.J. 1949).
2. Though the basis for revocation in this case was nonpayment of franchise taxes, the result would likely be the same if the basis for revocation was failure to file annual reports.
3. See Schwartz v. Magyar House, Inc., 335 P.2d 487, 490-92 (Cal. Ct. App. 1959) (permitting defendant corporation to move for a continuance so that it could be reinstated and participate in trial); see also U.S. v. 2.61 Acres of Land , More or Less, Situated in Mariposa County, State of Cal., 791 F.2d 666 (9th Cir. 1985) (interpreting California law as permitting district court discretion to grant a continuance in order to allow suspended corporation to get reinstated).

Patricia McManus is an associate in the Corporate Department of Fox Rothschild LLP.  She concentrates her practice in health law. Eric Michaels is a partner at Fox Rothschild LLP in the firm’s Roseland and New York offices. His practice focuses on general corporate matters and tax and business representation of closely held businesses, their owners and families.