When a business fails, creditors that have contracted with that business that are owed money often try to recover their debt from any source they can. Recently the Commercial Division of the New York County Supreme Court issued an important decision thwarting a creditor’s attempt to collect a debt from entities or individuals with whom it was not in direct contractual privity. In American Media Inc. v. Bainbridge & Knight Laboratories LLC, the plaintiff creditor sought to recover a debt against an individual who was the owner, chief executive officer, president, chairman, secretary, treasurer and director of the company that contracted for $1.3 million in advertising services.
After the company defaulted, the plaintiff sued the individual under alter ego, fraud and debtor/creditor law theories. On September 19, 2014, the court granted the individual defendant’s motion to dismiss, reasoning that an officer is not individually liable for the debt of his company even though he made decisions for the company that caused the company to be unable to pay its debt. The Court held that conclusory allegations that the corporate form is a “sham” could not overcome a motion to dismiss and do not warrant any discovery.
Creditors can avoid this issue by making sure they obtain a personal guaranty from the owner of closely-held businesses with whom they provide advanced payments for services. If the owner is unwilling to provide such a guaranty, that is a red flag that should be carefully evaluated before making any advanced payments.
The decision of the Commercial Division in this case is on appeal.
After the company defaulted, the plaintiff sued the individual under alter ego, fraud and debtor/creditor law theories. On September 19, 2014, the court granted the individual defendant’s motion to dismiss, reasoning that an officer is not individually liable for the debt of his company even though he made decisions for the company that caused the company to be unable to pay its debt. The Court held that conclusory allegations that the corporate form is a “sham” could not overcome a motion to dismiss and do not warrant any discovery.
Creditors can avoid this issue by making sure they obtain a personal guaranty from the owner of closely-held businesses with whom they provide advanced payments for services. If the owner is unwilling to provide such a guaranty, that is a red flag that should be carefully evaluated before making any advanced payments.
The decision of the Commercial Division in this case is on appeal.