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Good Corporate Governance; Liability to your Surety – How Long?

Alan L. Stefaniak

Good Corporate Governance

If you are in business either as a Contractor, Subcontractor or Developer you most likely do so as a Corporation or more recently a Limited Liability Company. The reason for doing so is to insulate yourself from personal liability for the acts and/or omissions of the business. However, merely forming the business entity is not enough. You need to make sure that you are following legal formalities to maintain the protection the law provides for corporations and limited liability companies.

Many times a creditor of a business entity will try and pierce the corporate veil in order to impose personal liability on the shareholders and directors. This can be done if the corporation fails to hold appropriate annual meetings and keep minutes of them, commingles corporate and personal funds, fails to properly document transactions between shareholders and the corporation i.e. loans or does not issue proper stock certificates.

As business owners you are busy running your day to day operations and in the current economy just surviving is a major challenge. However, this seemingly mundane issue of keeping good corporate records is important. It can become even more so if your business encounters problems and you need to deal with creditors who will be looking to pierce the corporate veil and impose personal liability if they can. Some questions to ask and be prepared for are the following:

  1. Are you keeping minutes of meetings and properly documenting transactions that are not routine?
  2. Have you issued proper stock certificates and any new ones if the need arises, i.e. a new shareholder buys in or you gift stock to a child?
  3. Has the company been properly capitalized?
  4. Do not commingle personal and corporate funds. if shareholders make loans properly document them.
  5. Are all directors and officers taking an active part in the business operations?
  6. If transactions occur between the business and its owners i.e. you lease property to the business is it at market rates and properly papered with a lease that has all the usual terms and provisions?

The above list is not exhaustive but should give you an idea as to the types of issues that need to be addressed. Those of you who consult with me know that I strongly recommend that you let us provide corporate/limited liability company maintenance for you on an annual basis. You are busy with other business issues and usually don’t have time for this and may not think it important. However, this is what we do as lawyers and advisers to you. We charge a nominal fee for this service but I believe it is well worth the cost to make sure the insulation from personal liability is maintained. Those of you who have asked me about this issue know that I advise the nominal fee you pay us is “cheap insurance” to maintain proper corporate governance that can protect your personal assets should a business calamity occur. If we are not already doing this for you give me a call and I can give you more information about this service we provide.

Liability To Your Surety—How Long?

General Contractors that do public work are familiar with having to post payment and/or performance bonds. Sometimes the obligation for doing so is also placed on subcontractors for their part of the work. There are also private jobs where an owner will require a bond. In any event when you have to post a surety bond. the bonding company is going to require your personal guaranty to indemnify against any loss it sustains. When you give the guaranty and the indemnification your personal assets are liable to satisfy any judgment that is obtained against you. If your company defaults on the underlying construction contract and the surety has to come in and complete performance or pay creditors it will make a demand against you to indemnify for the losses it sustained. In a recent Illinois Supreme Court case the issue was how long does the bonding company have to file a lawsuit against you after it makes a demand and you fail to pay. Is the statute of limitations the four year statute that applies to construction improvements to real estate or is it the ten year statute of limitations that applies to written contracts?

In Travelers Casualty & Surety Company v Bowman the Illinois Supreme Court stated that in order to answer this question you have to look at the nature of the liability and not the nature of the relief that is sought. The four year statute of limitations applicable to construction improvements applies to the design, planning, supervision, observation or management of construction or construction of an improvement to real property. In order for this statute of limitations to apply, liability must rest on construction related activity. The Supreme Court held that this was not the basis upon which Travelers was seeking to impose liability on the individuals involved. Rather the liability at issue arose from a breach of the contractual duty to indemnify.

The construction company’s breach of the underlying construction contract resulted in the bonding company having to pay claims. Payment of these claims then triggered the individuals obligation to perform under the indemnity provisions of the bond. The individuals liability arose from their breach of their duty to indemnify and not from the construction company’s breach of the construction contract. Accordingly, the Illinois Supreme Court ruled that the bonding company had ten years from the date of the demand to bring an action against the individuals who had given their personal guarantees and agreed to indemnify the bonding company from its losses.

In these difficult economic times the possibility of defaulting on a contract is a real possibility. Things can just happen no matter how hard you try. The Travelers case lets us know how long the bonding company has to come after you. Its ten years which is a long period to have to have potential liability hanging over your head. While posting these bonds is something you cannot avoid if you are doing public work the Travelers decision lets you know for how long your personal assets are at risk should something go wrong.

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