Individual Tort Liability of Officers and Directors

Notwithstanding the exception for alter ego liability, many members of the public (and even the State Bar) believe that operating a business through an entity will protect the entity’s officers and directors from personal liability for negligence and other torts. Not surprisingly, officers and directors are liable for their intentional torts committed against those dealing with the corporation.^[1] In addition, officers and directors can also be liable for negligence and cannot hide behind the company shield. “Director status therefore neither immunizes a person from individual liability nor subjects him or her to vicarious liability.”^[2]

Smaller Companies Beware

Officers and directors of smaller business entities are often creating and carrying out company policy and running day to day operations; thus, the risk of personal liability is greater than with larger, more structured and complex entities. This article highlights the law governing individual director and officer liability and some situations where directors and officers may be personally liable for negligence, whether or not the company is also liable. As the case law illustrates, director and officer liability is an important concern that should be addressed with the client at the entity formation stage and during the course of representing the entity, its officers and directors, and whoever else the attorney advises.

The Duty and Scope of Duty Owed by Officers and Directors

A director’s duty to a third person is not governed by the business judgment rule.^[3] The business judgment rule does not replace the common law duty to refrain from conduct that imposes an unreasonable risk of injury to third persons, which every person owes to others.^[4] Officers or directors may be subject to personal liability if they personally directed or participated in the tortious conduct. To impose tort liability on a director or officer, one must show that (1) the director or officer specifically authorized, directed, or otherwise participated in the tortious conduct, or that, (2) although the director or officer knew or reasonably should have known that some hazardous condition or activity under their control could injure plaintiff, he or she negligently failed to take or order appropriate action to avoid the harm.^[5]

Discussion and Illustration of Officers’ and Directors’ Duties

“Directors and officers have frequently been held liable for negligent nonfeasance where they knew that a condition or instrumentality under their control posed an unreasonable risk of injury to the plaintiff, but then failed to take action to prevent it.”^[6] One such case involved Anthony Benavides (Benavides), the president, director, and fifty percent stockholder of a cement contractor, A & J Stamped Concrete, Inc. (“A & J”), who contracted with a general contractor to build a patio and driveway at plaintiffs’ home.^[7] Benavides made all of the construction decisions for the patio and driveway, but his brother performed all of the manual labor.^[8] The homeowners alleged Benavides was personally liable for economic damages the homeowners suffered from Benavides’ negligent construction of the patio and driveway.

The appellate court reversed a judgment in favor of Benavides because, in part, he “did not merely make a corporate policy decision which was carried out by someone else. He personally participated in and directed the construction of appellants’ patio and driveway. He personally bid for appellants’ job and he personally negotiated with appellants for completion of the job. He personally made the decisions to use cheaper materials and construction methods which allegedly resulted in the patio’s and driveway’s structural inadequacies.”^[9]

Even though Benavides did business as a limited liability company, because he authorized, directed, and participated in the negligent conduct, he was personally liable for the plaintiffs’ economic damages.

Another example is Frances T. v. Village Green Owners Assn. There, a plaintiff alleged that members of the board of directors of a condominium homeowner’s association were each personally liable for negligently failing and refusing to take action to install sufficient exterior lighting at her condominium unit and requiring her to remove additional lighting that she had installed herself where they knew that past crimes had been committed linked to lack of lighting. The plaintiff suffered damages when she was sexually assaulted under the cover of darkness created by the lack of adequate lighting.

The court held that she had alleged causes of action against the individual members of the board of directors and demurrers to her complaint were improperly sustained. The court held that sufficient facts were alleged to establish that the directors took affirmative action that made the break-in more likely when they ordered her to immediately disconnect the lighting she had installed to protect herself from the foreseeable risk of another criminal break-in.^[10] Further, and as separate grounds for personal liability, plaintiff sufficiently alleged that the individual directors breached a duty of care owed to her by failing to take action to repair the hazardous lighting condition within a reasonable period of time.^[11]

As these two cases demonstrate, a director is an agent of his or her corporate principal and is liable for his or her own acts regardless of whether the principal is liable. As director, his or her role is to direct and ultimately control corporate conduct. Directors individually owe a duty of care, independent of the corporate entity’s own duty, to refrain from acting in a manner that creates unreasonable risk of personal injury to third parties. Otherwise a director could inflict injuries on others and then escape liability behind the shield of his or her representative character, even though the corporation might be insolvent or irresponsible.

Conclusion

Because many entities are closely held companies with day to day operations operated by their shareholders, or members in the case of a limited liability company, it is critical to understand that directors and officers are not fully protected from liability merely by operating as an entity and by complying with corporate formalities, commingling, and other acts or omissions commonly giving rise to alter ego liability. Moreover, it is also important for an attorney representing the victim of a tort to know that directors and officers may be liable individually for torts, even if they are committed on behalf of the corporation.