By Arina Shulga
One of the main benefits afforded to a corporate structure is the limited liability protection for its owners. This means that the corporation and its shareholders are treated as separate legal entities and it is the corporation’s assets, and not the assets of its individual shareholders, that are available to pay for judgments and claims of creditors.
In certain limited circumstances such as fraud, disregard for corporate formalities, and inadequate capitalization, the limited liability shield can be “pierced” by the courts to hold the corporation’s shareholders personally liable for the corporation’s debts and other obligations. Such “piercing” of the corporate limited liability shield is a prevalent practice in most if not all states.
In New York, however, the “corporate veil” can also be “pierced” for the top ten shareholders of a private corporation for nonpayment of compensation to the corporation’s employees, according to Section 630 of the New York Business Corporation Law. The shareholders may be held jointly and severally liable, which means that employees can seek to recover from just one or all ten shareholders. If some shareholders are unable or unwilling to pay, the others will have to cover the entire expense, but then can seek the recover the pro-rata amounts from the nonpaying shareholders. The law does not just cover salaries. It includes all forms of benefits such as vacation pay, employer contributions to insurance and pension funds, and promised bonuses. The law also sets out the procedure that the employees must follow to recover the money, including the requirement to first obtain a judgment against the corporation. Note, however, that the law only covers employees and not independent contractors.
For years, New York corporate lawyers advised their clients to incorporate in Delaware instead, thus avoiding this potential personal liability. However, since 2016, incorporating in another state just to avoid Section 630 became fruitless because Section 630 was amended to extend to corporations formed in other states that had New York employees.
Forming a New York LLC instead of a corporation to avoid Section 630 also does not work because Section 609 of the New York Limited Liability Company Law has a similar provision holding the top ten members of a New York LLC personally liable for unpaid employee compensation. The only difference is that it does not extend to LLCs formed in other states just yet.
In June 2019, the New York State Assembly and Senate passed a bill that, if signed into law by the New York Governor, would enable employees to obtain liens on their employers’ (business owners, managers and supervisors) personal and real property if there are allegations of wage theft. This is done to prevent employers from transferring assets to a friend or a family member when faced with such claims. Wage theft claims could include withheld tips, unpaid overtime, unlawful deductions, and other violations.
In conclusion, when forming a New York corporation or an LLC, or registering a foreign corporation in New York, beware that you may personally be responsible for unpaid compensation to your New York employees.
This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, Arina Shulga.