Going Out of Business, but Going on Vacation?
Business Owner Liability in Light of
Polsky v. Virnich

Wisconsin has long held the belief that when a business owner closes shop, creditors of the business had limited opportunities to collect amounts still due.  The creditor was either out of luck, or would have to “pierce the corporate veil” in an attempt to attach to the former business owner’s personal assets, a lengthy, expensive, and possibly unsuccessful process.  But what happens when the business owner intentionally runs the business into the ground, while paying himself/herself exhorbinant salaries and benefits?  That is the question currently pending in front of the Wisconsin Supreme Court in the case of Polsky v. Vinrich.

The case involves Communication Products Corp. (CPC), a now defunct Wisconsin corporation, owned and run by two individuals.  After building CPC into a thriving business, the two owners began funneling money out of the company and into their own pockets, by stock dividends, salaries, bonuses, and even through other shell corporations set up by the owners.  Eventually, CPC was unable to pay all of its creditors, and a Grant County circuit court appointed Polsky as a receiver over the company, to manage the assets of the company.  As receiver, Polsky was now able to review all of the actions taken by the owners and was able to parse through the shell companies and determine that the owners were not acting in the company’s best interests.   

Polsky filed suit, on behalf of the company he now managed, against the owners.  A jury agreed with Polsky and found the two owners owed the company $6.5 Million: $1.9 Million each, and $2.7 Million jointly.  The owners appealed the decision and the Court of Appeals certified the case directly to the Wisconsin Supreme Court.  On January 7, 2009, the Wisconsin Supreme Court heard oral arguments from both sides as to what they think the outcome of the case should be.

Possible Outcomes

Without delving into the myriad of procedural loopholes that the Supreme Court loves to utilize to dismiss appeals without considering the merits, there appears to be two possible outcomes to Polsky.  1) The owners owe a fiduciary duty to the creditors of a corporation, or 2) the owners do not. 

Fiduciary Duty

A fiduciary duty can be defined as the legal responsibility for investing money or acting wisely on behalf of another.  Wisconsin currently recognizes several professions with fiduciary duties: attorneys, bankers, and real estate agents, to name a few. 

Current Law

 Currently, Wisconsin’s law states that “in order for officers and directors to have a fiduciary duty to creditors, a corporation must be both insolvent and no longer a going concern.”  Beloit Liquidating Trust v. Grade, 2004 WI 39, ¶ 2, 270 Wis. 2d 356, 677 N.W.2d 298.  This position is different from most other states. 

Further, a secondary question in front of the Supreme Court is whether the officers and owners of the company owe a fiduciary duty to the company.  Corporate offices owe a fiduciary duty to the shareholders and shareholders owe a fiduciary duty to the corporation, but when it is the shareholders and corporate officers that are the ones acting, who can possibly disagree with them? 

Effect of the Possible Outcomes

If the Supreme Court upholds the status quo, keeping Wisconsin amongst the minority of U.S. States, creditors will be required to utilize the tried and true method of accountability, “piercing the corporate veil.”  However, because of the rules for attempting to “pierce,” more creditors should look to utilizing personal guarantees for all debtor corporations.  This has significant benefits legally, but can raise some suspicions when creditors seek to have long-time customers now personally guarantee the performance of the corporation. 

However, if the Supreme Court reconciles the differences between the majority of states and Wisconsin, many things will change. 

Benefits to Creditors

There are specific criteria that a creditor must prove in order to “pierce the corporate veil.”  A sole shareholder corporation, while continuing to be “a going concern,” can perform the tasks necessary to limit the ability of a creditor to “pierce,” while draining the corporation of assets.  Many individuals, and even small business owners, find this to be appalling behavior.  The ability to attach to these ill-gotten-gains, would certainly encourage fair dealing and accountability. 

Potential Pitfalls

How far of a lookback would be allowed by creditors in examining this new found fiduciary duty?  Will current creditors of Ford Motor Company be allowed to claim that Henry Ford received too much compensation for inventing the Model T?  While this is clearly a silly example, the moral rings true.

Further, will this allow the creditors of every failed business venture to open the books and attempt to find expenses that they disagree with?  Will every expense account lunch now be scrutinized?  To what degree and extent must an owner act in order to protect himself/herself?

Conclusion

We can expect the Wisconsin Supreme Court to issue its decision in Polsky v. Vinrich in the summer of 2009.  Will this be a “radical” change, as Chief Justice Shirley Abrahamson stated during her questioning on January 7, 2009?  Or will Wisconsin continue to be in the minority?  We can only wait and see.