Chapter 7 debtors were not personally liable for corporate debt

In the case of In re Rouette, a bankruptcy court in Connecticut dismissed, in part, an adversary claim filed by a judgment creditor against the Chapter 7 debtors, who were the sole stockholders, officers and directors of a corporation. The judgment creditor’s suit alleged that the claim against the debtors was non-dischargeable in bankruptcy. The suit asked the court to “pierce the corporate veil” and impose personal liability on the debtors for the debts of their wholly owned corporation.

Under Connecticut law, shareholders of a corporation are generally not liable to the corporation’s creditors. The corporation is considered to be a separate legal entity. Courts, however, have carved out an exception using a doctrine known as “piercing the corporate veil,” where, applying certain equitable principles, the corporate entity may be disregarded and shareholder liability may be imposed.

Background and procedural history

In 2013, the debtors jointly filed a voluntary petition for bankruptcy under Chapter 7. The judgment creditor subsequently filed an adversary proceeding against the debtors in the bankruptcy case. The suit requested a court ruling that the debtors were personally liable for a $1.65 million judgment debt, plus interest, which was entered in 2009 by a federal district court in New Jersey against the debtors’ wholly owned business. The suit also sought a ruling declaring that this debt was nondischargeable in bankruptcy.

The debtors denied any personal liability and filed a motion to dismiss the suit.

The bankruptcy court’s decision

The bankruptcy court determined that it had the authority to decide whether the doctrine of piercing the corporate veil was applicable. The judgment creditor’s suit involved a dispute over nondischargeability of the debt. The court stated that federal bankruptcy laws are a “public scheme for restructuring debtor-creditor relations” and bankruptcy courts have the authority to determine when a debtor’s right to a discharge applies and when it does not. The bankruptcy court held that it had jurisdiction under a “public rights” exception to decide the issue of whether the corporate veil could be pierced in order to hold the debtors liable for the judgment debt owed by the corporation. The veil-piercing issue was central to determining the issue of nondischargeability, the court said.

The bankruptcy court then applied the veil-piercing doctrine, but dismissed the judgment creditor’s suit, in part, to the extent the suit was based on allegations that the debtors, as shareholders, officers and directors of the corporation, owed a fiduciary duty to the judgment creditor. The bankruptcy court determined that the suit was not supported by any Connecticut statute or case law. The Connecticut General Statutes specifically exempts stockholders from liability for the actions taken, and the debts incurred, by the corporation. The bankruptcy court also cited rulings from several Connecticut courts, which previously determined that the shareholders, officers and directors of a corporation do not owe any fiduciary duties to the corporation’s creditors.

Contact an attorney

Individuals and business entities facing bankruptcy are strongly advised to retain the services of an attorney experienced in such matters to assist them in the protection of their legal rights.