February 27, 2017
One of the basic tenants of corporate law is that the individuals acting on behalf of a corporation generally are not personally liable for the debts and obligations of the corporation. The corporation is a distinct legal entity — an artificial person separate from its shareholders. While exceptions to that general rule are rare, they should be evaluated carefully because they can become traps for the unwary.
One noteworthy exception applies to corporations and other business entities doing business in Texas. Officers and directors of such businesses must be mindful of a May 15 deadline to file the company's Texas "franchise tax" return and pay any related franchise tax liabilities. While the filing date may be extended, the payment may not. The consequences of non-payment include personal liability for the company's directors and officers, which may be a stark and startling outcome, particularly in a state that is otherwise considered business-friendly. Although Texas is, in fact, business-friendly in many regards, the consequences to owners and officers for non-payment of the franchise tax (and other business taxes) are unfriendly in the extreme.
In most states, business entities like corporations and LLCs must pay an annual or biennial fee for the privilege of doing business there, which is accompanied by a short form of report identifying the entity's place of business and registered agent. But a franchise "tax" is generally considered to be a government levy (tax) charged for the privilege of doing business in the state. In Delaware, for example, in addition to filing fees, there is also a franchise tax, which is a significant source of revenue for the state. However, such unpaid taxes in Delaware do not create any personal exposure for directors and officers.
In Texas, directors and officers face personal liability for not just the amount of the unpaid franchise tax, but also for all liabilities of the company that arise once the state seeks to terminate the company's existence for failure to pay the franchise tax. In other words, while bank debt and other longer term liabilities that arose before May 15 of a given year will not suddenly become personal liabilities of the officers and/or directors, other current and recurring obligations arising after May 15, such as rent owed by the company, could produce unwanted personal liability. Of course, owners and officers of businesses operating in Texas also have personal liability for trust taxes, including sales and use taxes and withholding taxes, as they do in almost all other jurisdictions.
The Texas franchise tax base can be a complex calculation for some types of businesses. Texas franchise tax apportionment and sourcing rules are frequently misunderstood. Perhaps most alarming, given the sustained drop in oil prices and the resulting downward effect on Texas's energy economy, is that the various measures of the franchise tax may result in franchise tax liabilities for companies that are considered unprofitable. That is, as a result of the franchise tax base measured under various computations of margin as opposed to pure profits, a company might lose millions of dollars and still owe thousands or millions for the franchise tax. If such tax is not paid, the officers and directors may be held liable for the tax as well as other obligations of the company for which there would otherwise be no personal liability.
It is important to ensure that directors and officers of Texas companies fully understand their personal exposure for the liabilities of their companies that could result due to failure to timely pay franchise taxes. Many individuals serving in these positions naturally expect that they are not subjecting themselves to personal liability for the debts of their employers. Unfortunately, in Texas, this assumption is not always accurate.