Sharp  Thinking

No. 95     Perspectives on Developments in the Law from The Sharp Law Firm, P.C.      July 2013

“Deepening Insolvency” Theory Rejected . . .

Wage Payment Act Imposes No Duty To Make

More Capital Contributions To Failing Business

By John T. Hundley, Jhundley@lotsharp.com, 618-242-0246

            A business owner does not have a duty to make voluntary capital contributions to his financially-troubled business in order to avoid personal liability for its wage payment obligations, a bankruptcy judge in Northern Illinois has held.

            The decision in In re Montalbano, 486 B.R. 436 (Bankr. N.D. Ill. 2013), is a rare published treatment of corporate owners’ and managers’ potential personal liability under § 13 of the Illinois Wage Payment & Collection Act, 820 ILCS 115 (“IWPCA”).  It also appears to represent a rejection under Illinois law of the general doctrine of “deepening insolvency,” which some have urged as a general basis for personal liability for managers who allow business operations to continue after the prospect of insolvency is apparent.                                                     

            Facts Summarized.  In Montalbano, former employees of the bankrupt’s corporation sought to recover from the owner’s personal bankruptcy estate for wages earned during the final weeks of that corporation’s operations.  In administrative proceedings before the Illinois Department of Labor, an administrative law judge found the corporation liable for the wages but left the issue of personal liability for decision by the bankruptcy court. 

            The prospect of personal liability is raised by § 13 of the IWPCA, which provides that “[a]ny officers of a corporation or agents of an employer who knowingly permit such employer to violate  the provisions of this Act shall be deemed to be the employers of the employees of the corporation”.  As the corporation’s financial problems mounted, its 100% shareholder, sole director, CEO and president voluntarily for a time made capital infusions to keep it afloat, but he then ceased and the corporation failed to pay the wages and final compensation required by the IWPCA.

            Two-Step Analysis.  According to the court, to incur personal liability under IWPCA an officer must (1) have knowledge of the compensation arrangement and (2) knowingly permit the corporation to wrongfully deny compensation by participating in the decision to do so.  In the case of Montalbano’s closely-held corporation, the court had no difficulty finding the first test met. 

            Second Test More Complicated.  However, the court found the second test not met.  In this respect, the former employees contended that because Montalbano knew or should have known that the withdrawal of his funding would result in the corporation being unable to meet its employment obligations, he knowingly permitted the corporation to wrongfully deny the claimants their compensation.  This argument, the court said, “stretches the application of the Wage Act beyond any scope reasonably intended by the Illinois legislature.” 

            “Duty to Shut Down” Argument Rejected.  In Montalbano, the owner had made more than $36 million in loans and capital advances to the corporation.  The employees thus argued that he knew the business was not viable without continued advances and that he had a duty to prevent them from reporting to work when he ceased making advances.  Conceding that the loans evidenced that the owner knew the business was within the “vicinity of bankruptcy,” the court found that fact “too attenuated” to impose personal liability.  It found the capital infusions to be signs of the owner’s good faith and said that, absent deception, a corporate owner contributing capital would not be held to a higher standard than a third party contributing such capital.

            The court likened claimants’ arguments to the “deepening insolvency” theory urged to support owner liability in insolvency cases generally.  Noting that the logical conclusion of that theory is that owners have a duty to shut down operations at the very onset of insolvency, the court rejected that argument both as a matter of Illinois law and as a bankruptcy principle. 

            As to Illinois law, the court compared claimants’ arguments to other attempts to pierce corporate veils, and said the invitation to do so would be declined absent fraud or a separate corporate existence which was only fictional.  As to bankruptcy law, it said that “[i]f the court were to adopt claimants’ arguments, then in every instance where the risk of bankruptcy may exist, those in control of a corporation must immediately cease operations and send its employees home, or face individual liability.  This argument is in direct conflict with the principles of the Bankruptcy Code, which favors rescue of businesses”. 

            Several observations may be offered with respect to Montalbano.

            First, as a bankruptcy court opinion, it has little force as binding precedent, but its value as persuasive authority seems much greater.  It is well-reasoned, and in accord with controlling precedent where that precedent exists. 

            Second, the opinion will be of no assistance where the businessman has operated his business as a “d/b/a”.  This is because in such circumstances there is no corporate shield – the individual is the business and is directly liable.

            Third, the implications of the decision for limited liability companies are unclear.  An LLC was not at issue, and IWPCA § 13 does not address them.

            Fourth, the court’s leaving a potential exception for cases of fraud and deception may be an invitation to further litigation.  Often will be the situation where employees make some inquiry about the company’s viability as a going concern, the precise terms of the inquiry and of the response being as various as language permits.  On its face, Montalbano only covers the situation where no inquiry is made and no assurances given.  In the real world, real employees – and creative plaintiffs’ lawyers – often may be outside that premise.  

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