Case Study- Liability of Corporations, Shareholders and Officers

In 2008, Mr. and Mrs. Smith formed "Working Dogs, Inc." an Ohio corporation, for the purpose of breeding, raising and training German Shepherds for sale to various law enforcement agencies and similar businesses. They chose to incorporate so that their personal assets would be shielded from any liability arising out of the operation of the business. The Smith's purchased the vacant land next to the family home and constructed a concrete kennel with fenced dog runs for 25 dogs. Title to the lot and the kennel was in the name of the corporation. The Smith's son, John, helped raise and train the dogs until he went to college. After John went off to college, the Smiths decided that running the kennel was too much work and were considering selling the business. When John found out, he asked his parents to let him take over the family business, using the dog lot and kennel. The Smiths agreed and appointed John as the corporation's President, replacing Mr. Smith. John was offered 60% ownership of the shares in the corporation but he declined stating he didn't need want the hassle of stocks.

As the sole shareholders and directors of the corporation, Mr. and Mrs. Smith entered into a written agreement with John that stated any net annual profits would be split as follows: 60 % paid to John; 20% paid to Mr. and Mrs. Smith, and 20% retained by the corporation in earnings.

John consistently deposited the proceeds from dog sales into the corporate account, and paid only expenses related to Working Dogs, Inc. out of the corporation's bank account. The corporation held its annual shareholder and director meetings on December 31st, right before the annual New Year's party. These meetings served to inform the Smiths about how the business had performed over the prior 12 months, and John's future plans for the corporation. John typed up the minutes from these meetings and retained them in a file.

With his degree in marketing, John quickly established a demand for the dogs across the country by setting up a website in the corporate name, advertising in publications that were well-read by law enforcement and participating in working dog events. Because of the success of his advertising, Working Dogs, Inc. was able to sell dogs in advance of their births, based on their stated pedigrees. John received a healthy cash flow from the business and the Smiths were pleased with the John's success until they found out that the corporation was being sued by the Kansas City Police Department for fraudulent misrepresentation.

Unbeknownst to the Smiths, most of the puppies from the last 2 litters of pre-sold puppies died shortly after birth as a result of a virus. To avoid refunding the money, John purchased puppies from several German Shepherd rescue groups and shipped them to the purchasers with the standard representation on company letterhead that the puppies were the same as described in the contracts. The Kansas City Police Department received 6 of the puppies. By the time the case was scheduled for trial, two other purchasers joined the lawsuit. The claims totaled more than Working Dogs Inc.'s assets. Working Dogs, Inc., John, and Mr. & Mrs. Smith were all named as defendants in the lawsuit.

• Discuss the legal theories under which John and/or Mr. and Mrs. Smith may be held liable for the acts of the corporation.

• Can the plaintiffs obtain a judgment against John personally for his own individual liability, notwithstanding the existence of the corporation? Explain.