March 01, 2006
Glenn D. West
Private equity deal professionals should know the basic U.S. contract signing rule: “Always sign a contract or letter agreement only on behalf of the entity intended to be made a party and never individually.” While this rule sounds fairly straight-forward, each year a surprising number of contract-related cases arise in which claims are made against individuals purportedly acting solely on behalf of limited liability entities. These cases arise in two circumstances: (1) direct contractual claims asserting that the individual signatory intended to be personally bound by the contract and was not signing merely in a representative capacity on behalf of the named limited liability entity; and (2) extra-contractual claims alleging a misrepresentation regarding or a failure to disclose information respecting the subject matter of the contract. Given the fact that private equity deal professionals inevitably serve as officers of numerous acquisition vehicles and portfolio companies, it is critical that the means of becoming exposed to personal liability in that capacity be fully understood and avoided.
Understanding Basic Agency Law
While nothing prevents a representative of a limited liability entity from adding her personal liability to a contract otherwise intended to reflect the obligation of that limited liability entity, private equity deal professionals seldom deliberately do so. To understand how a private equity deal professional may nonetheless unintentionally become personally liable under such a contract requires some basic knowledge of agency law.
An officer or other representative of a limited liability entity is considered an agent of her “principal”—the limited liability entity. To avoid personal liability, the common law generally requires that an agent clearly disclose that she is acting in a representative capacity and to clearly identify the principal on whose behalf she is acting. If she fails to do so, the party with whom she is dealing is free to assume that the putative agent is actually acting on her own behalf. For example, many deal professionals would be surprised to learn that the following signature line may only be deemed to identify who Sarah Deal Professional is, as opposed to clearly and unequivocally limiting the capacity in which she signed:
Sarah Deal Professional
President, Private Equity LLC.
Adding the word “as” in front of “President” and “solely on behalf of” in front of “Private Equity LLC” would be required to make the capacity in which she is signing clear. When signing letter agreements and closing certificates this nuance can sometimes be overlooked. The better approach is to consistently use the following formulation for all signatures on behalf of corporations or other limited liability entities:
Private Equity LLCBy: _____________
Name: Sarah Deal Professional
Suggested Guidelines for Document Review and Execution to Avoid Direct Personal Liability on the Contract
Protecting yourself from unintended exposure to personal liability on contracts intended to be entered into solely on behalf of a limited liability entity, simply requires you to strictly follow these basic rules:
- Your representative capacity should be clearly set forth on the signature page of every contract, certificate or letter agreement you execute—that means listing only the name of the limited liability entity intended to be the actual party to the contract, with your signature, name and title only included after the express designation “by” immediately under the name of the limited liability entity.
- Personal pronouns, such as “we,” “my” or “I,” as well as the term “the undersigned” should be avoided in the operative contract, certificate or letter agreement, unless these terms are followed by language clearly designating on whose behalf the person or persons involved are acting. In other words, make sure that the only named party to the contract is expressly limited to the specific limited liability entity intended to be the sole obligor on whose behalf you are acting
- Finally, we also suggest that the contract or letter agreement expressly include a “no personal liability” or “non-recourse” provision to hopefully provide an ultimate blocker to any creative claims that may be made against you personally by an unhappy counter-party looking for leverage.
- Vigilantly observing these simple rules will help you avoid being named in or aid in you being promptly dismissed from a lawsuit based upon contractual obligations that were intended to be limited only to a particular entity.
Personal Liability for Fraud and Misrepresentation
Avoiding personal liability for extra-contractual claims requires even greater vigilance than protecting oneself from direct contractual claims. Merely because an agent is acting in a representative capacity on behalf of a disclosed principal does not relieve the agent of personal liability for the wrongful acts committed by the agent in the scope of that agency. That rule is fairly easy to appreciate when the wrongful act is an automobile accident resulting from an employee’s (i.e., an agent’s) negligence in driving a company car on company business. The common law recognizes that both the employee driver (agent) and the company employer (principal) are jointly and severally liable for the resulting damages caused—the employee because she owes a duty to the public to drive with due care and the principal because of the rule that generally requires the principal to answer for certain actions taken by the agent in the scope of the agency. When the alleged wrongful act is “negligent misrepresentation” or “fraud” arising out of the negotiation of a purchase and sale agreement, however, many deal professionals are surprised to learn that these same legal principals can impose personal liability on the officers of the limited liability entities that are the only contractually named parties to that purchase and sale agreement (without the need to “pierce the veil” or allege the limited liability entity was an “alter-ego” of an individual).
“Negligent misrepresentation” and “fraud” are both extra-contractual claims that arise from a breach of duties imposed by the common law, as opposed to a breach of duties proscribed by contract. Both are considered “wrongful acts” and the fact that you are acting solely as a representative of a limited liability entity when an alleged misrepresentation is made by you concerning the company being sold by your seller entity (or when you are acting on behalf of the buyer, concerning the financing that is available to the buyer entity) will not relieve you of personal liability for any resulting damages arising from the other party’s reliance on that misrepresentation.
Suggested Guidelines for Avoiding Personal Liability for Fraud and Misrepresentation
Many lawyers erroneously take the position that there is actually nothing contractual you can do to avoid extra-contractual “tort” claims, particularly those claims based on “fraud.” This is not true in all states, nor as a general principle respecting all extra-contractual claims. As to individual representatives of the contracting entity, the way to maximize your chances of avoiding these claims is to insist that the contracting entity follow the suggested guidelines in our companion article in this Alert: “Avoiding Extra-Contractual Fraud Claims in Portfolio Company Sales Transactions—Is “Walk-Away” Deal Certainty Achievable for the Seller?”
Today’s private equity deal professionals are required to be diligent in an increasing number of areas. Because plaintiffs will certainly seek out deep pockets when a transaction has gone bad, taking appropriate precautions to avoid personal liability should be no exception.
- See, e.g., Savoy Record Co. v. Cardinal Export Corp., 203 N.E.2d 206 (N.Y. 1964); Mencher v. Weiss, 114 N.E. 2d 177 (N.Y. 1953); BBTOD, Inc. v. FTS Int’l, Inc., 807 NYS.2d 379 (N.Y. App. Div. 2005); Taylor-Made Hose, Inc. v. Wilderson, 21 S.W.3d 484 (Tex. App.—San Antonio 2000, pet denied).
- See, e.g., Ennis v. Loiseau, 164 S.W.3d 698, 707-08 (Tex. App.—Austin 2005, no pet.); Epinosa v. Rand, 806 NYS.2d 186 (N.Y. App. Div. 2005); Ray-Tek Servs., Inc. v. Parker, 831 N.E.2d 948, 958 (Mass. App. Ct. 2005).
- See News Am. Mktg., Inc. v. Lepage Bakeries, Inc., 791 N.Y.S.2d 80, 82 (N.Y. App. Div. 2005); Austin v. Dunnan & Strong, 761 S.W.2d 115, 116 (Tex. App.—Houston [14th Dist.] 1998, no pet.).
- For a more complete discussion of some of these legal principals and some recent cases involving corporate officers being exposed to personal liability as a result of the application of these principles see Glenn D. West, Corporations, 54 SMU L. Rev. 1221, 1231-1233 (2001); Glenn D. West and Brandy L. Treadway, Corporations, 55 SMU L. Rev. 803, 816-818 (2002); Glenn D. West and Adam D. Nelson, Corporations, 57 SMU L. Rev. 799, 802-809 (2004).
- See West & Treadway, supra note 4, at 811-816.