Texas Court Rules No Derivative Liability for Debt Incurred Before Forfeiture

Failure to file Texas franchise tax reports or pay franchise taxes when due may result in officers, directors, and managing members becoming personally liable for debts of the taxable entity. These failures lead to forfeiture of corporate privileges. See Tex. Tax Code § 171.251. The forfeiture of corporate privileges results in personal liability for debts created or incurred by the corporation during the period of forfeiture. The Court of Appeals in Houston recently held that the sole manager of a limited liability company could not be held personally liable for the company’s debt that was created or incurred before the limited liability company failed to pay its Texas franchise taxes.

In Hovel v. Batzri, the Hovels hired a contractor (the “LLC”) to build a custom home, and then sued for its breach when the LLC delivered the home late and with construction defects. While the breach of contract suit was pending, the LLC failed to pay its franchise taxes which resulted in the forfeiture of its corporate privileges. In a subsequent suit, the Hovels contended that the sole manager of the LLC was personally liable for the judgment that they had obtained against the LLC. Thus, the Houston Court of Appeals had to determine when the debt was incurred. The Court held that the debt was incurred at the time the parties entered into the contract, which was executed before the LLC forfeited its corporate privileges. As a result, the sole manager was not personally liable for the amount of the judgment versus the LLC.