A divided Supreme Court of Vermont has set the conditions under which members of an unincorporated association can be held personally liable for the debts of the association when the association can’t meet its obligations.  It has refused to impose liability only on members who were actively involved in the wrongdoing that created the obligation, and imposed liability on anyone who was a member at the time.  (Daniels v. Elks Club of Hartford, Supreme Ct., VT, No. 2010-181, 8/3/12.)

The lengthy opinion is the latest ruling attempting to resolve liability for discrimination claims successfully brought by four women against the Elks Club of Hartford (VT) in a suit originally filed in 1998.  The women and the state Human Relations Commission each won judgments of $5000.  In a separate opinion in 2009, the women’s lawyers were awarded $446,000, and the Club’s own attorney obtained a lien for $30,000 in unpaid fees.  All of the amounts were junior to a bank mortgage on the property.

The Club was incorporated in 1940, but was administratively dissolved in 1989 for failure to file proper reports. Its charter was reinstated in 2008, but during the intervening 19 years it had operated under state law as an unincorporated association.

The Club fell behind on its mortgage to a bank and the bank assigned the mortgage to a long-time member of the club.  The member then sought to foreclose on the property, presumably hoping to wipe out the junior liens at the sale.  The creditors raised a number of defenses to the foreclosure action, including an argument that the foreclosing member personally owed them the amount of their judgment liens.  The trial court dismissed all of the objections to the sale.  The Supreme Court has permitted the sale, but set forth the conditions for possible personal liability if the sale does not bring sufficient proceeds to pay all of the liens.

On the issue of personal liability, the Court cited a state statute that provides that when execution on a judgment against an unincorporated association is not satisfied, a claim for the unpaid amount may be brought against “any or all” of the members.  This liability “is not individual liability for those acts that were the basis for the initial judgment but rather a secondary contractual liability for the voluntary association’s debt arising of the judgment,” the Court said. “The theory of the statute is that by becoming members of an unincorporated association, individuals agree to be liable in a collection action on a judgment if that judgment cannot be fully met by the association’s assets.”

A dissenting justice would hold that individuals were personally liable only “if they personally participated in the decision to deny membership to the plaintiffs because of their gender, or otherwise ratified that decision.”  But the Court said its decision was required by the language of the statute.

It offered several other reasons why it would not change the law even if it thought it had the opportunity to do so.  To require the creditors to prove active participation, it said, would be “almost certain to erect a hurdle that could never be cleared.”  It also said that “the overwhelming majority of the damages” arose not from the discrimination but from the expense of fighting the case for so many years.  It had no trouble choosing to protect the creditors, who would otherwise be left empty-handed, over those who had retained their membership throughout the protracted litigation.

The Court also had to consider the impact of the reinstatement of corporate status after the entry of the judgments.  The statute says that the reinstatement “relates back to and takes effect as of the effective date of the administrative dissolution” and the corporation may continue its activities as if the dissolution “had never occurred.”

The Court concluded, however, that the statute did not address the liability of the members for actions during the period the organization was an unincorporated association.  After reviewing precedents from other states, it concluded that it would be “unwise to adopt one hard-and-fast personal liability rule for reinstated corporations.”  It said that liability should depend on “the reasonable expectations of the parties at the time the liability arises.”

If the creditor dealt with the organization as if it were a corporation, there should be no liability, it said.  If the creditor knew it was an unincorporated association, “then retroactive restoration of the liability shield will circumvent the legitimate expectations of the creditors” and it would be “inequitable to permit an entity to hold itself out as an unincorporated association and then retroactively chameleon into a corporation.”

In this case, the creditors were dealing with the Club as if it were an association and liability was appropriate, it said.  As to who among the members could be personally liable, the Court agreed with the reasoning of a decision by Illinois Court of Appeals and held that a person who knew or should have known by virtue of his or her position that the organization was operating as an association could be personally liable if the association could not pay its full debts.

Because the foreclosure had not been held, and because it was impossible to know whether the foreclosure would bring enough to pay all of the liens, the Court said it was premature to determine whether the creditors had the right to recover from the member who was bringing the foreclosure action.

YOU NEED TO KNOW

This is an extraordinarily complicated case involving a number of questions other than the liability of members of an unincorporated association.  But it does make clear the potential for personal liability for members of unincorporated associations and gives a sense of just how unsettled the law is in such matters.  As we have said so often, operating as an unincorporated association is not, in our view, a very wise thing to do.  There are many too many unanswered questions.