When extending credit to your customer, do you know their true legal identity? Claims are often submitted and it is apparent that the creditor actually had no idea as to the legal identity or legal composition (i.e., partnership, proprietorship, or corporation) of the debtor. This information is absolutely essential when suit is necessary to enforce payment. To successfully pursue litigation, the identity and composition of the debtor must be confirmed.

A file recently handled by our office demonstrated the extreme importance of knowing exactly with whom you are dealing. In this case, the defendant was successful in asserting that the creditor had sued the wrong party. The lawsuit was filed against Jane M., an individual doing business as Gifts Unlimited. The business was no longer operating, and a search of the Secretary of State’s office web site revealed that there was no filing for a corporation identified as Gifts Unlimited. Therefore, presumably, Jane M. was operating the business as a proprietorship and suit was brought against her individually. Jane M. failed to file an Answer to the Summons and Complaint and a default judgment was subsequently entered against her.

Jane M. then retained the services of an attorney who petitioned the court to set aside the default judgment on the basis that she was not personally liable for the debt because the debtor was, in fact, a corporation. It was then disclosed that Gifts Unlimited was an assumed name of a corporation known as GU, Inc. Under the law, if the creditor did not know, and had no reason to, of the existence of the corporation called GU Inc., the creditor was legally entitled to collect this debt against Jane M. personally as an agent for her undisclosed principal corporation.

The matter went to a jury trial. Representing the creditor as a witness was John B., the sales representative, and Rachel H., the credit manager. Both testified that at no time did Jane M. tell them that the business was incorporated. Rachel H. testified that she had specific discussions regarding the nonexistence of a corporation with John B. Jane M.’s testimony, according to the attorney, seemed to be less credible than that of John B. However, the court allowed Jane M. to testify about the money she invested into the corporation and how she, along with her three children, ran the business. This testimony was totally irrelevant, improper, and for the sole purpose of improperly appealing to the jury’s sympathy. Nonetheless, the judge, over the attorney’s objection, allowed this testimony. The end result was that the jury was sympathetic to Jane M. and, therefore, set aside the judgment. This result emphasizes the difficulty in predicting case outcome. Adding insult to injury, the debtor was entitled to apply for an award of statutory costs.

In this case, the creditor’s representatives learned how easy it is for a business (which is a corporation) to become defunct and, in the process, have all assets syphoned off. All the while, the debtor corporation continues to obtain goods from unsuspecting, unsecured creditors. The current state of the law heavily favors the debtor against the unsecured creditor who supplies goods on an open account basis without obtaining security or personal guaranties of the owner of the corporation. It is generally recommended to all creditors that an attempt be made to clearly identify the debtor and its legal corporation. Further, if the debtor is a corporation, the credit application can include a section for the personal guaranty of the principal owner of the business. Should the principal refuse to sign the guaranty, this can be a warning sign to prospective creditors.

Furthermore, most attorneys do not like to bring lawsuits against agents for an undisclosed principal corporation unless the creditor has a written credit application showing individual ownership at the time the account was opened or unless the creditor has other strong testimony indicating that it was relying solely on the credit worthiness of the individual when extending open account credit terms. In this particular case, the claim was forwarded to the attorney as a “sole proprietorship” and, in spite of the efforts to determine the legal identity of Gifts Unlimited, it could not be associated with any corporation when a check was made with the state’s Corporation and Securities Bureau.

To summarize, this case is somewhat unique inasmuch as everyone thought they had, in fact, confirmed the identity of the debtor, but, in fact, they had not. Not enough can be said as to the importance of determining your customer’s true legal identity.