Chapter 11 Piercing the Corporate Veil

1. Module V – Corporate Externalities Chapter 11Piercing the Corporate Veil Bar exam • PCV in tort cases • Enterprise liability • Corporate shareholders • PCV in contract cases • Abuse of form • Assumption of risk • PCV in corporate groups • “Normal” parent-sub relationship • Corporate confusion • Compare to UFTA Corporate practice Law profession PCV factors Close vs. public corporation Fail to observe formalities Commingling personal and business Inadequate capitalization Active participation Why limited liability? Investment Diversification Public trading markets Citizen of world Chapter 11 Piercing the Corporate Veil

2. What is limited liability? Mandatory rule? Default rule? Majoritarian Tailored Penalty NC Bus Corp Act § 55-6-22.  Liability of shareholders.            (a)  A purchaser from a corporation of its own shares is not  liable to the corporation or its creditors with respect to the  shares except to pay the consideration for which the shares were  authorized to be issued or specified in the  subscription agreement.            (b)  Unless otherwise provided in the articles of  incorporation, a shareholder of a corporation is not personally  liable for the acts or debts of the corporation except that he  may become personally liable by reason of his own acts or  conduct. Chapter 11 Piercing the Corporate Veil

3. Early corporation shareholders = partners calls on Shs (2x-5X) Mid-19th Century innovation LL - selected businesses some retain Sh call regime banks through Depression Late 20th Century expansion LL all bus orgs except professional "supervisors” (some states) Is limited liability inherent? Owners Entity Outside creditors Chapter 11 Piercing the Corporate Veil

4. Consider risks of investing in a pharmaceutical company. Value of limited liability … Encourage investment? Permit diversification? Reduce monitoring cost? No need monitor co-Shs? Uniform share valuation? Permit public stock mkt? Why limited liability? Chapter 11 Piercing the Corporate Veil

5. Diversification Inv. X Inv. Y Inv. Z Portfolio XYZ Weak 15% 2% -5% 4% Strong 5% 18% 25% 16% Expected 10% 10% 10% 10% Chapter 11 Piercing the Corporate Veil

6. Should limited liability have exceptions? • Pros • Encourage investment  • Foster diversification • Encourage mgmt risk-taking • Facilitate stock markets • Cons • Discourage extension of credit  • Insider opportunism  • Externalization of risks  • Sh irresponsibility  Chapter 11 Piercing the Corporate Veil

7. Piercing in tort cases …verbigeration (vuhr-bij-uh-RAY-shun) noun Obsessive repetition of meaningless words and phrases. Chapter 11 Piercing the Corporate Veil

8. Walkovsky v. Carlton(N.Y. Court of Appeals 1966) Chapter 11 Piercing the Corporate Veil

9. Theories of liability PCV (Individual) liability Carlton . . . . . . . . . Walkovsky (tort creditor) • Corp 1 • 2 cabs • 2 mdls • Seon • 2 cabs • 2 mdls • Corp 3 • 2 cabs • 2 mdls • Corp 10 • 2 cabs • 2 mdls Garage Inc. Enterprise liability Chapter 11 Piercing the Corporate Veil

10. Enterprise liability “… these corporations are alleged to be operating as a single entity, unit and enterprise. … It is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business … Walkovsky v. Carlton(N.Y. Court of Appeals 1966) Individual liability "It is not enough to allege the defendant dominated and controlled a fragmented corporate entity.  The corporate form may not be disregarded merely because the assets of the corporation, together with mandatory insurance coverage, are insufficient to sure the plaintiff recovery.  Taxi owner operators are entitled to form such corporations.  Chapter 11 Piercing the Corporate Veil

11. Majority “The responsibility for imposing condition on incorporation has been committed to the Legislature, [which does not] require taxi corporations [to] carry automobile liability insurance over and above that mandated by the Vehicle and Traffic Law. Dissent The attempt to do corporate business without providing any sufficient basis of financial responsibility to creditors is an abuse of the separate entity and will be ineffectual to exempt the shareholders from corporate debts. Ballantine. It certainly could not have intended to shield those individuals who organized corporations, with the specific intent of avoiding responsibility to the public, where the operation of the corporate enterprise yielded profits sufficient to purchase additional insurance.  New York State Legislature Chapter 11 Piercing the Corporate Veil

12. Individual liability "There were no allegation that Carlton was actually doing business in his individual capacities or shuttling personal funds in and out of the corporation without regard to formality.  What happens on remand? Chapter 11 Piercing the Corporate Veil

13. What if corporate shareholder? Chapter 11 Piercing the Corporate Veil

14. Radaszewski v. Telecom Corp. (8th Cir. 1992) Telecom wholly-owned subsidiary Contrux inadequate insurance Radaszewski Chapter 11 Piercing the Corporate Veil

15. Alter Ego Doctrine "Under Missouri law, a plaintiff needs to show ... (1) complete combination ... of policy and business practice in respect to the transaction attacked .... (2) such control must have been used by the defendant to commit fraud or wrong .... and (3) the aforesaid control and breach of duty must proximately cause the injury .... “ Is buying cheap insurance “wrong”? By the way, what law applies in a piercing case – did the tort victim choose the law where the tortfeasor is incorporated? Chapter 11 Piercing the Corporate Veil

16. Walkovsky (taxi cab) General test “prevent fraud / achieve equity” Radasjewski (parent co.) Alter ego (1) control (2) used to commit wrong, (3) proximate cause Does the PCV “test” matter … No piercing No piercing Chapter 11 Piercing the Corporate Veil

17. Piercing in Contract Cases … What are PCV factors? Chapter 11 Piercing the Corporate Veil

18. Complex Computing Co. Horton Street Assoc. Straw SH Glazier Albert Option to buy Runs business Gets consulting K Full control No formalities Personal assurances C3 Horton Street Sales rep agreement Note Theberges Freeman Chapter 11 Piercing the Corporate Veil

19. Complex Computing Co. Glazier, with the help of some buddies, incorporates C3 to acquire a computer license from Columbia Univ. Glazier, though designated a "scientific adviser" of C3, holds an option to buy all the C3 stock and actually runs C3 C3 signs up Freeman as sales rep under an agreement that promises commissions and a hefty severance package To sell out to Thomson, Glazier has C3 can Freeman / Glazier is then paid handsomely in the sale and Freeman gets nothing Freeman holds unfulfilled contractual promises and sues – C3, which is a shell  Glazier on a PCV theory Horton Street Assoc. Albert incorporates Horton Street to buy rental properties from the Worden Group in a heavily leveraged acquisition Albert assumes full control of HS, though does not maintain separate books or follow corporate formalities  HS assumes a promissory note that Worden Group had given Theberges / Albert says he will "stand behind" HS after economic reversals, HS liquidates 2 properties to discharge part of Theberges' mortgage, but defaults on note Theberges hold an unpaid note and sue – HS, which is insolvent Albert on a PCV theory. No piercing Piercing Chapter 11 Piercing the Corporate Veil

20. Count the piercing factors … Factor Wisdom C3 / HS Thompson (1600 cases thru 1985) 1 – Public vs. CHC CHC Y / Y Public 0% / CHC 40.5% 2 – corp vs. indiv Corp SH N / N Corp 37.2% / indiv 43.1% 3 – tort vs. K Tort N / N Tort 31.0% / K 42.0% 4 – sole shareholder Y Y / Y 1 Sh 49.6% / 3+ Shs 35.0% 5 – dominate/control Y Y / Y Found 34% - PCV 57.0% 6 – fail formalities Y Y / Y Found 10% - PCV 66.9% 7 – inadequate capital Y N / Y Found 8% - PCV 73.3% 8 – confusion/commingle Y Y / Y Found 16% - PCV 84.2% 9 – misrepresentation Y N / N Found 11% - PCV 91.6% 10 – personal guarantees Y N / Y N/A TOTAL 5-5 / 7-3 Chapter 11 Piercing the Corporate Veil

21. Complex Computing Co. “evidence of wrongdoing” Horton Street Assoc. “oral promises … sharp business practices” Distinguish the cases … Piercing No piercing Chapter 11 Piercing the Corporate Veil

22. Piercing in Corporate Groups … How different from “individual” cases? What is framework? What are factors? Chapter 11 Piercing the Corporate Veil

23. Chapter 11 Piercing the Corporate Veil

24. Gardemal v. Westin Hotel Co (5th Cir 1999) The concierge at a Westin hotel in Mexico suggested that John Gardemal go snorkeling at Lover's Beach. He did and died. The beach was notoriously unsafe. Westin-Mexico is the Westin sub that managed the hotel. Is the parent liable for tort of its sub? No piercing! (“typical parent-sub relationship”) OTR Associates v IBC Services (NJ App 2002) A shopping mall leased space to a Blimpie subsidiary, whose franchisee failed to pay rent and was kicked out. The mall then sued the parent, Intl Blimpie Corp, to collect rent arrearages owed by the sub. Is the parent liable? Veil pierced!(“evasion, fraudulently carried out”) Chapter 11 Piercing the Corporate Veil

25. PCV as remedy for“fraudulent conveyance” … Chapter 11 Piercing the Corporate Veil

26. Fraudulent Conveyance Howard(devoted spouse) Howard(devoted spouse) Assigns income Wanda(medical grad) Student loans Bank Chapter 11 Piercing the Corporate Veil

27. Uniform Fraudulent Transfer Act • § 7. Remedies of Creditors • (a) In an action for relief against a transfer or obligation under this [Act], a creditor . . . may obtain: • (1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor’s claim • (3) ... • (i) an injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property; • (ii) appointment of a receiver to take charge of the asset transferred or of other property of the transferee; or • (iii) any other relief the circumstances may require. § 4. Transfers Fraudulent as to Present/Future Creditors • A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation . . . . (1) with actual intent to hinder, delay, or defraud creditors (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due . Chapter 11 Piercing the Corporate Veil

28. Uniform Fraudulent Transfer Act • § 4. Transfers Fraudulent as to to Creditors • Transfer is fraudulent as to a creditor if debtor made the transfer . . . . • (1) with actual intent to hinder creditors OR • (2) without receiving FMV and debtor: • Was business where remaining assets were unreasonably small OR • should have believed would be unable to pay debts as came due. § 4. Transfers Fraudulent as to to Present/Future Creditors • A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation . . . . (1) with actual intent to hinder, delay, or defraud creditors or (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due . Chapter 11 Piercing the Corporate Veil

29. Pop quiz –How do six cases come out(1) under PCV doctrine, (2) UFTA? Chapter 11 Piercing the Corporate Veil

30. Case Pierce? UFCA? Shareholders Walkovsky Y (“shuffling”) Y Radazjewski N (insured) N Siphon Complex Computing Y (profited when sold business) Y Deceive Darbro N (no siphoning) N Corporation Westin Hotel N (not undercap) N IBC Services Y (deceive + undercap) Y Credit Creditor Chapter 11 Piercing the Corporate Veil

31. The end Chapter 11 Piercing the Corporate Veil

32. Reverse piercing … Chapter 11 Piercing the Corporate Veil

33. Connolly v. VFW (Colo. 2006) Connolly (bankruptcy trustee) Phillips Margaret 49% Quit claim How does Connolly Propose to get Parcel A Into Phillips’s estate? 51% Philsax, Inc. Parcel A Chapter 11 Piercing the Corporate Veil