edvard munch, the scream (1893) (depicting effect of mt. krakatoa eruption in 1883)

Edvard Munch, The Scream (1893) (depicting effect of Mt. Krakatoa eruption in 1883)

http://knowledgenuts.com/2014/03/15/the-skies-were-actually-red-in-the-scream/

Corporations:A Contemporary Approach

Chapter 11Piercing the Corporate Veil

Slide 2of 36


• 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

• 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

Module V – Corporate Externalities

Citizen of world

Citizen of world

Law profession

Law profession

Corporate practice

Corporate practice

Bar examBar exam



Slide 3of 36

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.



Slide 4of 36

• 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)

Entity

Owners

Outsidecreditors

Is limited liability inherent?



Slide 5of 36

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?



Slide 6of 36

Diversification

10%10%10%10%Expected

16%25%18%5%Strong

4%-5%2%15%Weak

Portfolio XYZ

Inv. ZInv. YInv. X



Slide 7of 36

Pros • Encourage investment • Foster diversification• Encourage mgmt risk-

taking• Facilitate stock markets

Cons

• Discourage extension of credit

• Insider opportunism • Externalization of risks • Sh irresponsibility

Should limited liability have exceptions?



Slide 8of 36

Piercing in tort cases …

verbigeration (vuhr-bij-uh-RAY-shun) noun Obsessive repetition of meaningless words and phrases.



Slide 9of 36

Walkovsky v. Carlton (N.Y. Court of Appeals 1966)



Slide 10of 36

Carlton

. . . . . . . . .

Walkovsky

(tort creditor)

Corp 1•2 cabs•2 mdls

Seon•2 cabs•2 mdls



GarageInc.

Theories of liability

Enterprise

liability

PCV (Individual)

liability



Slide 11of 36

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.



Slide 12of 36

New York State Legislature

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.



Slide 13of 36

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?



Slide 14of 36

What if corporate shareholder?



Slide 15of 36

Telecom

Contrux

wholly-owned subsidiary

Radaszewski

inadequate insurance

Radaszewski v. Telecom Corp. (8th Cir. 1992)



Slide 16of 36

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?



Slide 17of 36

Walkovsky (taxi cab)

General test“prevent fraud / achieve equity”

Radasjewski (parent co.)

Alter ego(1) control(2) used to commit wrong, (3) proximate cause

No pie

rcing

No pie

rcing

Does the PCV “test” matter …



Slide 18of 36

Piercing in Contract Cases …

What are PCV factors?



Slide 19of 36

Complex Computing Co. Horton Street Assoc.

C3

Straw SH Glazier

Freeman

Sales repagreement

Option to buyRuns business

Gets consulting K

HortonStreet

Albert

Full control No formalities

Theberges

Note

Personal assurances



Slide 20of 36

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.

Piercin

g

No pie

rcing



Slide 21of 36

Found 34% - PCV 57.0%Y / YY5 – dominate/control

5-5 / 7-3

N / Y

N / N

Y / Y

N / Y

Y / Y

Y / Y

N / N

N / N

Y / Y

C3 / HS

Y

Y

Y

Y

Y

Y

Tort

Corp SH

CHC

Wisdom Thompson (1600 cases thru 1985)Factor

TOTAL

N/A10 – personal guarantees

Found 11% - PCV 91.6% 9 – misrepresentation

Found 16% - PCV 84.2%8 – confusion/commingle

Found 8% - PCV 73.3%7 – inadequate capital

Found 10% - PCV 66.9%6 – fail formalities

1 Sh 49.6% / 3+ Shs 35.0%4 – sole shareholder

Tort 31.0% / K 42.0%3 – tort vs. K

Corp 37.2% / indiv 43.1%2 – corp vs. indiv

Public 0% / CHC 40.5%1 – Public vs. CHC

Count the piercing factors …



Slide 22of 36

Complex Computing Co.

“evidence of wrongdoing”

Horton Street Assoc.

“oral promises … sharp business practices”

Piercin

g

No pie

rcing

Distinguish the cases …



Slide 23of 36

Piercing in Corporate Groups …

How different from “individual” cases?What is framework?

What are factors?



Slide 24of 36



Slide 25of 36

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”)



Slide 26of 36

PCV as remedy for“fraudulent conveyance” …



Slide 27of 36

Fraudulent Conveyance

Howard(devoted spouse)

Wanda(medical grad)

Bank

Student loans

Assignsincome

Howard(devoted spouse)



Slide 28of 36

Uniform Fraudulent Transfer Act

§ 4. Transfers Fraudulent as to Present/Future Creditors

(a) 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 .

§ 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.



Slide 29of 36

Uniform Fraudulent Transfer Act

§ 4. Transfers Fraudulent as to to Present/Future Creditors

(a) 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 .

§ 4. Transfers Fraudulent as to to Creditors

(a) 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.



Slide 30of 36

Group hypo

How do six cases we’ve studied come out …

(1) under PCV doctrine(2) UFTA?



Slide 31of 36

Shareholders

Corporation

Creditor

Credit

Siphon

YY (deceive + undercap)

IBC Services

NN (not undercap)Westin Hotel

NN (no siphoning)Darbro

YY (profited when sold business)

Complex Computing

NN (insured)Radazjewski

YY (“shuffling”)Walkovsky

UFCA? Pierce? Case

Deceive

PCV ~ UFTA

Case PCV UFTA

Walkovsky v. Carlton

No PCV because setting up corp structure + min insurance OK under NY law. Yes PCV for “shuffling”

Yes FT when corps made payments to Sh, leaving “unreasonably small assets”

Radazjewski v. Telecom

No PCV because sub bought low-cost insurance (allowed by law)

No FT because insurance as required, no $ transfers to parent

Freeman v. C3, Glazier

Yes PCV because dominant “Sh” left C3 asset-less after Thomson sale

Yes FT because Thomson proceeds went only to “Sh”

Theberge v. Darbro

No PCV because Shs never withdrew $$, just sharp dealings

No FT because Shs actually putting in more $$, not out

Gardemal v. Westin Hotel

No PCV because no indication Mex sub lacked financial resources

No FT because no commingling of operations, no transfers

OTR v. IBC Services

Yes PCV because parent confused creditor about who obligated

Yes FT because “shell” was intended to confuse creditor + insufficient assets



Slide 32of 36



Slide 33of 36

The end



Slide 34of 36

Reverse piercing …



Slide 35of 36

Connolly v. VFW (Colo. 2006)

Philsax, Inc.

Phillips

51%

Parcel A

Connolly(bankruptcy trustee)

Quit claim

Margaret

49%How does ConnollyPropose to get Parcel AInto Phillips’s estate?

edvard munch, the scream (1893) (depicting effect of mt. krakatoa eruption in 1883)

Documents

corporate veil slide

x slide

contemporary approach

corporate veil pcv factors

liability of shareholders

limited liability inherent

value of limited liability

public corporation