Friday, September 25, 2009

On Piercing the Corporate Veil

First off, I must thank my colleagues here at the Corporate Justice Blog for inviting me to guest-post here. It's a privilege.

This week, I taught my Business Associations students about piercing the corporate veil. Among the cases we covered is one of the classics (and one of my favorites), Baatz v. Arrow Bar. In this South Dakota case, a husband and wife injured in an accident with a drunk, uninsured motorcyclist sue the corporation that owns the bar at which the motorcyclist was served (asserting dram shop liability under an applicable statute) and also sue the shareholders of the corporation on a veil piercing theory. The shareholders and their daughter (who is the manager of the bar) move for summary judgment and it is granted. So the case against them is dismissed, and the decision is affirmed on appeal.

Some students do not like the result in this case. In particular, they point to the thin capitalization of the corporation with loans (which the court finds is not dispositive in the veil-piercing analysis), the failure of the corporation to buy insurance, and the fact that the daughter of the owners was the bar manager. Of course, these students are very sympathetic to the plaintiffs' plight--an uninsured (and likely judgment-proof) motorist and a corporation with limited wherewithal are the only other potentially responsible parties.

I fear that true middle age has set in (if the shoe fits . . . ) given my commentary on the case this year. I found myself saying something akin to the following: if you don't like the result in this case (as to the dismissal of the case against the shareholders), then maybe you don't like the corporate form altogether. My thought was directed mostly at those who rely on the undercapitalization argument for veil piercing. Here (in my view), the shareholders were not using the corporate form to commit fraud or other wrongful conduct or injustice. (The dissent apparently disagrees, when it characterizes the individual plaintiffs actions as fraudulent and states: "As a result of this holding, the message is now clear: Incorporate, mortgage the assets of a liquor corporation to your friendly banker, and proceed with carefree entrepreneuring.") However, the shareholders' capitalization of the entity was not egregiously low, in any case. (In fact, Internet searches reveal that, although the couple who originally owned Arrow Bar are both deceased, the bar continues to be operated by their daughter.) In essence, state legislatures allow individuals to use corporations in just this way, to shield themselves from personal liability for the obligations of the business, whether in contract or tort or under a statutory law. Those same state legislatures could mandate and enforce minimum capital requirements (and in fact they used to do so). So, our problem--if we don't like the veil-piercing result in Baatz--is with the corporation, an easy target in the new millennium.

Or is it? Perhaps the more essential and direct problem with the result in the Baatz case is that businesses selling alcohol in South Dakota, at least at that time, were neither required to maintain a minimum capital nor maintain a minimum amount of dram shop insurance. Since bars are required to be licensed to sell alcohol (through the liquor permitting process), it would seem that there is an easy way to enforce these types of requirements without changing or eviscerating corporate law or the corporate form. This type of solution would give the plaintiffs in Baatz the possibility of some relief for their injuries while, at the same time, preserving the corporate form as an engine of commerce.

I welcome your further thoughts . . . .

13 comments:

  1. professor heminway:

    any other outcome in the case would chill entrepreneurship and discourage individuals from opening small businesses that drive economic growth, no? i wonder if those that oppose the outcome are uncomfortable with legislative enactments that would require insurance coverage and minimum capitalization.

    doesn't the corporate veil have to remain nearly impenetrable in order to buoy new business and encourage entrepreneurship?

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  2. Yes. This is a nice analysis. I especially like the way you say "nearly impenetrable." I invite your suggestions (and those of others) as to the narrow range of circumstances in which the veil should be pierced.

    Courts have made a muddle of this over time. Even those who (I think wisely) limit their veil piercing to circumstances in which the shareholders abuse the corporate form to knowingly commit significant torts (e.g., Western Rock Co. v. Davis, 432 S.W.2d 555 (Tex. Civ. App. 1968)) or continue to renew businesses by continuously incorporating new entities to hide from creditors (e.g., K.C. Roofing Center v. On Top Roofing, 807 S.W.2d 545 (Mo. App. 1991)) do not clearly articulate the criteria that they are employing and do not consistently apply those criteria in subsequent cases. This leaves entrepreneurs guessing on what they can and cannot do in using the corporate form to shield themselves from liability.

    Thanks for these thoughts.

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  3. Lydie Nadia Cabrera Pierre-LouisSeptember 27, 2009 at 5:54 PM

    I also taught limited liability in Business Association last week. Since I am a New Yorker, I usually ask the students to read the Walkovsky v. Carlton case. The facts are uncomplicated. Carlton a controlling shareholder of a New York cab company, Seon Cab Corp, is sued by Walkovsky who was "run down" by a cab owned by Seon Cab. Seon Cab's total assets consist of 2 taxicabs and an auto insurance policy for $10,000, the minimum coverage allowed by the New York State Legislature. It is determined that Carlton is a shareholder of not only Seon Cab but also 10 other taxicab companies each cab company has total assets consisting of 2 cabs and the minimum auto insurance policy of $10,000. Walkovsky sues Carlton on the theory that multiple corporate structures of the cab companies constitute an unlawful attempt "to defraud the members of the general public who might be injured." The New York State Court of Appeals ruled in favor of Carlton holding that taxi owners-operators are "entitled to form such corporations,” and if the requisite insurance is inadequate for the protection of the public, "the remedy lies not with the court but with the Legislature." Students really dislike this decision and much class time is spent explaining the court's rationale. Judge Keating's dissent in Walkovsky is very instructive. Judge Keating relying on the analysis of Supreme Court decision in Anderson v Abbott quotes Chief Judge Cardozo stating that "there are occasions when limited liability sought to be obtained through corporation will be qualified or denied...when the sacrifice is so essential to the end that some accepted public policy may be defended or upheld.... An obvious inadequacy of capital, measured by the nature and magnitude of the corporate undertaking, has frequently been an important factor in cases denying stockholders their defense of limited liability." Therefore, Judge Keating would hold Carlton liable because a participating shareholder of a corporation "vested with a public interest, organized with capital insufficient to meet liabilities which are certain to arise in the ordinary course of business," may be held personally responsible for such liabilities. The students almost always like Judge Keating’s dissent. The students believe that Judge Keating’s dissent is a fair holding, and the courts not the Legislature should determine the equity of legal disputes.

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  4. The veil of corporation is undoubtedly the most advantageous feature in a corporate context and indeed it promotes entrepreneurship allowing economies to flourish. I am curious as to your views on lifting the corporate veil in the 'interest of justice' (somewhat discussed above). In the case of Baatz v. Arrow Bar. I feel the right decision was made, to hold contrary would have 'chilling' consequences. However,
    suppose a large quantity (400 or so) former employees of subsidiary (X) of an asbestos-manufacturing company (Y), tried to sue (Y) for asbestos-induced work related ailments. it would seem to introduce a substantial moral issue and likely to spark public interest. Do you think the judges would be inclined to take a lenient approach to the lifting of the veil? I would be grateful for your views on such issues.

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  5. Lydie and Anonymous:

    Thanks for the further thoughts.

    Lydie, I also teach the Walkovsky case--just taught it today. I agree with your assessment. I also find that the court's distinction between the ramifications of suing under a veil piercing theory versus suing under a business enterprise doctrine theory is quite nicely drawn and well taken.

    Anonymous, if I understand your example properly, the parent corporation--the asbestos manufacturer--is committing a direct tort against the employees. No veil piercing is required there to find liability. But if I misunderstand, please correct me and give me a few more facts . . . .

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  6. Professor Heminway: I'm an attorney planning to bring a piercing the veil claim. I won't argue the philosophic basis for piercing in your dramshop case, but I'm sure you'll agree there are circumstances when individuals try to hide behind the corporate form and then engage in fraud or other such conduct, and that such circumstances can raise a legitimate need for application of the piercing principle. Since you've taught this subject recently, I wonder if you can provide a cite or two concerning piercing multiple corporate layers to reach the ultimate shareholder. In my case an individual has interposed two levels of corporate entity and I am trying to reach him through these two entities. Any chance you could provide a good cite or two involving this scenario?

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  7. It's understandable that corporations are formed for the very reason of limited liability. However, it goes too far to say that a corporation that is poorly managed and without sufficient assets to cover its own negligence should be shielded from personal liability. The facts of the BAATZ case certainty disturb me. It seems there are sufficient facts in place to pierce the corporate veil and find the owners personally liable. It seems as though the state legislature's failure to make established minimum capitalization requirements helped the corporations case. This is a shame and I feel bad for the plaintiff (like all the other students).

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  8. Professor Hemingway,

    It seems in cases of undercapitalization, such as this, there is a temptation to engage in the overburdened "piercing the corporate veil" discussion. It is hard to argue with the conclusion that the corporate veil should not be lifted. This is, after all, why corporations exist -- so that the incorporators are not personally liable.

    Let's do a tort analysis instead. If a corporation creates circumstances where it would be foreseeable that someone could be injured, and someone is injured, the corporation is liable for the tort of negligence. However, is an individual not also negligent if they create an undercapitalized, or underinsured, corporation to operate in circumstances where someone could become injured?

    In other words, the major question should be whether the injury was foreseeable by the individual who undercapitalized the corporation, not whether the corporate veil should be lifted.

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  9. Can an individual be sued under "piercing the corporate veil" if the corporation itself is not sued?

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  10. In teaching this material again this year, I had occasion to go back and look at my earlier post--and I realized there were additional comments! I apologize to those who posted comments after I last checked this post. As a guest blogger, I had no idea this would continue to generate interest long after my guest blogging was done . . . .

    For an interesting article on piercing the veil in multi-level corporate groups (under the Alien Tort Claims Act), see http://law.scu.edu/corplaw/file/Santa-Clara-Symposium-Douglas%20M-Branson-Paper-Draft.pdf. Thee types of cases--multilevel veil piercing--also can be brought as enterprise liability cases. For an article on veil piercing in corporate groups, see Kurt A. Strasser, Piercing the Veil in Corporate Groups, 37 Conn. L. Rev. 637 (2005).

    To the anonymous poster who stated: "the major question should be whether the injury was foreseeable by the individual who undercapitalized the corporation, not whether the corporate veil should be lifted," I will respond that most courts head down that path to some extent. But they require more than mere foreseeability. They require that the corporation be dominated in a way that the controlling person uses the corporation to commit a fraud, injustice, or wrong. Ordinary torts incidental to an otherwise legal business (like serving an over-intoxicated person at a bar), even if foreseeable, are not sufficient to counteract the statutory presumption that shareholders enjoy limited liability in the corporate form. This limited liability rule represents a policy judgment by the state legislature that desirable business is encouraged by that rule. As one of my current students (not all of whom are concerned about the result in the Baatz case) notes:

    "I believe that this analysis of foreseeability and adequate capitalization poses a danger to development of new business. Many entrepreneurs may be scared away by this 'foreseeability' factor.

    I'm afraid that corporations may be seen (or perhaps already are) as an insurance for any liability that may result from their operation. But the whole idea of a Limited Liability entity is to provide limited liability, however obvious this may sound. Other than intentional torts, such as fraud, I don't think that anyone should have to engange in a foreseeability analysis."

    As for whether a plaintiff should be able to sue the shareholder directly without first suing the corporation, here is what the same student said, in pertinent part:

    "I think that absent some form of corporate dissolution (administrative or not), or some other type of agreement (e.g. contract providing for personal liability) an individual should not be sued for 'pierce of corporate veil.' Again, the corporation is there to provide some type of limited liability, without going first to the corporation and their assets, individuals might as well be held liable for any actions of the corporations, thus hindering the limited liability aspect of a corporation."

    I might say this a bit differently, but we end up in roughly the same place. A veil piercing claim allows a plaintiff to reach a corporate control person (typically a shareholder) for the obligations of the corporation. The obligations of the corporation can only be definitively determined through a court action against the corporation, so the corporation should be required to be a party to a legal action with or preceding the veil piercing claim to adjudicate the predicate claim of liability--to be borne by someone.

    I hope that these additional thoughts are helpful.

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  11. posted by professor joan heminway:

    I had occasion to come back to this post in teaching the same material this fall and was surprised to find additional comments here after I last checked. Sorry to those who posted for not responding sooner.

    I am sure that Anonymous (the attorney) long ago made his or her decision on whether to bring a veil piercing claim in the case then at issue. On the question of piercing the veil through multiple levels, I want to refer you to an article written by Doug Branson on this issue as it relates to the Alien Tort Claims Act, available at http://law.scu.edu/corplaw/file/Santa-Clara-Symposium-Douglas%20M-Branson-Paper-Draft.pdf. Some of the cases cited in this article should be helpful in looking at the multi-tiered piercing concept.

    As for the comment on foreseeability and undercapitalization, although foreseeability may play a role in veil piercing liability, the combination of foreseeability and undercapitalization is not sufficient, taken alone, to trigger veil piercing liability. Liability for torts and contract claims may be a given for certain businesses, making the torts or contract claims entirely foreseeable. moreover, the meaning of "undercapitalization" is unclear--seemingly related to context. But, in some cases, where a dominating control person uses a corporation for the purpose of committing fraud or a wrong or injustice, the control person is held liable.

    One of my students this year put it the following way:

    "I believe that this analysis of foreseeability and adequate capitalization poses a danger to development of new business. Many entrepreneurs may be scared away by this "foreseeability" factor. . . . "

    Can an individual controlling person can be sued on a veil piercing claim without the plaintiff suing against the corporation first? On its face, this seems problematic, since the controlling person's liability is based on the successful adjudication of a liability claim against the corporation. My student also commented on this question, taking a different approach.

    " . . . [T]he corporation is there to provide some type of limited liability . . . . [W]ithout going first to the corporation and . . . [its] assets, individuals might as well be held liable for any actions of the corporations, thus hindering the limited liability aspect of a corporation."

    Parenthetically, I must note that I am not a litigator. But typically, what I have seen is a case brought against the corporation and any controlling shareholder, director, and officer. The theories of liability may be stated in the aggregate or in the alternative.

    I hope that these comments do help complete the "conversation," even though this response is very tardy.

    - Professor Heminway

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  12. Hello There,
    I just wanted to see if you were currently interested in additional guest bloggers for your blog site.
    I see that you've accepted some guest posters in the past - are there any specific guidelines you need me to follow while making submissions?
    If you're open to submissions, whom would I need to send them to?
    I'm eager to send some contributions to your blog and think that I can cover some interesting topics.
    Thanks for your time,
    Tess

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  13. Companies incorporate for the very purpose of avoiding personal liability. Incorporating is a safe harbor carved out in law to encourage industry and entrepreneurship when the members conduct their business in a manner permissible by a corporation.

    In the case at hand, there is no indication that the members of the corporation failed to meet the minimum requirements to avail themselves of the shield provided their personal assets. Since no law existed requiring dram shop insurance, the defendants did not violate that nonexistent law. The fact innocent people (Plaintiffs) were harmed by a drunk driver is terrible and wrong. However, the law does not provide a way for the plaintiffs in this matter to pierce the corporate veil when the corporation has conducted itself reasonably. It seems to me the court ruled correctly.

    I think that the corporation concept is a fine one that should be upheld. When a business chooses to be involved in risky undertakings such as serving alcohol or providing parasailing services in shark-infested waters, should that business be required to maintain minimum insurance policies? The fine print on parasailing documents includes the 'we are not responsible if you die or something else bad happens' language. If a consumer chooses to sign such a waiver, should they then be able to complain when they suffer harm? That is not the circumstances in the case in question, I merely wonder how far the law would go and what the ultimate outcome of requiring certain business to carry insurance would be long term.

    Nichole Kaiser

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