PA Court Refuses to Pierce Veil of LLC

James T. Walmsley and Christopher W. Sullivan v. Frederick H. Ehmann, Steven Fishman, et al., C.A. No. 1845 EDA 2009 (Pa. Super. Ct. Feb. 28, 2012).

This decision concerns the Pennsylvania Superior Court upholding the Court of Common Pleas ruling not to pierce the corporate veil of a Pennsylvania LLC, and the factors that are considered when determining whether to pierce the veil of a non-corporate entity. [For supplemental reading on the topic of piercing the corporate veil as applied in the LLC context, a professorial discussion is available on these pages here. Highlights of a Delaware Court of Chancery decision on this topic appear on these pages here. Doug Batey writes here about a recent decision by a Federal District Court in New York that did pierce the veil of a Delaware LLC.]

This summary was prepared by Jill Agro of Eckert Seamans.

Factual Background

In 1998, Frederick Ehmann, a retired attorney, and Steve Fishman, an accountant and a director of ZA Consulting, formed FELD, LLC in Pennsylvania. FELD filed articles of organization, obtained a federal employee identification number, and filed federal tax returns during the years it was operative. Ehmann and Fishman were 50/50 owners of FELD. FELD acquired and became the sole shareholder of 22 Acquisition Corporation, a Pennsylvania corporation formed in 1998 by Healthcare Financial and CCS, and which acquired leasehold interests in nursing homes. FELD’s only business purpose was to hold the stock of 22 Acquisition; it did not have any employees, it didn’t record minutes at any minutes, it didn’t have a bank account, and its few expenses were handled by Ehmann and Fishman.

FELD and 22 Acquisition executed an agreement whereby 22 Acquisition would be FELD’s agent. FELD appointed both members of 22 Acquisition’s board, including: G. Walmsley (Appellant Walmsley’s brother) and R. Scott (an attorney at Appellee Ehmann’s former law firm). The agreement between FELD and 22 Acquisition provided that 22 Acquisition would act as FELD’s agent in all business affairs, and would act solely at FELD’s direction. The agreement also allowed Ehmann and Fishman (FELD’s 50/50 owners) to take operating losses incurred by 22 Acquisition, thereby providing them with a tangible tax benefit.

Healthcare Financial, one of 22 Acquisition’s founders, was a partner of ZA Consulting. CCS, 22 Acquisition’s other founder, was ZA Consulting’s biggest client and a client of Ehmann’s former law firm. 22 Acquisition’s day to day operations were managed by CSS pursuant to a comprehensive management agreement. In its role as manager, CCS hired NovaCare, a therapy provider, to provide services to the nursing homes held by 22 Acquisition.

In 1999, rising health care costs and Medicare’s reduced payment rates  led to serious financial problems for 22 Acquisition, and it was unable to meet its outstanding obligations to its vendors, including NovaCare. By May 1999, when 22 Acquisition’s debt to NovaCare exceeded $750,000, NovaCare terminated its contract with 22 Acquisition and filed a lawsuit against 22 Acquisition and FELD. While the case was pending, 22 Acquisition filed bankruptcy causing NovaCare’s action to be stayed until 22 Acquisition emerged from bankruptcy in 2005. NovaCare was then able to obtain separate judgments against 22 Acquisition and FELD for almost $2 million. These judgments were ultimately assigned to James Walmsley and Christopher Sullivan, the Appellants.

Procedural History

Appellants filed suit against Ehmann and Fishman to pierce FELD’s corporate veil and enforce the judgments against them personally. Fishman settled with the Appellants before trial, and the court ruled against piercing the corporate veil as to Ehmann following a bench trial. On appeal, the Appellants challenge the trial court’s consideration (or lack of consideration) of certain factors in making its decision, and ask the court to determine whether creditworthiness, undercapitalization, and violations of public policy should be among the factors weighed in determining whether to pierce the corporate veil of a Pennsylvania LLC.

Legal Analysis

“Piercing the corporate veil is a ‘means of assessing liability for the actions of a corporation against an equity holder in the corporation.’” Pennsylvania has a strong presumption against piercing the corporate veil, and the courts will recognize and uphold the corporate entity “unless specific, unusual circumstances” require otherwise. These corporate principles apply equally to LLCs.

Pennsylvania courts consider many factors in determining when it is appropriate to disregard the corporate (or LLC) form and pierce the veil, including: “(1) undercapitalization; (2) failure to adhere to corporate formalities; (3) substantial intermingling of corporate and personal affairs; and (4) use of the corporate form to perpetrate fraud.” These factors focus on actions and conduct that could justify disregarding the corporate form, and particularly consider the actions of the control person, to determine whether that person used his control, or used the company’s assets, to further his own personal interests. This list of factors is not exhaustive, and cases involving veil-piercing require a factual evaluation.

Capitalization

The capitalization of a corporation is an important factor and is primarily relevant “for the inference it provides into whether the corporation was established to defraud its creditors” or other improper purposes. However, for capitalization to be a weighty factor, the corporation cannot simply be short on capital, bankrupt, or insolvent; it must be “so undercapitalized that it is unable to meet the debts that may reasonably be expected to arise in the normal course of business.” (Emphasis added). Accordingly, the court looks to the corporation’s capitalization at the time of formation, and whether the capitalization was reasonable for the nature of the business practiced by the corporation.

In this case, FELD was adequately capitalized for its purpose: to hold the stock of 22 Acquisition. FELD didn’t incur debts or liabilities, and therefore, did not require any capital to fulfill its corporate purpose.

Corporate Formalities

The court determined that in the context of an LLC, “[c]ertain corporate formalities may be relaxed or inapplicable to limited liability corporations . . . ,” since LLCs aren’t required to adhere to the same strict formalities as corporations. The court also noted that a lack of corporate formalities alone is not sufficient to pierce the corporate veil; there must be some “serious misuse of the corporate form.”

As an LLC, FELD was not required to adhere to strict corporate formalities. FELD met the requirements for forming and maintaining an LLC in Pennsylvania, including filing a certification of formation and paying federal taxes. Adherence to further or additional formalities was not required.

Substantial Intermingling of Corporate and Personal Affairs

The record in this case did not show any intermingling of FELD’s assets and Ehmann’s assets.

Use of the Corporate Form to Perpetrate Fraud

Ehmann did not control FELD, and therefore, could not have used the company to perpetuate fraud. FELD was managed/controlled by 22 Acquisition pursuant to the agency agreement between the companies, and 22 Acquisition’s business was managed/controlled by CCS. The debt due to NovaCare by 22 Acquisition was due to CCS retaining NovaCare—and Ehmann had no involvement in CCS’s decision to retain NovaCare, or CCS’s decision not to pay NovaCare its fees.

Because the court concluded that the facts were insufficient to overcome the strong presumption against piercing the corporate veil, the court affirmed the trial court’s decision.