Search results for: piercing corp veil

The relatively short Chancery opinion in Doberstein v. G-P Industries, Inc., C.A. No. 9995-VCP (Oct. 30, 2015), is noteworthy for its examination and dismissal of a claim for piercing the corporate veil. It is notable not only because the court describes the standard that will be applied in connection with such a claim, but of equal importance is the fact that the court considered and dismissed the claim on a substantive level, but did not dismiss it for procedural irregularities such as, for example, the failure to obtain a judgment against the entity–before bringing such a claim against the underlying individual.

Notwithstanding the reprehensible behavior of the individual behind the entity involved in this case, this opinion also exemplifies how difficult it is to pierce the corporate veil under Delaware law.

 

Professor Stephen Bainbridge posts here about his scholarly writings in which he argues in favor of abolishing the doctrine of piercing the corporate veil, especially in the LLC context. The good professor also refers to, and links to, an analysis of the topic by Dutch lawyer Jaap Barneveld of The Defining Tension blog, who concludes that the case law in the US on this topic is, at best, lacking in coherence.

Westmeyer v. Flynn,  2008 WL 2152498 (Ill.App., 1st Dist., May 20, 2008). Courtesy of famed Chicago bankruptcy lawyer Steve Jakubowski, this decision  by the Appellate Court of Illinois, First District, Second Division, read opinion here, determined that Delaware law would recognize the concept of piercing the corporate veil in the context of an LLC. However, the 2 or 3 Delaware cases cited by the court are not directly on point in my view. Curiously, the court relies for its conclusion more heavily on opinions by the courts of other states applying Delaware law.  I think that a more nuanced approach is necessary  before one commences a wholesale application to the LLC context of piercing the corporate veil. As we have discussed on these pages frequently, not all the "conventional corporate analyses are automatically subject to being imposed onto the separate LLC framework."
See generally, Donald Wolfe and Michael Pittenger, Delaware Corporate and Commercial Practice in the Delaware Court of Chancery at Section 2.03[b][1][iii] (2008)(discussing  the concept of piercing the corporate veil generally as applied to corporations).

A recent Court of Chancery decision underscores the difficulty, at least in Delaware, of attempting to disregard the separate existence of a legal entity, sometimes referred to as “piercing the corporate veil”—though in the case styled  Verdantus Advisors, LLC v. Parker Infrastructure Partners, LLC, C.A. No. 2020-0194-KSJM, Order (Del. Ch. Mar. 2, 2022), the goal was to “pierce the veil” and disregard the separate existence of a limited liability company. (Although this decision was in the form of an Order, as compared to a more formal Opinion, it remains permissible in Delaware to cite in briefs to an Order.)

We have written before about piercing the corporate veil on these pages, and have referred readers to a definitive book on the topic by this blog’s favorite corporate law professor, whose scholarship is cited by the Delaware courts: Prof. Stephen Bainbridge.

Highlights of the more noteworthy aspects of the pithy ruling in this matter include the following:

  • The Court explained that: “Veil piercing is a tough thing to plead and a tougher thing to get, and for good reason.” Order at 4 (citations omitted.)
  • In addition, the Court added that: “Delaware is in the business of forming entities, and so ‘Delaware public policy does not lightly disregard their separate legal existence.'” Id.
  • Five factors considered in determining whether to pierce the corporate veil are: (1) whether the company was adequately capitalized for the undertaking; (2) whether the company was solvent; (3) whether corporate formalities were observed; (4) whether the dominant shareholder siphoned company funds; and (5) whether, in general, the company simply functioned as a facade for the dominant shareholder.” Id. at 5. (citations omitted.) See n.14 (citing cases for the position that no single factor will suffice; and in order to apply the alter ego theory, the entity must “exist for no other purposes than as a vehicle for fraud.”)
  • Notably, the Court observed that most single-member LLCs don’t follow many formalities for the good reason that there are “few statutorily mandated formalities imposed on those entities.” Order at 5.
  • In conclusion, the Court noted that, in light of its reasoning and holding, it need not address the argument made that veil-piercing theories should be unavailable or extraordinarily limited in the alternative entity context. n.18.

The Delaware Business Court Insider again published this year’s Annual Review, reprinted below with the courtesy of The Delaware Business Court Insider. (c) 2020 ALM Media Properties, LLC. All rights reserved.

This is the 17th year that Francis Pileggi has published an annual list of key corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery, often with co-authors. This list does not attempt to include all important decisions of those two courts that were rendered in 2021. Instead, this list highlights notable decisions that should be of widespread interest to those who work in the corporate and commercial litigation field or who follow the latest developments in this area of Delaware law. Prior annual reviews are available here.

This year’s list focuses, with some exceptions, on the unsung heroes among the many decisions that have not already been widely discussed by the mainstream press or legal trade publications. Links are also provided below to the actual court decisions and longer summaries.

DELAWARE SUPREME COURT DECISIONS

Supreme Court Confirms Impact of Bankruptcy on LLC Membership

A recent Delaware Supreme Court ruling endorsed the reasoning of a Delaware Court of Chancery decision holding that federal bankruptcy law does not entirely preempt the Delaware LLC Act to the extent that the LLC Act provides for a member of an LLC to become an assignee only, with economic rights, upon the filing of bankruptcy by that member, in Zachman v. Realtime Cloud Services LLC, 228 A.3d 1065 (Del. April 20, 2021).

Delaware High Court Finds First State Charter Outweighs Other Factors in Dole Foods Choice-of-Law Ruling

The Delaware Supreme Court decided a consequential case in 2021 addressing choice-of-law and fraud-exclusion issues in connection with requiring D&O insurers to pay settlements with investors who claimed that the CEO of Dole Foods Company Inc. cheated them in a going-private buyout.  RUSI Indemnity Co. Inc. v. Murdock, et al., No. 154, 2020 (Del. March 3, 2021).  Among the reasons that this decision is noteworthy is because it established the applicability of Delaware law to the insurance policy of a company incorporated in Delaware, but which had many contacts elsewhere.  Also, importantly, the court determined that insurance coverage would not be defeated simply because it covered payment for the settlement of fraud allegations.  The high court added that Delaware does not have a public policy against the insurability of losses occasioned by fraud, reasoning that Delaware’s statutory indemnification provisions allow corporations to purchase D&O insurance against any liability whether or not the corporation has the power to indemnify against such liability.

Delaware Rules Shareholder Franchise Right Question Tops Entire Fairness Test

In Coster v. UIP Companies, Inc., et al., No. 29, 2020 (Del. June 28, 2021), the unanimous opinion of Delaware’s high court en banc required that on remand the Court of Chancery determine if a board acted for inequitable purposes or in good faith, but for the primary purpose of disenfranchisement without a “compelling justification,” in connection with a stock sale intended to shift the power balance between rival deadlocked stockholder fashions, even if the sale were fairly negotiated.  If the trial court found after remand that the transaction was intended for inequitable purposes without a compelling justification, the trial court could consider available remedies including cancelling the stock sale and considering the appointment of a custodian.  Chief Justice Seitz wrote for the Supreme Court that the sanctity of the shareholder franchise superseded entire fairness review based on the circumstances of this case.

Supreme Court Clarifies Test for Direct v. Derivative Stockholder Claims

Although this is a decision that has already received widespread commentary, the Supreme Court decision in Brookfield Asset Management, Inc. v. Rosson [TerraForm], No. 406, 2020 (Del. Sept. 20, 2021), is a seminal decision that every corporate litigator must be aware of because it redefines and clarifies the test in Delaware to distinguish between a direct stockholder claim and a derivative stockholder claim.

Supreme Court Clarifies Pre-Suit Demand Analysis

Another Supreme Court decision that has already been the subject of extensive analysis but is still required reading for all corporate litigators is United Food and Commercial Workers’ Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, No. 404, 2020 (Del. Sept. 23, 2021), because it clarifies and restates the law in Delaware for the analysis of pre-suit demand futility for purposes of pursuing a derivative stockholder claim.

Supreme Court Decides Important Contract Dispute in Sale of Business

The Supreme Court of Delaware affirmed an epic Delaware Court of Chancery decision that found a breach of an agreement of sale that permitted the buyer to avoid consummation of the purchase for failure to comply with the “ordinary course covenant” in connection with how the business was managed between the date the agreement of sale was signed and the date of closing.  See AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, Del. Supr., No. 71, 2021 (Dec. 8, 2021).  The Supreme Court explained that the seller was required to obtain the prior written consent of the buyer before making the changes that it made, and distinguished the separate reasoning that applied to the material adverse change clause.

DELAWARE COURT OF CHANCERY DECISIONS

Company’s Privileged Communications Must Be Provided to Board Members

The Court of Chancery decided an issue of first impression in Delaware by rejecting the argument that the management of a Delaware corporation has the authority to unilaterally preclude a director of the corporation from obtaining privileged information of the corporation.  See In re WeWork Litigation, No. 2020-0258-AGB (Del. Ch. Aug. 21, 2021).

Recent Chancery Decision Addresses Dissolution Based on LLC Deadlock

The Delaware Court of Chancery penned a seminal decision that explains the analysis necessary to determine when a deadlock in an LLC might be the basis for a dissolution.  In Mehra v. Teller, C.A. No. 2019-0812-KSJM (Del. Ch. Jan. 29, 2021), the court addressed whether there was a failure to achieve the votes necessary for board action and whether the board deadlock was genuine or merely manufactured to force the appearance of a deadlock.

Chancery Keeps Dissolution Case Despite Mandatory NY Forum Clause

Although the general rule in Delaware is that forum selection clauses will be upheld, even if they require litigation to be conducted in states outside of Delaware, an exception to the rule was applied to keep a dissolution case in Delaware notwithstanding a contrary mandatory forum selection clause, in Seokoh, Inc. v. Lard-PT, LLC, C.A. No. 2020-0613-JRS (Del. Ch. March 30, 2021).

Self-Sacrifice Not Required of Controlling Stockholder

A useful Chancery decision that is bound to be of widespread applicability is the ruling in RCS Creditor Trust v. Schorsch, C.A. No. 2017-0178-SG (Del. Ch. March 18, 2021), in which the court explained that the fiduciary duties of a majority or a controlling stockholder do not require self-sacrifice, nor do they mean that such a fiduciary forfeits her contractual rights.

Chancery Addresses Forum Non Conveniens

Delaware law has evolved regarding the nuances of forum non conveniens, and those most recent iterations are explained in the Chancery decision styled Sweeny v. RPD Holdings Group, LLC, C.A. No. 2020-0813-SG (Del. Ch. May 27, 2021).

Chancery Recognizes Reverse Veil-Piercing

The Delaware Court of Chancery recently recognized “outside reverse veil-piercing,” as compared to “insider reverse veil-piercing.”  The former iteration was explained based on the unusual circumstances present in Manichaean Capital, LLC v. Exela Technologies, Inc., C.A. No. 2020-0601-JRS (Del. Ch. May 25, 2021).

Chancery Clarifies Standard to Shift Fees for Improper Litigation Conduct

The Court of Chancery’s pithy ruling in Pettry v. Gilead Sciences, Inc., C.A. No. 2020-0132-KSJM (Del. Ch. July 22, 2021), remains noteworthy for its guidance that provides litigators in general, and corporate litigators in particular, with a definition of “glaringly egregious,” and helps to clarify where the line is drawn for determining when fees will be shifted for inappropriate litigation conduct.  This decision gives greater instruction for what behavior will be sufficient to trigger the exception to the general American Rule that each party pays its own legal fees.

Can Fiduciary of a Debtor Assist a Creditor-Entity that Fiduciary Has Interest In?

The Court of Chancery addressed the titular topic in Skye Mineral Investors, LLC v. DXS Capital (U.S.) Limited, C.A. No. 2018-0059-JRS (Del. Ch. July 28, 2021).

Chancery: LLC Managers Breached Fiduciary Duties

The Chancery decision in Stone & Paper Investors, LLC v. Blanch, C.A. No. 2018-0394-PAF (Del. Ch. July 30, 2021), deserves attention for its treatment of well-established principles of fiduciary duty with widespread applicability in the LLC context, absent unambiguous waiver.  Also noteworthy, is the explanation about why the circumstances of this case allowed breach of contract claims to proceed to the extent that they did not overlap the fiduciary claims–and why both were permitted to be pursued through trial.

Chancery Explains Policy Limits to Contractual Restrictions on Fraud Claims

In connection with perennial post-closing claims related to the sale of a business, the Chancery decision in Online Healthnow, Inc. v. CIP OCL Investments, LLC, C.A. No. 2020-0654-JRS (Del. Ch. Aug. 12, 2021), explains the consequential nuances about what specific language in an agreement of sale will allow, or will bar, certain types of fraud claims.  The money quote from the decision provides the best insight into its holding: “Under Delaware law, a party cannot invoke provisions of a contract it knew to be an instrument of fraud as a means to avoid a claim grounded in that very same contractual fraud.”

Chancery Clarifies When Forum Selection Clause Binds Non-Signatory

While it may be surprising to some, quite a few Delaware decisions have bound non-signatories to forum selection clauses.  The Chancery decision in Florida Chemical Company, LLC v. Flotek Industries, Inc., C.A. No. 2021-0288-JTL (Del. Ch. Aug. 17, 2021), provides the most thorough analysis of the titular topic, with scholarly insights and copious citations that explain the theoretical and public policy underpinnings that support the decision to bind a non-signatory to a forum selection clause, and the prerequisites for doing so.

Chancery Does Deep Dive into Corporate Dissolution Details and Winding-up Process

Those interested in the not self-evident winding-up process in connection with the dissolution of a corporation under Delaware law need to read the Court of Chancery decision styled:  In re Altaba, Inc., C.A. No. 2020-0413-JTL (Del. Ch. Oct. 8, 2021), which provides an extensive analysis of the statutory provisions for the dissolution of corporations and a description of the corresponding winding-up process.

Chancery Declines to Follow First-Filed Rule in Advancement Case

A recent Chancery decision explained why the first-filed rule was not applied in an advancement case under Section 145 of the Delaware General Corporation Law.  See Lay v. Ram Telecom International, Inc., C.A. No. 2021-0631-SG (Del. Ch. Oct. 4, 2021).

Chancery Provides Guidelines for Non-Delaware Lawyers Issuing Formal Delaware Legal Opinion Letters

The Court of Chancery in Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, C.A. No. 2018-0372-JTL (Del. Ch. Nov. 12, 2021), provides comprehensive detail of the factual background of the issuance of a formal legal opinion letter in connection with a transaction, and provides a thorough analysis of problems with that letter in a 194-page decision which also offers guidance to lawyers around the country who are involved in issuing a formal opinion letter based on Delaware law.  The court found that the formal opinion letter given in the transaction at issue was not rendered in good faith, and explained what lawyers need to do in order to make sure the formal opinion letters that they grant do not suffer the same fate.

Chancery Clarifies Officer Consent Statute

Several years ago the Delaware Supreme Court expanded the prior interpretation of Delaware’s consent statute that imposes personal jurisdiction on directors and officers who agree to service in that capacity for Delaware corporations.  The contours of that expansion continue to be clarified and defined for those situations where there has been no breach of fiduciary duty.  See BAM International, LLC v. MSBA Group, Inc., C.A. No. 2021-0181-SG (Del. Ch. Dec. 14, 2021).

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SUPPLEMENT: Professor Stephen Bainbridge, one of Delaware’s favorite corporate law scholars, and one of the most prominent corporate law expert’s in the country, was kind enough to link to this article and described it as “essential reading”.

*Francis G.X. Pileggi is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP, and the primary author of the Delaware Corporate and Commercial Litigation Blog at www.delawarelitigation.com.

**Ciro C. Poppiti, III practices in the Delaware office of Lewis Brisbois Bisgaard & Smith LLP.

***Cheneise V. Wright is a corporate and commercial litigation associate in the Delaware office of Lewis Brisbois Bisgaard & Smith LLP.

Regular readers of these pages may recall multiple prior blog posts on both veil-piercing and reverse veil-piercing over the last 16 years. Serious students should review the book on the topic by the renowned corporate law scholar, and a friend of this blog, Professor Stephen Bainbridge. The Delaware Court of Chancery recently recognized reverse-veil-piercing in the matter styled: Manichaean Capital, LLC v. Exela Technologies, Inc., C.A. No. 2020-0601-JRS (Del. Ch. May 25, 2021).

Much commentary has already been published about the public policy and related implications of this decision. See, e.g., Professor Bainbridge’s emphasis that the opinion in this recent Chancery ruling only endorses “outside reverse veil piercing and not insider RVP.” See also Keith Paul Bishop’s commentary on the case.  See generally samples of Professor Bainbridge’s  multiple publications on the topic as referenced in many of this blog posts. I typically do not supplement existing extensive commentary on a decision that has already been the subject of many published insights, but because this is a topic of enduring importance, I want to call to the reader’s intention some of the existing commentary.

Of note, in connection with the facts of this case, is the long list of entities involved as parties, and the court’s observance that to disregard the legal entities, it was first required to engage in conventional corporate veil-piercing, as well as reverse corporate veil-piercing by traveling the following route: reaching upwards to the parent, and then downwards to reach wholly-owned subsidiaries. The court acknowledged that the legality of reverse veil-piercing appeared to be a matter of first impression in Delaware. The ruling was in the context of denying a motion to dismiss under Rule 12(b)(6), so we do not yet know the final outcome if the case goes to trial.

The court found that the pleadings sufficiently alleged fraud and injustice that might result, depending on the evidence presented at trial, from abusing the corporate form to avoid collection of a judgment.

The Court of Chancery recently allowed, after trial, a claimant to disregard the corporate entity, which the court found was involved in a fraudulent conveyance. The case styled: Fringer v. Kersey Homes, Inc., C.A. No. 9780-VCG (Del. Ch. June 25, 2018), begins with the following three sentences:  “The great advantage of the corporate form is that it permits investment and ownership without risk of personal liability for entity debt.  This advantage has its limits, obviously.  One such limitation is involved here.” (FYI: There is no typo in the Plaintiff’s name in the above case caption.)

For those interested in the topic of “piercing the corporate veil,” friend of the blog, Professor Stephen Bainbridge, has co-authored a book that includes an in-depth scholarly analysis of the topic. The good professor has published a lengthy list of books and articles on corporate law that are often cited by the Delaware courts.

Although the net result is the same, this decision does not undertake a “conventional analysis” that directly addresses piercing the corporate veil, and the facts of this case are not likely to be repeated, but a number of more traditional “piercing the corporate veil” cases have been highlighted on these pages over the last 13 years.

Brief Background:

The corporation involved, Kelsey Homes, Inc., was a defendant in a prior lawsuit based on allegations of fraud in connection with an agreement to sell a modular home. At the time of that agreement, Kelsey Homes, Inc. was “moribund.”  By the time trial approached in the prior fraud suit, its only asset was the modular home at issue in the litigation.  Kersey Homes, Inc. had transferred its only asset in a back-dated bill of sale to a relative of one of the stockholders, and then defaulted on the fraud action.

The court found that the stockholders of the corporate defendant were wrong when they thought that a judgment against the now-insolvent Kersey Homes, Inc. would be beyond the reach of the resulting judgment creditors.

The court held that the “sale” of the only corporate asset to a related party was a “sham” and the transfer was fraudulent under Delaware’s Uniform Fraudulent Transfer Act. The court granted the plaintiff in this case  a levy on the property, to receive the sales proceeds in an amount sufficient to satisfy the judgment.

Procedural History:

The prior fraud suit against Kersey Homes, Inc. regarding the sale of the modular home, resulted in a judgment being entered by the Superior Court.  Although Kersey Homes, Inc. had initially defended the Superior Court action, shortly before trial they informed the court that they would not defend it.  The modular home that was the subject of the Superior Court lawsuit, was transferred by Kersey Homes, Inc. to an affiliated party in exchange for discharging a prior debt of Kersey Homes, Inc.  This transfer of the only asset of Kersey Homes, Inc. was made about one year into the litigation over the home that was the subject of the transfer and about two months prior to judgment being entered shortly before the trial date.

The instant litigation in the Court of Chancery was commenced about two weeks after the judgment was obtained in the Superior Court. The Chancery complaint sought relief against Kersey Homes, Inc. (which filed a certificate of dissolution several months after the Chancery complaint was filed), as well as the principal stockholder of Kersey Homes, Inc. and the related party that had received the fraudulent transfer.  Kersey Homes, Inc. did not defend the Chancery litigation.

The court did not believe the testimony of the principal stockholder in part because the transfers were not documented and the only person available to testify about the transfer was the transferor.

The court determined that a more likely explanation for what happened was that the principals of Kersey Homes, Inc. realized they might be liable for a judgment and decided to take steps to evade any judgment that might be obtained. At the time of the fraudulent transfer, Kersey Homes, Inc. was already out of business and insolvent, without assets to satisfy a judgment.  But about a year earlier, the only asset of Kersey Homes, Inc. had been transferred for no consideration.  In an effort to defend a potential fraudulent conveyance claim, the principals of Kersey Homes, Inc. attempted to cover their tracks and create a story about a backdated transfer one year earlier.  The court found that those transfers were intended to avoid execution on a judgment.

Key Legal Principles:

The court reviewed the elements of a claim under the Delaware Uniform Fraudulent Transfer Act (“DUFTA”) whose purpose the court described as providing a remedy to creditors who were defrauded by debtors who transfer assets or incur obligations with the intent to hinder, delay or defraud any creditor or, without receiving reasonably equivalent value. The court described the elements of a claim as recited in Section 1304(a) of Title 6 of the Delaware Code.

There are eleven factors that the statute lists as non-exclusive factors to consider in determining whether there was actual intent to defraud. It is not necessary that all the factors support a finding of intent.  In this case, the court found that seven of the factors supported a finding of actual intent to defraud.

The court also found that Kersey Homes, Inc. violated Section 1305(a) which provides that a transfer is fraudulent as to a creditor whose claim arose before the transfer was made, if the debtor made the transfer without receiving a reasonably equivalent value or the debtor became insolvent as a result of the transfer. See footnote 117.

The opinion also discussed the broad latitude that a court has to craft a remedy subject to applicable principles of equity. Even though the original judgment was against a defunct corporation, the court traced the fraudulently transferred assets of the corporation to its current owner who was a stockholder in that corporation.

In sum, the court allowed the plaintiff to levy execution on the home involved in order to satisfy the judgment obtained in the Superior Court. The court also required the defendants to account for rental receipts on the house, and to the extent the sale of the property is insufficient to satisfy the judgment, the shortfall shall be made up from the rental receipts.

Because of a statute that applied in the Superior Court to grant treble damages for consumer fraud on senior citizens, the court found it inequitable to depart from the American Rule on fees.

Professor Stephen M. Bainbridge is the William D. Warren Distinguished Professor of Law at UCLA, a friend of this blog, and a nationally recognized corporate law expert who is often cited in opinions of the Delaware courts. He is a prolific scholar who has written countless books and articles. His latest article examines “reverse veil piercing” (as compared to piercing the corporate veil to find shareholders liable). The article also discusses the duty of majority shareholders–but in the context of his rebuttal to an amicus brief filed by other corporate law professors in a pending case before the U.S. Supreme Court. A partial synopsis of the article follows:

On March 25, 2014, the Supreme Court will hear oral argument in the Hobby Lobby and Conestoga Wood cases, in which the shareholders of two for-profit family-owned corporations argue that requiring them to comply with the contraception mandate [of The Affordable Care Act] violates the Religious Freedom Restoration Act. Forty-four corporate law professors filed an amicus brief in these cases, arguing that the essence of a corporation is its “separateness” from its shareholders and that, on the facts of these cases, there is no reason to disregard the separateness between shareholders and the corporations they control. The Brief is replete with errors, overstated claims, or red herrings, and misdirection.

Contrary to the Brief’s arguments, basic corporate law principles strongly support the position of Hobby Lobby and Conestoga Wood. In particular, the doctrine known as reverse veil piercing provides a clear and practical vehicle for disregarding the legal separateness of those corporations from their shareholders and thus granting those shareholders standing to assert their free exercise rights.

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 a former associate 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.