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Module V – Corporate Externalities. Chapter 11 Piercing 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

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chapter 11 piercing the corporate veil

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

slide2
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

slide3
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

slide4
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

diversification
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

slide6

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

slide7
Piercing in tort cases …verbigeration (vuhr-bij-uh-RAY-shun) noun Obsessive repetition of meaningless words and phrases.

Chapter 11

Piercing the Corporate Veil

walkovsky v carlton n y court of appeals 1966
Walkovsky v. Carlton(N.Y. Court of Appeals 1966)

Chapter 11

Piercing the Corporate Veil

theories of liability
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

walkovsky v carlton n y court of appeals 19661
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

slide11
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

slide12
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

what if corporate shareholder

What if corporate shareholder?

Chapter 11

Piercing the Corporate Veil

slide14

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

Telecom

wholly-owned subsidiary

Contrux

inadequate insurance

Radaszewski

Chapter 11

Piercing the Corporate Veil

slide15
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

slide16
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

piercing in contract cases

Piercing in Contract Cases …

What are PCV factors?

Chapter 11

Piercing the Corporate Veil

slide18
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

slide19
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

slide20

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

slide21
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

piercing in corporate groups

Piercing in Corporate Groups …

How different from “individual” cases?

What is framework?

What are factors?

Chapter 11

Piercing the Corporate Veil

slide23
Chapter 11

Piercing the Corporate Veil

slide24
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

pcv as remedy for fraudulent conveyance
PCV as remedy for“fraudulent conveyance” …

Chapter 11

Piercing the Corporate Veil

fraudulent conveyance
Fraudulent Conveyance

Howard(devoted spouse)

Howard(devoted spouse)

Assigns

income

Wanda(medical grad)

Student loans

Bank

Chapter 11

Piercing the Corporate Veil

uniform fraudulent transfer act
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

uniform fraudulent transfer act1
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

pop quiz how do six cases come out 1 under pcv doctrine 2 ufta
Pop quiz –How do six cases come out(1) under PCV doctrine, (2) UFTA?

Chapter 11

Piercing the Corporate Veil

slide30

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

the end
The end

Chapter 11

Piercing the Corporate Veil

reverse piercing
Reverse piercing …

Chapter 11

Piercing the Corporate Veil

connolly v vfw colo 2006
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

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