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Edvard Munch, The Scream (1893) (depicting effect of Mt. Krakatoa eruption in 1883)
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Chapter 11Piercing the Corporate Veil
• 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
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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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.
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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• 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?
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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?
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Diversification
10%10%10%10%Expected
16%25%18%5%Strong
4%-5%2%15%Weak
Portfolio XYZ
Inv. ZInv. YInv. X
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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?
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Piercing in tort cases …
verbigeration (vuhr-bij-uh-RAY-shun) noun Obsessive repetition of meaningless words and phrases.
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Walkovsky v. Carlton (N.Y. Court of Appeals 1966)
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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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
GarageInc.
Theories of liability
Enterprise
liability
PCV (Individual)
liability
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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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.
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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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.
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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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?
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Chapter 11Piercing the Corporate Veil
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What if corporate shareholder?
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Telecom
Contrux
wholly-owned subsidiary
Radaszewski
inadequate insurance
Radaszewski v. Telecom Corp. (8th Cir. 1992)
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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?
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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 …
Corporations:A Contemporary Approach
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Piercing in Contract Cases …
What are PCV factors?
Corporations:A Contemporary Approach
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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
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Chapter 11Piercing the Corporate Veil
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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
Corporations:A Contemporary Approach
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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 …
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Complex Computing Co.
“evidence of wrongdoing”
Horton Street Assoc.
“oral promises … sharp business practices”
Piercin
g
No pie
rcing
Distinguish the cases …
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Piercing in Corporate Groups …
How different from “individual” cases?What is framework?
What are factors?
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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”)
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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PCV as remedy for“fraudulent conveyance” …
Corporations:A Contemporary Approach
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Fraudulent Conveyance
Howard(devoted spouse)
Wanda(medical grad)
Bank
Student loans
Assignsincome
Howard(devoted spouse)
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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.
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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.
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Group hypo
How do six cases we’ve studied come out …
(1) under PCV doctrine(2) UFTA?
Corporations:A Contemporary Approach
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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
Corporations:A Contemporary Approach
Chapter 11Piercing the Corporate Veil
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Corporations:A Contemporary Approach
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The end
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Reverse piercing …
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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?