Piercing the Veil, Alter Ego, and Other Bases for Holding an Owner Liable for Debts of an Entity Allen Sparkman

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Hastings Business Law Journal Volume 12 Article 2 Number 3 Spring 2016 Spring 2016 Will Your Veil be Pierced? How Strong Is Your Entity’s Liability Shield? -- Piercing the Veil, Alter Ego, and Other Bases for Holding an Owner Liable for Debts of an Entity Allen Sparkman Follow this and additional works at: https://repository.uchastings.edu/ hastings_business_law_journal Part of the Business Organizations Law Commons Recommended Citation Allen Sparkman, Will Your Veil be Pierced? How Strong Is Your Entity’s Liability Shield? -- Piercing the Veil, Alter Ego, and Other Bases for Holding an Owner Liable for Debts of an Entity, 12 Hastings Bus. L.J. 349 (2016). Available at: https://repository.uchastings.edu/hastings_business_law_journal/vol12/iss3/2 This Article is brought to you for free and open access by the Law Journals at UC Hastings Scholarship Repository. It has been accepted for inclusion in Hastings Business Law Journal by an authorized editor of UC Hastings Scholarship Repository. For more information, please contact [email protected]. Will Your Veil Be Pierced? How Strong Is Your Entity’s Liability Shield? — Piercing the Veil, Alter Ego, Ego, and Other Bases for Holding an Owner Liable for Debts of an Entity Allen Sparkman I. INTRODUCTION Courts, commentators, and attorneys describe corporations and limited liability companies as limited liability entities, but limited liability is not always the end result. While debts of a separate legal entity ordinarily would not be considered those of the owners1 even if the statutes applicable to these entities did not contain limitations on the owners of the entities,2 exceptions exist. For example, courts developed piercing the veil in corporate cases over a century ago as an equitable remedy to prevent perceived misuses of the corporate form.3 In the corporate context, courts Sparkman + Foote LLP, Houston, TX and Denver, Colo., © The Author October 19, 2015. The author thanks Herrick K. Lidstone, Jr., of Burns, Figa & Wills, P.C., in Denver, Colorado, for his helpful and thoughtful comments. Any mistakes are of course the responsibility of the author. 1. BAYLESS MANNING & JAMES G. HANKS, JR., LEGAL CAPITAL 16-17 (4th ed. 2013). 2. See, e.g., 6 DEL. CODE § 18-303: (a) Except as otherwise provided by this chapter, the debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities of the limited liability company, and no member or manager of a limited liability company shall be obligated personally for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company. (b) Notwithstanding the provisions of subsection (a) of this section, under a limited liability company agreement or under another agreement, a member or manager may agree to be obligated personally for any or all of the debts, obligations and liabilities of the limited liability company. 3. See United States v. Milwaukee Refrigerator Transit Co, 142 F. 247, 255 (E.D. Wis. 1905) (“A corporation will be looked upon as a legal entity as a general rule, and until sufficient reason to the contrary appears; but, when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons.”). A notable early veil-piercing case arose in Berkey v. Third Ave. Railway Co., 244 N.Y. 84, 155 N.E. 58 (1926). Plaintiff was injured on a street car operated by Forty-Second Street Railway Co., but she sued Third Avenue Railway Co., which owned substantially all of the stock of Forty-Second Street Railway Co. Although the court declined to pierce the corporate veil of Forty-Second Street Railway Co., which had its own bank accounts and employees as well as assets in excess of its 349 350 HASTINGS BUSINESS LAW JOURNAL Vol. 12:3 may pierce the veil where a subsidiary corporation is merely an alter ego or agent of the corporate parent, where the corporation is merely the alter ego of the shareholder, or where the corporate shield is being used to defraud creditors.4 An owner of an entity may also incur direct liability for debts of the entity or otherwise become liable on grounds other than veil piercing or alter ego. These grounds, which will be discussed later in this Article, include acting in the name of an unformed entity,5 acting for an undisclosed principal,6 liability to return improper distributions,7 liability for unpaid employment taxes,8 liability under other federal and state statutes,9 and liability for one’s own actions and the actions of agents.10 The author was prompted to write this Article in part by his experiences as an expert witness in veil-piercing cases. The author’s research did not find any analysis of veil-piercing cases that appeared aimed at assisting practicing attorneys who needed a resource to help them liabilities, Judge Cardozo (who wrote the opinion) stated “[w]e say at times that the corporate entity will be ignored when the parent corporation operates a business through a subsidiary which is characterized as an ‘alias’ or a ‘dummy.’” 155 N.E. at 61. Senter Construction Company, Inc. v. Deka Investments, LLC, 2013 WL 3272487 at *7 (Ill. Ct. App. June 24, 2013) (“The doctrine of piercing the corporate veil is an equitable remedy that permits a court to impose liability on an individual or entity that uses a corporation merely as an instrumentality to conduct that individual’s or entity’s business.”). 4. Great Neck Plaza v. Le Peep Rests., 37 P.3d 485, 490 (Colo. App. 2001). See also Fish v. East, 114 F.2d 177 (10th Cir. 1940). In determining whether the subsidiary was an alter ego or a mere instrumentality, FREDERICK J. POWELL, PARENT AND SUBSIDIARY CORPORATIONS, LIABILITY OF A PARENT FOR THE OBLIGATIONS OF ITS SUBSIDIARY (Chicago, Callahan & Company 1931) listed eleven factors that should be assessed: (a) Does the parent own all or most of stock of the subsidiary? (b) Do the parent and subsidiary corporations have common directors or officers? (c) Does the parent corporation finance the subsidiary? (d) Did the parent corporation subscribe to all of the capital stock of the subsidiary or otherwise cause its incorporation? (e) Does the subsidiary have grossly inadequate capital? (f) Does the parent pay the salaries and other expenses or losses of the subsidiary? (g) Does the subsidiary do no business except with the parent or does the subsidiary have no assets except those conveyed to it by the parent? (h) Is the subsidiary described by the parent (in papers of statements) as a department or division of the parent or is the business or financial responsibility of the subsidiary referred to as the parent corporation’s own? (i) Does the parent use the property of the subsidiary as its own? (j) Do the directors or executives fail to act independently in the interest of the subsidiary, and do they instead take orders from the parent, and act in the parent’s interest? (k) Are the formal legal requirements of the subsidiary not observed? 5. See infra notes 632-38 and accompanying text. 6. See infra notes 639–54 and accompanying text. 7. See infra notes 632–38 and accompanying text. 8. See infra notes 672–85 and accompanying text. 9. See infra notes 687–88 and accompanying text. 10. See infra notes 687–97 and accompanying text. Spring 2016 WILL YOUR VEIL BE PIERCED? 351 advise clients on how to avoid being subject to a successful veil-piercing claim or who needed a resource to help them pursue or oppose a veil- piercing claim.11 This Article draws from materials prepared for a program presented at the 2014 Annual Meeting of the Business Law Section of the American Bar Association. The program was titled “Piercing the Unincorporated Veil” and was sponsored by the Committee on LLCs, Partnerships and Unincorporated Entities. The program was chaired by Professor Stephen B. Presser of the Northwestern University College of Law, and the additional panelists were Elizabeth S. Fenton12 and Thomas E. Rutledge.13 The program materials included a 100 plus page summary of LLC veil-piercing cases prepared by Professor Elizabeth Miller of Baylor University School of Law from her comprehensive summaries of LLC cases that she has prepared for many years. This Article focuses on limited liability companies. This Article also discusses corporate cases to an extent because courts developed the veil- piercing and alter ego doctrines in corporate cases and much of the reasoning in corporate veil piercing and alter-ego cases will be applicable to limited liability companies as well. Veil piercing claims also arise in what are known as reverse veil piercing cases. This Article discusses reverse veil-piercing cases after discussing traditional veil-piercing.14 II. VEIL PIERCING IN GENERAL Some commentators have asserted that veil piercing “seems to happen freakishly. Like lighting, it is rare, severe, and unprincipled.”15 Indeed, Stephen Bainbridge thought veil piercing as applied by the courts to be so “rare, unprincipled, and arbitrary” that it should not be applied to LLCs and 11. In the course of working on this Article, the author found an excellent recent article reporting on the use of modern quantitative machine learning methods to analyze the full text of 9,380 judicial veil-piercing opinions. Jonathan Macey & Joshua Mitts, Finding Order in the Morass: The Three Real Justifications for Piercing the Corporate Veil, 100 CORNELL L. REV. 99 (2014). Macey and Mitts will doubtless be cited in many briefs in veil-piercing cases in the future and will be referred to in this Article at several points.
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