Veil Piercing Money Judgment Survives Res Judicata Defense – Mich. Court

Piercing the corporate veil, as metaphorical phrase and very real remedy, applies when a shareholder abuses the corporate form to shield himself from liability to corporate creditors. A prototypical piercing scenario is where a sole shareholder so controls his company that it blurs the separation between shareholder and company and is unfair to protect the shareholder from personal liability for company debts.  In such a case, the law views the company and shareholder as inseparable “alter egos” and a court will bypass the liability protection normally afforded a corporate shareholder.

Green v. Ziegelman, 310 Mich.App. 436 (2015) chronicles a piercing defendant’s efforts to avoid personal liability for a breach of contract debt by asserting the res judicata defense. After a 2006 breach of contract money judgment against an architectural firm went unsatisfied, the plaintiff sued the firm’s sole shareholder in 2012 to hold him responsible for the prior judgment.

The defendant – the sole shareholder of an architectural firm – moved for summary judgment that the claim against him was barred by res judicata.  He argued that the plaintiff could have sought to pierce the architecture firm’s corporate veil in the 2006 action but failed to do so.  Now, according to the defendant, it was too late.

The trial court disagreed and denied the shareholder’s summary judgment motion.  After the trial court entered judgment for the plaintiff after trial, the defendant appealed.

Result: Trial court judgment upheld.

Reasons: Michigan law applies a three-part res judicata test: if (1) there is a final judgment on the merits, (2) the second lawsuit’s issue could have been resolved in the first lawsuit, and (3) both actions (the first and second lawsuit) involve the same parties, a second claim will be barred by res judicata.

Res judicata extends not only to claims that were actually litigated but to claims that could have been raised.  The res judicata doctrine is applied to promote fairness; it balances a plaintiff’s right to have his day in court versus a defendant’s competing right to have litigation closure along with the court’s interest in case finality and conserving court resources.

To prevail on a piercing claim in Michigan, a plaintiff doesn’t have to prove a corporate shareholder committed intentional fraud.  It is enough if the shareholder acts “in such a manner as to defraud and wrong the [plaintiff]” or in such circumstances that a court “would aid in the consummation of a wrong” if it validated a company’s separate existence from its shareholder.

To determine whether the plaintiff could have (and should have) sought to pierce the architectural firm’s corporate veil in the 2006 case, the Court noted that under Michigan law, corporate officers are expected to respect a corporation’s separate existence from its individual members.  Because of this, absent evidence that the shareholder defendant abused the corporate form, a piercing claim would not have been well-founded when plaintiff sued in the 2006 case.

The appeals court found that since there was no evidence to signal misuse of the corporate form, there was no reason for the plaintiff to try to pierce the architect company’s corporate veil in the earlier lawsuit.  As a result, the 2012 piercing case did not stem from the same underlying transaction as the 2006 breach of contract case.

Upholding the piercing judgment, the appeals court held that the shareholder completely dominated the architectural firm such that the firm and shareholder were the same person.  Other important factors that led the court to approve the piercing judgment included evidence that the shareholder commingled personal assets with company assets, that the company failed to follow basic corporate formalities, and that 10 days after judgment, the shareholder dissolved the architectural firm and started a new one.

Take-aways:

1/ The res judicata defense won’t bar a piercing the corporate veil claim unless there was clear evidence of fraud or an alter-ego relationship between company and shareholder at the time a prior lawsuit against the corporation was filed;

2/ A plaintiff in a piercing suit under Michigan law isn’t required to show specific fraudulent conduct by the dominant shareholder.  It’s enough that there is an overall “feel” of unfairness based on a multitude of factors including failure to follow formalities, undercapitalization and commingling of personal vs. company assets.

Corporate Five-Year Winding Up or “Survival” Period Has Harsh Results for Asbestos Injury Plaintiffs – Illinois Court

An Illinois appeals court recently considered the interplay between the corporate survival statute, 805 ILCS 5/12.80 (the “Survival Act”), which governs lawsuits against dissolved corporations) and when someone can bring a direct action against another person’s liability insurer.

The personal injury plaintiffs in Adams v. Employers Insurance Company of Wasau, 2016 IL App (3d) 150418 sued their former employer’s successor for asbestos-related injuries. Plaintiffs also sued the former company’s liability insurers for a declaratory ruling that their claims were covered by the policies.

The former employer dissolved in 2003 and plaintiffs filed suit in 2011. The plaintiffs alleged the dissolved company’s insurance policies transferred to the shareholders and the corporate successor. The insurers moved to dismiss on the basis that the plaintiff’s suit was untimely under the Survival Act’s five-year winding up (“survival”) period to sue dissolved companies and because Illinois law prohibits direct actions against insurers by non-policy holders.

Affirming dismissal of the suit against the insurers, the court considered the scope of the Survival Act and whether its five-year repose period (the time limit to sue a defunct company) can ever be relaxed.

The Survival Act allows a corporation to sue or be sued up to five years from the date of dissolution. The suit must be based on a pre-dissolution debt and the five-year limit applies equally to individual corporate shareholders.  The statute tries to strike a balance between allowing lawsuits to be brought by or against a dissolved corporation and still setting a definite end date for a corporation’s liability. The five-year time limit for a corporation to sue or be sued represents the legislature’s determination that a corporation’s liability must come to and end at some point.

Exceptions to the Survival Act’s five-year repose period apply where a shareholder is a direct beneficiary of a contract and where the amount claimed is a “fixed, ascertainable sum.”

The Court held that since the plaintiffs didn’t file suit until long after the five-year repose period expired, and no shareholder direct actions were involved, the plaintiffs’ claims against the dissolved company (the plaintiffs’ former employer) were too late.

Illinois law also bans direct actions against insurance companies. The policy reason for this is to prevent a jury in a personal injury suit from learning that a defendant is insured and eliminate a jury’s temptation to award a larger verdict under the “deep pockets” theory (to paraphrase: “since defendant is protected by insurance, we may as well hit him with a hefty verdict.”)

The only time a direct action is allowed is where the question of coverage is entirely separate from the issue of the insured’s liability and damages. Where a plaintiff’s claim combines liability, damages and coverage, the direct action bar applies (the plaintiff cannot sue someone else’s insurer).

Here, the plaintiffs’ coverage claim was intertwined with the former employer’s (the dissolved entity) liability to the plaintiffs.  As a result, the plaintiffs action was an impermissible direct action against the dissolved company’s insurers.

Take-aways:

The Case starkly illustrates how unforgiving a statutory repose period is.  While the plaintiff’s injuries here were substantial, the Court made it clear it had to follow the law and that where the legislature has spoken – as it had by enacting the Survival Act – the Court must defer to it. Otherwise, the court encroaches on the law-making function of the legislature.

Another case lesson is that plaintiffs who have claims against dissolved companies should do all they can to ensure their claims are filed within the five-year post-dissolution period.  Otherwise, they risk having their claims time-barred.

 

Debtor’s Refusal to Return Electronic Data = Embezzlement – No Bankruptcy Discharge – IL ND

FNA Group, Inc. v. Arvanitis, 2015 WL 5202990 (Bankr. N.D. Ill. 2015) examines the tension between the bankruptcy code’s aim of giving a financial fresh start to a debtor and the Law’s attempt to protect creditors from underhanded debtor conduct to avoid his debts.

After a 15-year employment relationship went sour, the plaintiff power washing company sued a former management-level employee when he failed to turn over confidential company property (the “Data”) he had access to during his employment.

After refusing a state court judge’s order to turn over the Data and an ensuing civil contempt finding, the defendant filed bankruptcy.

The plaintiff filed an adversary complaint in the bankruptcy case alleging the defendant’s (now the debtor) embezzlement and wilfull injury to company Data.

The plaintiff asked the bankruptcy court to find that the debtor’s obligations to the plaintiff were not dischargeable (i.e. could not be wiped out).

Siding with the plaintiff, the Court provides a useful discussion of the embezzlement and the wilfull and malicious injury bankruptcy discharge exceptions.

The bankruptcy code’s discharge mechanism aims to give a debtor a fresh start by relieving him of pre-petition debts. Exceptions to the general discharge rule are construed strictly against the creditor and liberally in favor of the debtor.

Embezzlement under the bankruptcy code means the “fraudulent appropriation of property” by a person to whom the property was entrusted or to whom the property was lawfully transferred at some point.

A creditor who seeks to invoke the embezzlement discharge exception must show: (1) the debtor appropriated property or funds for his/her benefit, and (2) the debtor did so with fraudulent intent.

Fraudulent intent in the embezzlement context means “without authorization.” 11 U.S.C. s. 523(a)(4).

The Court found the creditor established all embezzlement elements. First, the debtor was clearly entrusted with the Data during his lengthy employment tenure. The debtor also appropriated the Data for his own use – as was evident by his emails where he threatened to destroy the Data or divulge its contents to plaintiff’s competitors.

Finally, the debtor lacked authorization to hold the Data after his resignation based on a non-disclosure agreement he signed where he acknowledged all things provided to him remained company property and had to be returned when he left the company.

By holding the Data hostage to extract a better severance package, the debtor exhibited a fraudulent intent.

The court also refused to allow a debtor discharge based on the bankruptcy code’s exception for willful and malicious injury. 11 U.S.C. s. 523(a)(6).

An “injury” under this section equates to the violation of another’s personal or property rights. “Wilfull” means an intent to injure the person’s property while “malicious” signals a conscious disregard for another’s rights without cause.

Here, the debtor injured the plaintiff by refusing to release the Data despite a (state) court order requiring him to do so. Plaintiff spent nearly $200,000 reconstructing the stolen property and retaining forensic experts and lawyers to negotiate the Data’s return.

Lastly, the debtor’s threatening e-mails to plaintiff in efforts to coerce the plaintiff to up its severance payment was malicious under Section 523 since the e-mails exhibited a disregard for the importance of the Data and its integrity.

Take-aways:

The bankruptcy law goal of giving a debtor fiscal breathing room has limits. If the debtor engages in intentional conduct aimed at evading creditors or furthers a scheme of lying to the bankruptcy court, his pre-petition debts won’t be discharged.

This case is post-worthy as it gives content to the embezzlement and wilfull and malicious property damage discharge exceptions.