Tag: piercing the corporate veil

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.

Feelin’ Minnesota? Most Likely (Court Pierces Corporate Veil of Copyright Trolling Firm To Reach Lawyer’s Personal Assets)

After being widely lambasted for its heavy-handed and ethically ambiguous (challenged?) BitTorrent litigation tactics over the past few years, an incarnation of the infamous Prenda law firm was recently hit with a piercing the corporate veil judgment by a Minnesota state court.

In Guava, LLC v. Merkel, 2015 WL 4877851 (Minn. 2015), the plaintiff pornographic film producer, represented by the Alpha, LLC law firm (“Alpha”), filed a civil conspiracy suit and state wiretapping claim against various defendants whom plaintiff claimed illegally downloaded adult films owned by the plaintiff.

Alpha’s lone member is Minnesota attorney and Prenda alum Paul Hansmeier, who has garnered some negative press of his own both for his copyright trolling efforts and his more recent ADA violation suits against small businesses.  In October 2015, the Supreme Court of Minnesota instituted formal disciplinary proceedings against Hansmeier for various lawyer misconduct charges.

The Alpha firm’s litigation strategy in the Guava case followed the familiar script of issuing a subpoena blitz against some 300 internet service providers (ISPs) to learn the identity of the movie downloaders.  Many of the ISP customers fought back with motions to quash the subpoenas.

After assessing monetary sanctions against Alpha for bad faith conduct – trying to extract settlements from the ISP customers with no real intent to litigate – the trial court entered a money judgment against Alpha for the subpoena respondents and John Doe defendants.

Through post-judgment discovery, the subpoena defendants learned that Hansmeier had transferred over $150,000 from Alpha, defunding it in the process.

The judgment creditor defendants then moved to amend the judgment to add Hansmeier individually under a piercing the corporate veil theory. After the trial court granted the motion, Alpha and Hansmeier appealed.

Held: Affirmed

Rules/Reasoning:

In Minnesota, a district court has jurisdiction to take actions to enforce a judgment when the judgment is uncollectable and where refusing to amend a judgment would be inequitable.

A classic example of an equitable remedy that a court can apply to amend an unsatisfied money judgment is piercing the corporate veil. A Minnesota court will pierce the corporate veil where (1) a judgment debtor is the alter ego of another person or entity and (2) where there is fraud.

The alter ego analysis looks at a medley of factors including, among others, whether the judgment debtor was sufficiently capitalized, whether corporate formalities were followed, payment or nonpayment of dividends, and whether the dominant shareholder siphoned funds from an entity to avoid paying the entity’s debts.

The fraud piercing factor considers whether an individual has used the corporate form to gain an undeserved advantage. The party trying to pierce the corporate veil doesn’t have to show actual (read: intentional) fraud but must instead show the corporate entity operated as a constructive fraud on the judgment creditor.

Here, the defendants established both piercing prongs. The evidence clearly showed Alpha was used to further Hansmeier’s personal purposes, there was a disregard for basic corporate formalities and the firm was insufficiently and deliberately undercapitalized.

The court also found that it would be fundamentally unfair for Hansmeier to escape judgment here; noting that Hansmeier emptied Alpha’s bank accounts after it became clear that defendants were trying to enforce the money judgment against the Alpha firm.

Afterword:

While a Minnesota state court ruling won’t bind other jurisdictions, the case is post-worthy The case lesson is clear: if a court (at least in Minnesota) sees suspicious emptying of corporate assets when it’s about to enter a money judgment, it has equitable authority to modify a judgment so that it binds any individual who is siphoning the corporate assets.

The case is also significant because it breaks from states like Illinois that specify that piercing the corporate veil is not available in post-judgment proceedings. In Illinois and other states, a judgment creditor like the Guava defendants would have to file a separate lawsuit to pierce the corporate veil.  This obviously would entail spending time and money trying to attach assets that likely would be dissipated by case’s end.  The court here avoided what it viewed as an unfair result simply by amending the money judgment to add Hansmeier as a judgment debtor even though he was never a party to the lawsuit.

LLC That Pays Itself and Insiders to Exclusion of Creditor Plaintiff Violates Fraudulent Transfer Statute – Illinois Court

Applying Delaware corporate law, an Illinois appeals court in A.G. Cullen Construction, Inc. v. Burnham Partners, LLC, 2015 IL App (1st) 122538, reversed the dismissal of a contractor’s claim against a LLC and its sole member to enforce an out-of-state arbitration award.  In finding for the plaintiff contractor, the court considered some important and recurring questions concerning the level of protection LLCs provide a lone member and the reach of the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et seq. (“UFTA”), as it applies to commercial disputes.

The plaintiff sued  a Delaware LLC and its principal member, an Illinois LLC, to enforce a $450K Pennsylvania arbitration award against the Delaware LLC.  The plaintiff added UFTA and breach of fiduciary duty claims against the Delaware and Illinois LLCs based on pre-arbitration transfers made by the Delaware LLC of over $3M.

After a bench trial, the trial court ruled in favor of the LLC defendants and plaintiff appealed.

Reversing, the appeals court noted that the thrust of the UFTA claim was that the Delaware LLC enriched itself and its constituents when it wound down the company and paid itself and its member (the Illinois LLC) to the exclusion of plaintiff.

The UFTA was enacted to allow a creditor to defeat a debtor’s transfer of assets to which the creditor was entitled.  The UFTA has two separate schemes of liability: (1) actual fraud, a/k/a “fraud in fact” and (2) constructive fraud or “fraud in law” claims.  To prevail on an actual fraud claim, the plaintiff must prove a defendant’s intent to defraud, hinder or delay creditors.

By contrast, a constructive fraud UFTA claim doesn’t require proof of an intent to defraud.  Instead, the court looks to whether a transfer was made by a debtor for less than reasonably equivalent value leaving the debtor unable to pay any of its debts. (¶¶ 26-27); 740 ILCS 160/5(a)(1)(actual fraud), 160/5(a)(2)(constructive fraud).

When determining whether a debtor had an actual intent to defraud a creditor, a court considers up to eleven (11) “badges”of fraud which, in the aggregate, hone in on when a transfer was made, to whom, and what consideration flowed to the debtor in exchange for the transfer.

The court found that the Delaware LLC’s transfers of over $3M before the arbitration hearing had several attributes of actual fraud. Chief among them were that (i) the transfer was to an “insider” (i.e. a corporate officer and his relative), (ii) the Delaware LLC transferred assets without telling the plaintiff knowing that the plaintiff had a claim against it; (iii) the Delaware LLC received no consideration a $400K “management fee” paid to the Illinois LLC (the Delaware LLC’s sole member); and (iv) the Delaware LLC was insolvent after the  transfers.

Aside from reversing the UFTA judgment, the court also found the plaintiff should have won on its piercing the corporate veil and breach of fiduciary duty claims.  On the former, piercing claim, the court held that the evidence of fraudulent transfers by the Delaware LLC to the Illinois LLC presented a strong presumption of unjust circumstances that would merit piercing.  Under Delaware law (Delaware law governed since the defendant was based there), a court will pierce the corporate veil of limited liability where there is fraud or where a subsidiary is an alter ego of its corporate parent.  (¶ 41)

On the fiduciary duty count, the court held that once the Delaware LLC became insolvent, the Illinois LLC’s manager owed a fiduciary duty to creditors like the plaintiff to manage the Delaware LLC’s assets in the best interest of creditors. (¶¶ 45-46)

Afterwords:

A pro-creditor case in that it cements proposition that a UFTA plaintiff can prevail where he shows the convergence of several suspicious circumstances or “fraud badges” (i.e., transfer to insider, for little or no consideration, hiding the transfer from the creditor, etc.).  The case illustrates a court closely scrutinizing the timing and content of transfers that resulted in a company have no assets left to pay creditors.

Another important take-away lies in the court’s pronouncement that a corporate officer owes a fiduciary duty to corporate creditors upon the company’s dissolution.

Finally, the case shows the analytical overlap between UFTA claims and piercing claims.  It’s clear here at least, that where a plaintiff can show grounds for UFTA liability based on fraudulent transfers, this will also establish a basis to pierce the corporate veil.