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.