Corporations and LLC's Feb 2003 Flashcards
(4 cards)
Summary
Stuart’s estate will probably be able to pierce the corporate veil to hold Corn Corp liable for the estate’s judgment against GCI. Whether a court will pierce the corporate veil depends heavily on the facts of a particular case, and here the facts support holding Corn Corp liable. In the first place, the usual facts supporting veil-piercing are present here: the business records of Corn Corp and GCI were completely intermingled, GCI did not observe the formalities of a separate corporate existence, GCI was inadequately capitalized, and GCI’s business (selling Super Corn Plus) was held out to the public as a mere extension of Corn Corp’s business. In addition, the activities that led to the judgment against GCI were the result of decisions made and directed by an officer of Corn Corp at a time when Super Corn Plus was still a Corn Corp product.
It is less likely that a court would pierce the corporate veil of Corn Corp in order to hold its shareholders liable to pay Stuart’s estate’s claim. There is nothing to suggest that the shareholders used Corn Corp as a “mere instrumentality” or their “alter ego.” They respected corporate formalities, and Corn Corp appears to have been adequately capitalized.
Stuart’s estate will likely be able to pierce GCI’s corporate veil and recover its judgment from Corn Corp, the “parent” corporation, because GCI failed to maintain a formal separate existence as evidenced by its inadequate capitalization and failed to maintain corporate formalities, and because justice requires piercing to prevent Corn Corp from insulating itself from its wrongdoing.
Shareholders generally are not liable for the corporation’s debts. See Revised Model Business Corporation Act § 6.22. A court, however, will “pierce the corporate veil” when circumstances indicate that the privilege has been misused or when necessary to do justice. See Pepper v. Litton, 308 U.S. 295, 310 (1939). The decision to pierce the corporate veil will be based on a determination of the facts.
While a parent corporation is expected to exert some measure of control over a subsidiary corporation, the subsidiary corporation is expected to be separate, at least in form. When a parent corporation so dominates a subsidiary corporation that the subsidiary has no real separate existence, and justice so requires, a court will disregard the corporate form and hold the parent corporation personally liable for the subsidiary’s debts.
One basis for piercing the corporate veils fraud or illegitimate purpose. In the absence of fraud or illegitimate purpose, a court may still pierce the corporate veil when justice so requires if (a) the parent and subsidiary intermingle their respective business transactions, accounts, and records; (b) the subsidiary fails to observe the formalities of separate corporate procedures; (c) the subsidiary is not adequately financed in light of its foreseeable normal obligations; or (d) the parent and subsidiary do not hold themselves out to the public as separate enterprises. See Harry Henn & John R. Alexander, LAWSOF CORPORATIONS § 148 (1983).
Application
Based on the facts, GCI is a wholly owned subsidiary of Corn Corp. Corn Corp had a legitimate purpose for organizing GCI. Creating a separate entity for marketing reasons (because some food processors might not have wanted genetically engineered corn) is an acceptable business reason. Despite this legitimate purpose, a court might still pierce the corporate veil because GCI did not formally maintain a separate existence from Corn Corp (internally or externally). GCI did not formally maintain corporate formalities and was not initially adequately capitalized.
Corn Corp and GCI intermingled their assets and business transactions. GCI operated out of the offices of Corn Corp and had exactly the same directors and officers. GCI did not keep separate records of its business transactions. Additionally, while the two corporations each had separate bank accounts, the fact that GCI received “informal” loans from Corn Corp is further evidence of the blurred boundaries between the parent and subsidiary.
GCI did not observe corporate formalities. It did not keep separate minute books. Additionally, Corn Corp did not adequately finance GCI in light of its foreseeable normal obligations. Corn Corp funded GCI with only the patent, which was new and of speculative value, and $6,000, which was only enough to produce the seed for the first crop. The inadequate initial capitalization was further evidenced by GCI’s need for “emergency loans” from Corn Corp to meet day-to-day cash flow needs.
Finally, Corn Corp and GCI marketed products with very similar names (Super Corn and Super Corn Plus). These similar product names could be reasonably interpreted by the public to be from the same entity. The decline in sales experienced by Corn Corp after Stuart’s death seems to indicate that the public viewed Corn Corp as the same entity as GCI. Further, as discussed above, both Corn Corp and GCI operated from the same location, which could lead the public to conclude that the businesses were not distinct.
Justice requires piercing because Super Corn Plus was developed by Corn Corp, and an officer and director of Corn Corp negligently rushed it to market without the proper testing. Corn Corp should not now be able to use a wholly owned subsidiary that did not maintain a separate existence to insulate itself from liability.
The facts do not support piercing Corn Corp’s corporate veil to hold Alan, Bruce, and Kathy, as shareholders, liable for Stuart’s estate’s judgment. Kathy, however, might be liable for her negligent acts.
While the facts support piercing the corporate veil to hold Corn Corp liable for the judgment against GCI, this will not help Stuart’s estate because the facts indicate that Corn Corp cannot pay its bills (so it will be unable to pay the judgment). Therefore, Stuart’s estate would like to recover the judgment against GCI from the shareholders of Corn Corp (Alan, Bruce, and Kathy). However, the facts do not support a claim to recover from Alan, Bruce, or Kathy in their capacity as shareholders of Corn Corp.
Shareholders generally are not liable for the corporation’s debts. See RMBCA § 6.22. Courts generally respect the corporate form and shield shareholders from liability unless the shareholders use the corporation as a “mere instrumentality” or “alter ego” to carry out an improper or illegal purpose (e.g., to perpetrate fraud, to evade the law, to escape obligations). “[W]here corporate formalities are substantially observed, initial financing reasonably adequate, and the corporation not formed to evade an existing obligation or a statute or to cheat or to defraud, even a controlling shareholder enjoys limited liability.”
There are no facts to support a conclusion of an illegal or improper purpose when Corn Corp was incorporated. There is also no suggestion that Corn Corp was inadequately capitalized when it was incorporated. Corn Corp had $500,000 of initial capitalization and had been profitable for 20 years. The fact that Corn Corp cannot currently pay its bills is irrelevant to this determination.
Further, there is no evidence that the shareholders did not respect the corporate formalities. For example, Kathy scrupulously kept Corn Corp’s minute books. Nor is there any evidence that Alan, Bruce, or Kathy ignored the “separateness” of Corn Corp. In summary, there are no facts to indicate that any of the shareholders of Corn Corp treated Corn Corp as their “alter ego” or a “mere instrumentality,” and the interests of justice do not require piercing the corporate veil in this case.
Although the facts do not support a holding that Kathy is liable in her capacity as a shareholder of Corn Corp, Stuart’s estate could bring a separate action against Kathy for her negligent acts as the head of Corn Corp’s product development.
