(Part III) Sticky Situations & Solutions: Morris the Manufacturer
This is the third article in the series. Although it's not necessary to read them, if you would like to read the two prior articles, and the interesting issues they discussed about this case, you can click here for part I and here for part II.
Disclaimer: The following information does NOT constitute legal advice and is only for general educational purposes. Each situation is different and specific legal issues usually require additional research and investigation, so do not rely on this article to address a particular legal issue; use this as a starting point to gain a general understanding.
Recap
This case is about Morris Manufacturer, who had a deal with Acme LLC (a sole member Limited Liability Company run by Carl Crafty) to manufacture thumb drives. Morris had switched from making DVDs (at substantial cost). Morris also had a lot of difficulty and expense switching production items, and wasn’t sure he could make the production deadline for Acme LLC. Carl, assuming Morris would not make the deadline, in violation of their contract, switched producers (he made an anticipatory breach of contract). Carl actually saved money because the second producer was cheaper, and Carl paid his friend Angie Angle a commission fee for finding the second producer.
In our prior articles in this series, we discussed how Morris sued Acme and also Carl, separately and together for breach of contract and some other claims. At the time, Acme and Carl challenged the lawsuit, with what’s called a Motion to Dismiss, which is a motion asking the judge to throw out one or more claims or an entire lawsuit.[1] Oh yeah, what is a “motion?” It’s a formal request made to a judge for an order or judgment.[2] So, Morris began the case by serving (i.e. delivering) a Summons and Complaint to Acme and to Carl (these issues were discussed more thoroughly in Part I of this series), and Acme and Carl, each filed a Motion to Dismiss with the court and served Morris.
Morris “won” meaning the court “denied” Acme and Carl’s motions, but all this really meant is that the case still had to go forward. Huh? didn’t Morris win? Not exactly. Acme and Carl’s Motion to Dismiss was denied. Acme and Carl were trying to … “knock out” Morris’s lawsuit, essentially on technical legal grounds. Even though Morris “won” against the Motion to Dismiss, Morris still has to prove his underlying case.
Act 4: Piercing the Corporate Veil
Scene 1: Official Immunity
So, Carl signed the contract, but he did so as an officer and president of Acme LLC, not as Carl Crafty, individually. The contract was between Morris and Acme LLC, and not between, Morris and Carl. When we work for our employer, say as Grand Poobah[3] of Sales Ordering, generally speaking, we aren’t personally liable if things go bad. I mean IBM won’t come after you for a bad sale[4] (although I have heard of contracts that attempt to make salespeople personally liable for them). New York law is even more specific: if an officer does not sign twice, once in his official capacity and once in his individual capacity, it is assumed that the officer signed only as a corporate agent, even if the contract indicates that officer bears personal liability.[5] This is true even for a corporation consisting of only one person.
In this case, Carl signed as President of Acme, LLC, not as himself, individually. Further, Carl did not provide any kind of personal guaranty. In many commercial transactions, such as a commercial lease, the landlord will ask for a personal guaranty from a commercial tenant, to ensure someone is on the hook, in case the company has no funds, a practice that has become much more common since the recession of 2008.[6] Therefore, Morris doesn’t look like he has the best case for suing, Carl, individually.
Scene 2: Piercing Plan
So, Carl’s off the hook, then? Not necessarily. There is something called “disregarding the corporate form” which is a far more boring way of saying the expression many business people actually know: “piercing the corporate veil.” Personally, I like much better the second way of saying it, because it sounds more poetic, like Shakespeare.[7] But let’s get a bit more boring still. One definition is “The judicial act of imposing personal liability on otherwise immune corporate officers, directors and shareholders for a corporation's fraudulent or wrongful acts.”[8]
So, how do we do this? Turns out, in New York, there is a fairly handy test: In New York, "[b]roadly speaking, the courts will disregard the corporate form, or, to use accepted terminology, 'pierce the corporate veil', whenever necessary 'to prevent fraud or to achieve equity'.”[9] Complete domination of the corporation is the key to piercing the corporate veil, especially when the owners use the corporation as a mere device to further their personal rather than the corporate business.[10] The party seeking to pierce the corporate veil must establish that the owners, through their domination, abused the privilege of doing business in the corporate form to perpetrate a wrong or injustice against that party such that a court in equity will intervene.[11] So, Morris is going to have prove that Carl “abused” and “dominated” the corporate form to “commit a wrong.”
Scene 3: Don’t Let Your Alter Ego Get You In Trouble
Well, common examples of abusing and dominating are mixing and matching finances. For instance, depositing corporate checks into personal bank accounts, instead of keeping them separate. For instance, in an LLC, for tax purposes, there is *no* separation of an LLC from its owner(s) (unless the LLC “checked the box”).[12] This means any income the LLC earns becomes an immediate tax liability to its owner Member(s)[13], even if the LLC retains the revenue in its own bank account, as opposed to the bank account of its Member(s).[14]
So, some LLC owners - well - they get sloppy. They gotta pay taxes on the cash anyway, and they don’t feel like depositing the check from their customer into their LLC’s bank account, *and then* write a check from the LLC to themselves, like they are supposed to do. They see that process as annoying and ridiculous, especially since they are the only Member of the LLC and have to pay taxes on it, whether it was deposited with the LLC or to their own personal account.
But … there’s a price to pay for cutting corners like this. In a lawsuit, the court could find there was no separation of identities. That the corporation was the “alter ego”[15] of its Member (or Members), and therefore the corporate form should be disregarded or pierced - meaning the person(s) who formed it, could be on the hook personally for a corporate debt or wrong inflicted on someone else. In plain English, this is a good way for a person to lose their house. Yes, you heard me correctly. Being sloppy with the corporate form, is a way to get yourself *personally* in trouble for your debts and wrongs. And, then, what was the point of incorporating in the first place?
Besides commingling assets, there are other ways to be sloppy. They include: not holding annual meetings of directors and shareholders or members, keeping accurate, detailed records (called "minutes") of important decisions that are made at the meetings, not adopting company bylaws, not making sure that officers and agents abide by those bylaws, not adequately capitalizing the corporation, i.e. keeping enough money on hand.[16]
Obviously, with only one Member, you don’t necessarily need to hold meetings (can you even hold a meeting by yourself?), but I personally recommend Sole Member LLCs actually do some kind of formal documentation, at least once a year, like an annual meeting, outlining crucial official decisions, like a review of assets, revenues, profits, losses, company policies, etc. It may sound silly, but I optimistically predict, you would get bonus points for that if your corporate form was questioned. Have it notarized so no one later can accuse you of making it up, retroactively.
Scene 4: Fraud and Deceit
The other side of it, though, is often (but not always) you have to use your abuse and domination of your company to commit a “wrong.” So, for instance a court may disregard the corporate entity to prevent fraud, illegality, injustice, a contravention of public policy, or to prevent the corporation from shielding someone from criminal liability.[17] In other words, some courts have ruled that mere domination of the corporate form is not enough; wrongdoing is also necessary.[18] Others, though, have ruled that "excessive control" for personal rather than corporate purposes were enough to support a veil piercing claim. However, it is not very easy to pierce the corporate veil, and under ordinary circumstances, a court will not do so.[19] Each case is highly fact specific.[20]
Scene 5: Acme and Crafty
So, What did Carl do? Well, Carl signed the contract once as President of Acme. He did not represent that he was on the hook, personally, in any way. We know from the first article in this series that Carl has a separate office, so that’s a good way to maintain a separate identity. We don’t know if he keeps good books or not, but we do know that he maintains a separate corporate bank account, which also helps separate identity. So far it’s not looking great for Morris’s case on the merits against Carl, personally.
On the other hand, Carl did breach his contract, which is arguably a wrong that he used his corporation to commit. Carl will argue that breach should be excused because he had no choice, but the fact that Carl saved a lot of money by breaching, makes it seem he did it out of greed, not necessity. Morris probably also will argue that Carl mislead Morris, either intentionally or negligently, into spending a lot of money to retool his factory for no reason, which is kind of costly fraud.
Finally, we also know that Carl never keeps much cash on hand on Acme. This could be fine, but it also could be a no-no. In New York, the fraudulent transfer law is designed to protect creditors by preventing debtors from hiding property that can and should be used to satisfy debts. At the most basic level, it allows creditors to recover property and undo transfers that debtors make in an attempt to hinder, delay, or defraud their creditors.[21] So, for instance, if Carl is using the corporation to move money around wrongfully, Morris may be able to "piece the corporate veil" to get to the Carl’s money, personally (or even undo the transfer of cash).
Final Thoughts
So, if it’s so difficult to pierce the corporate veil, why did the court permit Morris’s lawsuit against Carl to go forward? Well, veil piercing claims are inherently fact driven, they are not typically susceptible to attack on a pre-answer motion to dismiss.[22] Also, "The issues raised with respect to a piercing of the corporate veil . . . raise factual questions not determinable on a pre-answer motion to dismiss."[23] In fact, New York courts typically even are reluctant to dispose of veil piercing claims on summary judgment.[24] Basically, this is such a case-by-case, fact complicated issue, whether a person sufficiently abused their own corporation, that courts often want parties to conduct Discovery and find out all the facts first, and then see what’s what.
Is it easy to pierce the veil and get to the person behind the corporation protection? No. And, by the way, it’s not supposed to be. Otherwise, why bother having corporate protection? Shielding personal assets is one of the main reasons people incorporate. However, even if difficult, getting to the actual person behind the big bad faceless corporate entity, is indeed possible. And the sloppier and more corrupt the person you are suing, the easier it will be to do it.
Next issue in the series we still need to talk about Angie’s role and damages.
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[2] http://dictionary.law.com/Default.aspx?selected=1287. Motions are made in court all the time for many purposes: to continue (postpone) a trial to a later date, to get a modification of an order, for temporary child support, for a judgment, for dismissal of the opposing party's case, for a rehearing, for sanctions (payment of the moving party's costs or attorney's fees), or for dozens of other purposes.
[3] Grand Poobah usually means someone “really important” and typically is used by older people who remember a time before computers or at least the Internet and Smart Phones. Supposedly, the term actually comes from The Mikado by Gilbert & Sullivan (look it up); the Pooh-Bah holds numerous exalted offices, including "First Lord of the Treasury, Lord Chief Justice, Commander-in-Chief, Lord High Admiral ... Archbishop ... Lord Mayor" and "Lord High Everything Else". The name has come to be used as a mocking title for someone self-important or locally high-ranking and who either exhibits an inflated self-regard or who has limited authority while taking impressive titles. https://www.google.com/?gws_rd=ssl#q=grand+poobah.
[4] Salzman Sign Co. v. Beck, 10 N.Y.2d 63, 67 (1961); American Media Concepts v. Atkins Pictures, 179 A.D.2d 446 (1st Dept. 1992).
[5] Salzman Sign Co. v. Beck, 10 N.Y.2d 63, 67 (1961); American Media Concepts v. Atkins Pictures, 179 A.D.2d 446 (1st Dept. 1992) ("In modern times most commercial business is done between corporations, everyone in business knows that an individual stockholder or officer is not liable for his corporation's engagements unless he signs individually, and where individual responsibility is demanded the nearly universal practice is that the officer signs twice — once as an officer and again as an individual.").
[9] Morris v. New York State Dept. of Taxation and Finance, 603 N.Y.S.2d 807 (1993); Intl Aircraft Trading Co. v. Manufacturers Trust Co., 297 NY 285 (1948).
[10] Morris v. New York State Dept. of Taxation and Finance, 82 N.Y.2d 135 (1993).
[11] Morris v. New York State Dept. of Taxation and Finance, 603 N.Y.S.2d 807 (1993); Rose Ocko Foundation, Inc. v. Lebovits, 686 N.Y.S.2d 861 (2nd Dept. 1999).
[13] The owners of an LLC, at least in New York, are called “Members.” They are like shareholders in a corporation or partners in a partnership.
[15] In order to prevail on an alter-ego claim, a plaintiff must establish that there was such a unity of interest and control between the defendant and the other entity that they cannot really be said to be two separate entities. Rohmer Assoc. Inc. v. Rohmer, 830 N.Y.S.2d 356 (3rd Dept. 2007).
[17] Aspex Eyewear, Inc. v. Altair Eyewear, Inc., 361 F.Supp2d 210 (S.D.N.Y. 2005); Billy v. Consolidated Machine Tools, 432 NYS2d 879 (1980); but c.f. Passalcqua Builders, Inc. v. Resnick Developers South, Inc., 933 F.2d 131, 141 (2nd Cir. 1991) (it would be error for a court to instruct a jury that plaintiffs are required to prove fraud to pierce the corporate veil).
[18] Casa de Meadows, Inc. v. Zaman, 908 NYS2d 628 (1st Dept. 2010).
[19] Matter of Seagroatt Floral, Co., Inc., 576 NYS2d 831 (1991).
[20] Marc Contracting, Inc. v. 39 Winfield Assoc., LLC, 880 NYS2d 346 (2nd Dept. 2009).
[21] Philip Michael Guffy, Exempt No More: How New York's Uniform Fraudulent Conveyance Act Threatens Exemptions in Bankruptcy, Brooklyn Law Review, Vol. 80, Issue#3, p. 1122, 1124 (2015).
[22] Cornwall Mgmt. Ltd. v. Kambolin, 2015 NY Slip Op 30740(U) (N.Y. Sup. Ct., 2015).
[23] Kralic v Helmsley, 294 AD2d 234, 236 (1st Dept. 2002).
[24] Ledy v. Wilson, 38 AD3d 214, 215 (1st Dept. 2007).
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