Tuesday, April 1, 2014

Courts Should Tread Lightly When Disregarding (Even Dissolved) Entities

As I discussed briefly last week, I think reverse veil piercing in the Hobby Lobby case is a bad idea, in part because it uses a doctrine designed to prevent fraud to impute characteristics to the entity. One of the reasons this concerns me is that there are other recent decisions that imply courts may be missing the point about the separate and distinctive nature of entities, even as the individual rights of entities appear to be expanding. 

In a recent West Virginia case, for example, a lower court allowed a wildly improper use of the statutory provision, “Unknown claims against dissolved corporation” to be the basis what became a $25 million jury award for punitive damages for emotional impact to a former entity’s shareholders. In the Order Addressing AIG Posttrial Motions (pdf) of May 1, 2012 (“Order”) Ryan Environmental, Inc. v. Hess Oil Co., Inc., Civil Action No. 10-C-20, the court adopted a plaintiff’s argument that, under W. Va. Code § 31D-14-1407(d), “the interests of the shareholders are joined with the interests of the corporation after a corporation’s dissolution.” See Order at 7.  The court later explained its view that, because the plaintiff’s former entity was dissolved, damages and hardships attributable to the shareholders were a sufficient basis for the defendants’ liability directly to the shareholders and that such damages and hardships did not need to attributed to the former entity.  That is, the defendants’ liability ran to the entity’s shareholders post-dissolution even though the harms claimed were never attributable to the entity.  Click below to read more.

In that case, in support of this determination, the court stated that under § 31D-14-1407(d)(2), “[i]f the assets of a [corporate defendant] have been distributed in liquidation,” recovery may be enforced “against a shareholder.”  Order at 9 (alterations in original). Thus, the court concluded, because liability can run to the former shareholder, the former shareholder can pursue claims directly. 

The court was accurate that this provision can lead to personal liability for former shareholders, but the claim is an incomplete statement of the law. The full provision of the statute the court cited includes a critical limit that necessarily impacts the reading of that section.  The full section of the statute reads: 

(d) A claim may be enforced under this section:

(1) Against the dissolved corporation, to the extent of its undistributed assets; or

(2) If the assets have been distributed in liquidation, against a shareholder of the dissolved corporation to the extent of his or her pro rata share of the claim or the corporate assets distributed to him or her in liquidation,whichever is less, but a shareholder’s total liability for all claims under this section may not exceed the total amount of assets distributed to him or her.

W. Va. Code § 31D-14-1407 (emphasis added). This limiting language preserves for the shareholders, post-dissolution, the limited liability shield that Hess Oil provided as a pre-dissolution corporation. 

Therefore, although the court was correct that the defendants could recover for successful cross-claims against the dissolved entity’s shareholders, any such recovery would be, again, “limited to the extent of [each shareholder’s] pro rata share of the claim or the corporate assets distributed to him or her in liquidation, whichever is less, but a shareholder’s total liability for all claims under this section may not exceed the total amount of assets distributed to him or her.” Id. Thus, the defendants could only recover from the former shareholders the amount that would have been available from the entity at the time the entity was liquidated to the shareholders. That is, each shareholder could be liable only to the amount he or she received in liquidation and would not be jointly liable for the debts of other shareholders. See id. 

The Supreme Court of Appeals of West Virginia corrected this in AIG Domestic Claims, Inc. v. Hess Oil Co., Inc., 751 S.E.2d 31, 35 (W. Va. 2013), but the concept here could have set a dangerous precedent by eliminating the separate nature of the entity and the shareholder post-dissolution. Under common law and statutory law, I think courts should tread lightly on expansion of any concepts that disregard the entity because we cannot always expect the (U.S. or State) Supreme Court to fix it. 


Business Associations, Corporations, Joshua P. Fershee | Permalink

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