Tuesday, July 2, 2019

If Sole Ownership of an Entity Means Alter Ego, then Veil Piercing Will Be Inevitable

Veil piercing continues its randomness. Back in April, in Hawai'i Supreme Court decision, Calipjo v. Purdy, 144 Hawai'i 266, 439 P.3d 218 (2019), the court determined that there was evidence to support a trial court jury's decision to pierce the veil of an multiple entities and hold the sole member/shareholder of the entities liable.  (An appellate court had determined that there was insufficient evidence to support veil piercing.)

The decision may be sound, but the evidence for the decision makes the outcome seemingly inevitable. In determining there was evidence to support the jury's decision, the court notes the plaintiff's allegations were that "sole ownership and control is one of many factors that can establish alter ego and, therefore, evidence of Purdy’s ownership and control was pertinent to this claim."  The court then explains, 

In this case, the jury was presented with evidence that Purdy exercised exclusive ownership and control over Regal Corp. and Regal LLC. Purdy testified that he was the sole shareholder, director, and officer of Regal Corp. and the sole member and manager of Regal LLC. This court has held that “sole ownership of all of the stock in a corporation by one individual” is one relevant factor to determine alter ego. Id. (quoting Associated Vendors, 26 Cal. Rptr. at 814). Purdy’s testimony supports the jury’s determination that Purdy exercised exclusive ownership and control over Regal Corp. and Regal LLC; it constitutes evidence that Purdy was the sole owner and manager of either company.

Note, though, that the plaintiff claimed that "sole ownership and control ... can establish alter ego."  The court more accurately  states that ownership and control are a factor.  They are not dispositive or else limited liability for a single-member LLC, corporation, or other limited liability entity would be a fiction.  The jury instructions, though, seem to eliminate the possibility that an entity and a single shareholder or member could be separate.  The jury was told: 

You should consider the following facts in determining whether or not to disregard the legal entity of Regal Capital Corporation and return a verdict in favor of plaintiff against Defendant Jack Purdy, as an individual.

One, whether or not defendant Jack Purdy owned all or substantially all the stock in Regal Capital Corporation; two, whether or not Jack Purdy exercised discretion and control over the management of Defendant Regal Capital Corporation; three, whether or not Defendant Jack Purdy directly or indirectly furnished all or substantially all of the financial investment in Defendant Regal Capital Corporation; four, whether or not Regal Capital Corporation was adequately financed either originally or subsequently for the business in which it was to engage.

Five, whether or not there was actual participation in the affairs of Regal Capital Corporation by its stockholders and whether stock was issued to them. Six, whether or not Regal Capital Corporation observed the [formalities] of doing business as a corporation such as the holding of regular meetings, the issuance of stock, the filing of necessary reports and similar matters. Seven, whether or not Defendant Regal Capital Corporation [dealt] exclusively with Defendant Jack Purdy, directly or indirectly in the real estate sales development activities in this case. Eight, whether or not Defendant Regal Capital Corporation existed merely to do a part of business of Defendant Jack Purdy.

So, here was have an undercapitalization factor, and that could be separate from the shareholder/member, and we have the traditional "corporate formalities" test, but even there, these instructions imply that the entity must have additional shareholders to be "real." For numbers one, two, three, five, seven, and eight, a jury would almost always have to find that those factors would support veil piercing for any sole shareholder corporation or single-member LLC.  I don't think that's either the intent or the substance of current law in most jurisdictions, though the Hawai'i Supreme Court clearly disagrees with me. 

In this case, there seems to be at least some evidence of fraud, and I'm more than willing to defer to a jury if they determined that the defendant had sole control of his entities and he used those entities to commit fraud.  I just object to court's apparent comfort level with the idea having sole control of an entity or entities, and exercising that control, on its own suggests something nefarious.  

I know people use LLCs and corporations to engage in all sorts of bad behavior, and I'd like to see that punished more often than it seems to be.  But relaxing the application of legal standards to get there is not a good way to do it.  If the law should be changed, then legislatures should get to work on that.  If we think single-owner entities are a bad idea (I don't think they are inherently so), let's deal with that through legislation so that at least everyone knows the rules. 

Ultimately, it's not as though current veil piercing jurisprudence has been clear or sound or predictable. There has always been a random nature to it. However, for single-member entities, if the current trends continue, the randomness of veil piercing will not attach not to the outcome of a lawsuit -- it will attach to whether or not someone brings suit at all.  

https://lawprofessors.typepad.com/business_law/2019/07/if-sole-ownership-of-an-entity-means-alter-ego-then-veil-piercing-will-be-inevitable.html

Contracts, Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink

Comments

Post a comment