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Edvard Munch, The Scream (1893) (depicting effect of Mt. Krakatoa eruption in 1883)

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Presentation on theme: "Edvard Munch, The Scream (1893) (depicting effect of Mt. Krakatoa eruption in 1883)"— Presentation transcript:

1 Edvard Munch, The Scream (1893) (depicting effect of Mt. Krakatoa eruption in 1883)

2 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 2 of 36 Chapter 11 Piercing the Corporate Veil PCV factors –Close vs. public corporation –Fail to observe formalities –Commingling personal and business –Inadequate capitalization –Active participation Why limited liability? –Investment –Diversification –Public trading markets PCV in tort cases –Enterprise liability –Corporate shareholders PCV in contract cases –Abuse of form –Assumption of risk PCV in corporate groups –“Normal” parent-sub relationship –Corporate confusion Compare to UFTA Module V – Corporate Externalities Citizen of world Law profession Corporate practice Bar exam Bar exam

3 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 3 of 36 What is limited liability? Mandatory rule? Default rule? –Majoritarian –Tailored –Penalty NC Bus Corp Act § Liability of shareholders. (a) A purchaser from a corporation of its own shares is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued or specified in the subscription agreement. (b) Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct.

4 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 4 of 36 Early corporation –shareholders = partners –calls on Shs (2x-5X) Mid-19th Century innovation –LL - selected businesses –some retain Sh call regime –banks through Depression Late 20th Century expansion –LL all bus orgs –except professional "supervisors” (some states) Entity Owners Outside creditors Is limited liability inherent?

5 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 5 of 36 Consider risks of investing in a pharmaceutical company. Value of limited liability … Encourage investment? Permit diversification? Reduce monitoring cost? No need monitor co-Shs? Uniform share valuation? Permit public stock mkt? Why limited liability?

6 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 6 of 36 Diversification 10% Expected 16%25%18%5%Strong 4%-5%2%15%Weak Portfolio XYZ Inv. ZInv. YInv. X

7 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 7 of 36 Pros Encourage investment Foster diversification Encourage mgmt risk- taking Facilitate stock markets Cons Discourage extension of credit Insider opportunism Externalization of risks Sh irresponsibility Should limited liability have exceptions?

8 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 8 of 36 Piercing in tort cases … verbigeration (vuhr-bij-uh-RAY-shun) noun Obsessive repetition of meaningless words and phrases.

9 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 9 of 36 Walkovsky v. Carlton (N.Y. Court of Appeals 1966)

10 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 10 of 36 Carlton Walkovsky (tort creditor) Corp 1 2 cabs 2 mdls Seon 2 cabs 2 mdls Corp 3 2 cabs 2 mdls Corp 10 2 cabs 2 mdls Garage Inc. Theories of liability Enterprise liability PCV (Individual) liability

11 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 11 of 36 Enterprise liability “… these corporations are alleged to be operating as a single entity, unit and enterprise. … It is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business … Walkovsky v. Carlton (N.Y. Court of Appeals 1966) Individual liability "It is not enough to allege the defendant dominated and controlled a fragmented corporate entity. The corporate form may not be disregarded merely because the assets of the corporation, together with mandatory insurance coverage, are insufficient to sure the plaintiff recovery. Taxi owner operators are entitled to form such corporations.

12 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 12 of 36 New York State Legislature Majority “The responsibility for imposing condition on incorporation has been committed to the Legislature, [which does not] require taxi corporations [to] carry automobile liability insurance over and above that mandated by the Vehicle and Traffic Law. Dissent The attempt to do corporate business without providing any sufficient basis of financial responsibility to creditors is an abuse of the separate entity and will be ineffectual to exempt the shareholders from corporate debts. Ballantine. It certainly could not have intended to shield those individuals who organized corporations, with the specific intent of avoiding responsibility to the public, where the operation of the corporate enterprise yielded profits sufficient to purchase additional insurance.

13 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 13 of 36 Individual liability "There were no allegation that Carlton was actually doing business in his individual capacities or shuttling personal funds in and out of the corporation without regard to formality. What happens on remand?

14 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 14 of 36 What if corporate shareholder?

15 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 15 of 36 Telecom Contrux wholly-owned subsidiary Radaszewski inadequate insurance Radaszewski v. Telecom Corp. (8th Cir. 1992)

16 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 16 of 36 Alter Ego Doctrine "Under Missouri law, a plaintiff needs to show... (1) complete combination... of policy and business practice in respect to the transaction attacked.... (2) such control must have been used by the defendant to commit fraud or wrong.... and (3) the aforesaid control and breach of duty must proximately cause the injury.... “ Is buying cheap insurance “wrong”? By the way, what law applies in a piercing case – did the tort victim choose the law where the tortfeasor is incorporated?

17 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 17 of 36 Walkovsky (taxi cab) General test “prevent fraud / achieve equity” Radasjewski (parent co.) Alter ego (1) control (2) used to commit wrong, (3) proximate cause No piercing Does the PCV “test” matter …

18 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 18 of 36 Piercing in Contract Cases … What are PCV factors?

19 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 19 of 36 Complex Computing Co. Horton Street Assoc. C3 Straw SH Glazier Freeman Sales rep agreement Option to buy Runs business Gets consulting K Horton Street Albert Full control No formalities Theberges Note Personal assurances

20 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 20 of 36 Complex Computing Co. Glazier, with the help of some buddies, incorporates C3 to acquire a computer license from Columbia Univ. Glazier, though designated a "scientific adviser" of C3, holds an option to buy all the C3 stock and actually runs C3 C3 signs up Freeman as sales rep under an agreement that promises commissions and a hefty severance package To sell out to Thomson, Glazier has C3 can Freeman / Glazier is then paid handsomely in the sale and Freeman gets nothing Freeman holds unfulfilled contractual promises and sues – –C3, which is a shell –Glazier on a PCV theory Horton Street Assoc. Albert incorporates Horton Street to buy rental properties from the Worden Group in a heavily leveraged acquisition Albert assumes full control of HS, though does not maintain separate books or follow corporate formalities HS assumes a promissory note that Worden Group had given Theberges / Albert says he will "stand behind" HS after economic reversals, HS liquidates 2 properties to discharge part of Theberges' mortgage, but defaults on note Theberges hold an unpaid note and sue – –HS, which is insolvent –Albert on a PCV theory. Piercing No piercing

21 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 21 of 36 Found 34% - PCV 57.0%Y / YY5 – dominate/control 5-5 / 7-3 N / Y N / N Y / Y N / Y Y / Y N / N Y / Y C3 / HS Y Y Y Y Y Y Tort Corp SH CHC WisdomThompson (1600 cases thru 1985) Factor TOTAL N/A10 – personal guarantees Found 11% - PCV 91.6%9 – misrepresentation Found 16% - PCV 84.2%8 – confusion/commingle Found 8% - PCV 73.3%7 – inadequate capital Found 10% - PCV 66.9%6 – fail formalities 1 Sh 49.6% / 3+ Shs 35.0%4 – sole shareholder Tort 31.0% / K 42.0%3 – tort vs. K Corp 37.2% / indiv 43.1%2 – corp vs. indiv Public 0% / CHC 40.5%1 – Public vs. CHC Count the piercing factors …

22 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 22 of 36 Complex Computing Co. “evidence of wrongdoing” Horton Street Assoc. “oral promises … sharp business practices” Piercing No piercing Distinguish the cases …

23 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 23 of 36 Piercing in Corporate Groups … How different from “individual” cases? What is framework? What are factors?

24 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 24 of 36

25 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 25 of 36 Gardemal v. Westin Hotel Co (5th Cir 1999) The concierge at a Westin hotel in Mexico suggested that John Gardemal go snorkeling at Lover's Beach. He did and died. The beach was notoriously unsafe. Westin-Mexico is the Westin sub that managed the hotel. Is the parent liable for tort of its sub? No piercing! (“typical parent-sub relationship”) OTR Associates v IBC Services (NJ App 2002) A shopping mall leased space to a Blimpie subsidiary, whose franchisee failed to pay rent and was kicked out. The mall then sued the parent, Intl Blimpie Corp, to collect rent arrearages owed by the sub. Is the parent liable? Veil pierced! (“evasion, fraudulently carried out”)

26 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 26 of 36 PCV as remedy for “fraudulent conveyance” …

27 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 27 of 36 Fraudulent Conveyance Howard (devoted spouse) Wanda (medical grad) Bank Student loans Assigns income Howard (devoted spouse)

28 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 28 of 36 Uniform Fraudulent Transfer Act § 4. Transfers Fraudulent as to Present/Future Creditors (a)A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation.... (1) with actual intent to hinder, delay, or defraud creditors (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due. § 7. Remedies of Creditors (a) In an action for relief against a transfer or obligation under this [Act], a creditor... may obtain: (1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor’s claim (3)... (i) an injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property; (ii) appointment of a receiver to take charge of the asset transferred or of other property of the transferee; or (iii) any other relief the circumstances may require.

29 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 29 of 36 Uniform Fraudulent Transfer Act § 4. Transfers Fraudulent as to to Present/Future Creditors (a)A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation.... (1) with actual intent to hinder, delay, or defraud creditors or (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due. § 4. Transfers Fraudulent as to to Creditors (a)Transfer is fraudulent as to a creditor if debtor made the transfer.... (1) with actual intent to hinder creditors OR (2) without receiving FMV and debtor: (i)Was business where remaining assets were unreasonably small OR (ii)should have believed would be unable to pay debts as came due.

30 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 30 of 36 Group hypo How do six cases we’ve studied come out … (1) under PCV doctrine (2) UFTA?

31 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 31 of 36 Shareholders Corporation Creditor Credit Siphon YY (deceive + undercap) IBC Services NN (not undercap)Westin Hotel NN (no siphoning)Darbro YY (profited when sold business) Complex Computing NN (insured)Radazjewski YY (“shuffling”)Walkovsky UFCA?Pierce?Case Deceive

32 PCV ~ UFTA CasePCVUFTA Walkovsky v. Carlton No PCV because setting up corp structure + min insurance OK under NY law. Yes PCV for “shuffling” Yes FT when corps made payments to Sh, leaving “unreasonably small assets” Radazjewski v. Telecom No PCV because sub bought low- cost insurance (allowed by law) No FT because insurance as required, no $ transfers to parent Freeman v. C3, Glazier Yes PCV because dominant “Sh” left C3 asset-less after Thomson sale Yes FT because Thomson proceeds went only to “Sh” Theberge v. Darbro No PCV because Shs never withdrew $$, just sharp dealings No FT because Shs actually putting in more $$, not out Gardemal v. Westin Hotel No PCV because no indication Mex sub lacked financial resources No FT because no commingling of operations, no transfers OTR v. IBC Services Yes PCV because parent confused creditor about who obligated Yes FT because “shell” was intended to confuse creditor + insufficient assets Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 32 of 36

33 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 33 of 36 The end

34 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 34 of 36 Reverse piercing …

35 Corporations: A Contemporary Approach Chapter 11 Piercing the Corporate Veil Slide 35 of 36 Connolly v. VFW (Colo. 2006) Philsax, Inc. Phillips 51% Parcel A Connolly (bankruptcy trustee) Quit claim Margaret 49% How does Connolly Propose to get Parcel A Into Phillips’s estate?


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