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Corporate Officer Dismissed from Fraud Action Because the Plaintiffs Could Not Pierce the Corporate Veil

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  • Posted on: Jan 9 2019

In commercial and business litigation, it is common for plaintiffs to assert claims against a corporation (e.g., C-Corp. or an S-Corp.) or limited liability company (“LLC”) for wrongs committed by the entity. Often, plaintiffs will try to “pierce the corporate veil,” or get behind the corporate form, to hold the entity’s officers or members liable for the alleged wrongdoing.  Since a plaintiff must show that an officer or member used his/her control over the entity to commit a fraud or other wrong against the plaintiff, it is not unusual for a plaintiff to try to pierce the corporate veil in a fraud cause of action. Such was the case in Coast to Coast Energy, Inc. v. Gasarch, 2018 N.Y. Slip Op. 33350(U) (Sup. Ct. N.Y. Cnty. Dec. 18, 2018) (here), where Justice Eileen Bransten of the Supreme Court, New York County, granted a defendant’s motion for summary judgment because the plaintiffs were unable to pierce the corporate veil.

Piercing the Corporate Veil in New York

As a general matter, New York law allows business owners the ability to protect themselves from personal liability for the acts taken in the name of their business by forming a corporation or LLC. However, an officer or member will lose that protection (i.e., be subject to veil piercing) when he/she abuses the corporate form to perpetrate a fraud or other wrongdoing on a third party. TNS Holdings v. MKI Sec. Corp., 92 N.Y.2d 335, 340 (1998) (the corporate veil may be pierced to impose liability for corporate wrongs upon persons who have “misused the corporate form for [their] personal ends.”); Matter of Morris v. New York State Dept. of Taxation & Fin., 82 N.Y.2d 135, 142 (1993) (the corporate veil may be pierced where the owners have “abused the privilege of doing business in the corporate form” by “perpetrat[ing] a wrong or injustice . . . such that a court in equity will intervene.”); Tap Holdings, LLC v. Orix Fin. Corp., 109 A.D.3d 167, 174 (1st Dept. 2013) (citation omitted).

Importantly, domination and control of the corporate entity by its officers or members is not by itself sufficient to pierce the corporate veil. Matter of Morris, 82 N.Y.2d at 141-142;TNS Holdings, 92 N.Y.2d at 339. The plaintiff must show that the officer or member is operating the corporation or LLC for his/her personal benefit and the corporation or LLC is nothing more than an “alter ego” or instrumentality of the officer or member. TNS Holdings, 92 N.Y.2d at 339. Conclusory allegations of domination and control are insufficient. The plaintiff must demonstrate that there was a unity of interest and control between the defendant and the entity such that they are indistinguishable.

While application of the doctrine depends on the facts and circumstances of each case (Ledy v. Wilson, 38 A.D.3d 214, 214 (1st Dept. 2007)), several factors have emerged in determining whether the plaintiff has made the requisite showing. These factors include, among others: (1) the failure to adhere to corporate formalities; (2) inadequate capitalization (that is, the corporation or LLC does not have sufficient funds to operate); (3) a commingling of assets; (4) one person or a small group of closely related people were in complete control of the corporation or LLC; and (5) use of corporate funds for personal benefit. Shisgal v. Brown, 21 A.D.3d 845, 848 (1st Dept. 2005) (internal citation omitted). No one factor controls the consideration. Tap Holdings, 109 A.D.3d at 174 (citation omitted).

Courts recognize, however, “that with respect to small, privately-held corporations, ‘the trappings of sophisticated corporate life are rarely present,’” and, therefore, they “must avoid an over-rigid ‘preoccupation with questions of structure, financial and accounting sophistication or dividend policy or history.’” Bridgestone/Firestone, Inc. v. Recovery Credit Servs., Inc., 98 F.3d 13, 18 (2d Cir. 1996) (quoting Wm. Wrigley Jr. Co. v. Waters, 890 F.2d 594, 601 (2d Cir. 1989) (applying New York law)). Accord, Leslie, Semple & Garrison, Inc. v. Gavit & Co., Inc., 81 A.D.2d 950, 951 (3d Dept. 1981) (recognizing that it is often difficult and impractical for small closely-held corporations to comport with the typical corporate formalities). See also Bahar v. Schwartzreich, 204 A.D.2d 441, 443 (2d Dept. 1994); Bullard v. Bullard, 185 A.D.2d 411, 413 (3d Dept. 1992).

In addition to the foregoing factors, a plaintiff must establish a causal connection between the domination and control of the corporate entity and the injury complained of. Matter of Morris, 82 N.Y.2d at 141; Guptill Holding Corp. v. State of NY, 33 A.D.2d 362, 365 (3d Dept. 1970) (noting that an element of veil piercing is “an injury proximately caused by said wrong”) (citation omitted); East Hampton Union Free School Dist. v. Sandpepple Builders, Inc., 66 A.D.3d 122, 132 (2d Dept. 2009) (noting that the plaintiff must articulate conduct by the individual that creates a nexus between it and the “transactions or occurrences” alleged in the complaint), aff’d, 16 N.Y.3d 775 (2011).

Coast to Coast Energy, Inc. v. Gasarch

Background

Coast to Coastarose from an alleged fraudulent scheme by the defendants – Mark Gasarch (“Gasarch”), Walter Cuka Vic, and Petro Suisse Limited (“PSNY”) – to solicit investors to invest in various partnerships related to oil exploration and drilling in Trinidad.

According to plaintiffs, in 2003, defendants Gasarch and Wampler fraudulently solicited investments in limited partnerships for oil exploration in Trinidad from certain investors, including the plaintiffs. Gasarch and Wampler allegedly disseminated 54 private placement memoranda for the purpose of offering interests in twelve limited partnerships, which purportedly were formed to fund the building, drilling, and production of individual oil wells, and which would distribute to investors the revenues associated with each of the oil wells.

The partnerships were divided into two categories: oil-exploration and oil equipment. Each partnership had a general partner that was controlled by Gasarch and/or Wampler. Defendant PSNY was the general partner of approximately 50 limited partnerships. Plaintiffs invested in one or more of the limited partnerships.

Plaintiffs alleged that Gasarch and Wampler never intended to follow through on the representations made to investors. Instead, they allegedly collected money from the investors and lied about the building of wells and the production of oil from such wells. They allegedly fabricated production reports to induce new investments, using some of that money to make distributions to earlier investors, before eventually ceasing any payments to investors. Plaintiffs also alleged that defendants wrongfully transferred assets out of the partnerships and sold them to third parties for defendants’ own profit.

Plaintiffs Lawrence J. Doherty (“Doherty”) and William Spence (“Spence”) separately alleged that Gasarch fraudulently induced them (and other individuals and entities) to invest in one or more of the limited partnerships. These Plaintiffs maintained that Gasarch fraudulently induced them to invest in the limited partnerships by misrepresenting the number of wells drilled and the profits generated therefrom.

Doherty and Spence claimed that Gasarch never intended to build the wells, and, instead, operated a Ponzi scheme, wherein he falsified documents to induce new investors to invest in his companies, and used the new funds as distributions to older investors. Ultimately, payments to all investors ceased, and the assets of the limited partnerships were transferred to other companies and sold, with the proceeds allegedly going to Gasarch.

Doherty and Spence moved, pursuant to CPLR 3212, for partial summary judgment as to liability on their fraud claims against Gasarch. For his part, Gasarch moved for summary judgment to dismiss the complaint as against him on the grounds that, among other things, he was not personally liable because Plaintiffs could not pierce PSNY’s corporate veil.

The Court’s Decision

The Court granted Gasarch’s motion and denied plaintiffs’ motion.

The Court found that “Gasarch ha[d] established … prima facie entitlement to summary judgment dismissing the fraud claim against him,” because plaintiffs had failed to demonstrate that “he ‘abused the privilege of doing business in the corporate form’ with respect to PSNY.” Slip Op. at *13 (quotingMatter of Morris, 82 N.Y.2d at 142).

In granting Gasarch’s motion, the Court analyzed many of the factors discussed above to determine whether an officer or member abused the corporate form.  Those factors are discussed below.

Failure to Adhere to Corporate Formalities

Plaintiffs contended that Gasarch failed to adhere to corporate formalities as an officer and sole shareholder of PSNY. Among other documents, they relied on a complaint filed by “the former counsel for Gasarch and/or PSNY,” in which he alleged, “‘upon information and belief,’ that PSNY is an alter ego of Gasarch, and that Gasarch operated PSNY in violation of the corporate form.” Slip op. at **9-10. Justice Bransten discounted the submission as an improper “repetition or incorporation by reference of the allegations contained in [another] pleading[] ….” Id. at *10 (quoting Indig v. Finkelstein, 23 N.Y.2d 728, 729 (1968)). In doing so, the Court concluded that “[n]o evidence ha[d] been presented that Gasarch did not adhere to corporate formalities ….” Id. at *10. Instead, the evidence showed that “at a minimum Gasarch adhered to those formalities by filing separate tax returns.” Id. In fact, observed the Court, “PSNY maintained its own bank account, which was separate from [Gasarch’s] personal bank account, and … filed its own tax returns,” including one in 2007. Id. at *9. These facts were temporally important, noted the Court, because the “action [was] based on an alleged fraudulent inducement for investments occurring from 2003-2008.”Id. at *10.

Inadequate Capitalization

Gasarch argued that PSNY was sufficiently capitalized, having over $8 million in capital on hand at the time of the alleged fraud. Slip op. at *10. As evidence, Gasarch cited to a consent decree that PSNY entered into with the Securities and Exchange Commission. Id. Under that decree, PSNY and Gasarch were “directed” to “pay $8,370,000 in disgorgement” “or all of the proceeds that they obtained by selling partnership interests in the 21 Charged Offerings.”  Id. (internal quotation marks omitted). The decree “also provide[d] that [the] obligation [would] be deemed satisfied because Defendants ha[d] already disbursed $9.5 million to investors in the Charged Offerings.” Id. (internal quotation marks omitted). In addition, PSNY’s 2007 tax return showed “that PSNY had over $16 million in assets.” Id. at *11.

The Court noted that plaintiffs did not present any evidence in opposition. As such, there was no contrary “evidence that would raise a question of fact as to whether PSNY was adequately capitalized.” Id.

Commingling of Assets

The Court found that “Plaintiffs have not presented any evidence that Gasarch and PSNY’s assets were commingled.” Slip op. at *12. In particular, the Court rejected plaintiffs’ argument that Gasarch maintained multiple bank accounts in which he commingled PSNY’s assets with his own, noting that plaintiffs failed to proffer any evidence in support. Id. Without supporting evidence, plaintiffs’ argument was nothing more than “an averment of a factual conclusion,” that “does not raise a question of fact as to whether Gasarch commingled his personal funds with PSNY.” Id. (citations omitted).

Use of Corporate Funds for Personal Use

The Court held that Plaintiffs failed to present evidence that Gasarch used PSNY’s corporate funds for his personal use. Slip op. at *12-13. In so holding, the Court rejected Plaintiff’s argument that Gasarch used a “Special Account” to pay himself through corporate funds. Id. at *12. In fact, according to the Court, there was “ample evidence that the Special Account was not Gasarch’s personal account,” but rather his “client escrow account, wherein he held funds that belonged to John H. Wampler, President of Petro-Suisse, and his companies.” Id. Those funds, said the Court, “were only disbursed as directed by his client John Wampler.” Id.

Takeaway

In TNS Holdings, the Court of Appeals held that “[t]hose seeking to pierce a corporate veil … bear a heavy burden of showing that the corporation was dominated as to the transaction attacked and that such domination was the instrument of fraud or otherwise resulted in wrongful or inequitable consequences.” 92 N.Y.2d at 339. Coast to Coastillustrates the factual difficulties a plaintiff must overcome to satisfy this burden, especially on summary judgment.

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