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Want to Hold a Corporate Officer Personally Liable for an Alleged Wrong? Try Piercing the Corporate Veil … if You Can

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  • Posted on: Mar 4 2019

The title of a today’s post sums up the difficulties a plaintiff encounters when trying to pierce the corporate veil to hold a corporate officer, director or shareholder responsible for the wrongs alleged to have been perpetrated on the plaintiff. This is not to say that a plaintiff can never prevail. Rather, it is a reflection of the fact that the plaintiff bears a heavy burden to do so. ABN AMRO Bank, N.V. v. MBIA Inc., 17 N.Y.3d 208, 235 (2011).

In Town-Line Car Wash, Inc. v. Don’s Kleen Machine Kar Wash, Inc., 2019 N.Y. Slip Op. 01443 (2d Dept. Feb. 27, 2019) (here), the subject of today’s post, the plaintiff met its burden and successfully withstood a motion for summary judgment on its veil piercing claims.

The Law in New York

It is axiomatic that a corporation acts through its officers, directors and owners. Thus, these individuals are normally not liable for the debts incurred by the corporation. However, when an officer, director or shareholder abuses the corporate form to perpetrate a wrong or injustice against a third party, courts will intervene on behalf of the third party to hold the corporate actor personally liable. 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).

“Generally, a plaintiff seeking to pierce the corporate veil must show that (1) the owners exercised complete domination of the corporation in respect to the transaction attacked; and (2) that such domination was used to commit a fraud or wrong against the plaintiff which resulted in plaintiff’s injury.” Conason v. Megan Holding, LLC, 25 N.Y.3d 1, 18 (2015) (internal quotation marks omitted); TNS Holdings, 92 N.Y.2d at 339 (1998).

Importantly, it is not enough for the plaintiff to demonstrate that the officer, director or shareholder dominated and controlled the corporate entity. 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, director or member used the corporation for his/her personal benefit and the corporation was 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. East Hampton Union Free School Dist. v. Sandpebble Bldrs., Inc., 16 N.Y.3d 775, 776 (2011) (noting that at the pleading stage, “a plaintiff must do more than merely allege that [the defendant] engaged in improper acts or acted in ‘bad faith’ while representing the corporation”). 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 N.Y., 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).

Town-Line Car Wash, Inc. v. Don’s Kleen Machine Kar Wash, Inc.

Town-Line involved the purchase of a car wash business (defendant, Don’s Kleen Machine Kar Wash, Inc. (“DKM”)) by the plaintiff, Town-Line Car Wash, Inc., in March 2004. Town-Line sought to pierce the corporate veil to hold Barry Brookstein (“Brookstein”), the sole shareholder of DKM, liable for DKM’s alleged obligation to Town-Line.

At the time of the transaction, DKM’s business consisted of only “a car wash and automobile detailing business.” The purchase price included a down payment of $200,000, a cash payment of $1,100,000 at the time of closing, and a note in the principal amount of $1,200,000, payable by Town-Line over a period of 180 months in equal monthly installments of $10,785.94. Town-Line reserved the right to prepay the note at any time without penalty.

The agreement also included an indemnity provision for any claim made within 7½ years after the closing and arising out of or in connection with, inter alia, the breach, or inaccuracy, of any of DKM’s representations or warranties. The indemnity was payable by DKM, and was not personally guaranteed by the company’s principals, the defendants Brookstein and Donald Berman (“Berman”).

On December 20, 2007, more than three years after the closing, Town-Line exercised its right to prepay the installment note in full. On April 23, 2008, Brookstein caused DKM to be dissolved.

On or about September 15, 2011 – nearly seven years after the closing – Town-Line notified DKM of an alleged breach of DKM’s representations and warranties under the agreement. It maintained that since DKM had since been dissolved, “Town-Line holds [Brookstein] and [Berman] jointly and severally responsible for the obligations of [DKM] under the Agreement.”

Town-Line commenced the action in March 2012 against DKM, Brookstein, and Berman, asserting causes of action against all defendants based on fraud, breach of contract, and unjust enrichment, and asserting a further cause of action against Brookstein and Berman predicated on piercing the corporate veil. Following discovery, Brookstein moved for summary judgment dismissing the complaint against him and Town-Line cross moved for summary judgment on the issue of liability as against Brookstein. The motion court granted Brookstein’s motion and denied the cross motion. Town-Line appealed.

The Appellate Division, Second Department, reversed the grant of summary judgment in favor of Brookstein.

The Majority Opinion

The Court held that there was a triable issue of fact as to whether Brookstein stripped DKM of assets, leaving the corporation “without sufficient funds to pay its contractual contingent liabilities.” Slip op. at *2. The Court noted that “[i]t [was] undisputed that Brookstein dissolved DKM without making any reserves for contingent liabilities, despite the existence of a provision in the contract of sale pursuant to which DKM agreed to indemnify Town-Line for any breach of warranty for a period of 7½ years after the closing of the sale.” Id. “This factor” alone, said the Court, “was sufficient to raise a triable issue of fact.” Id.

The Court also held that the motion court correctly denied the cross motion for summary judgment, noting that there were triable issues of fact “as to whether Brookstein exercised complete domination of DKM in the transaction at issue and whether he abused the corporate form to commit a wrong or fraud causing injury to Town-Line.” Id.

The Dissenting Opinion

Justice Cheryl E. Chambers concurred in part and dissented in part. Justice Chambers agreed with the majority that the motion court properly denied Town-Line’s cross motion but disagreed with the majority as to the motion court’s order granting summary judgment to Brookstein. To the dissent, “Town-Line [was] improperly invoking the equitable doctrine of piercing the corporate veil in order to secure a personal guarantee from Brookstein – a contractual benefit that Town-Line omitted, or was unable, to negotiate when it purchased DKM’s assets in 2004.” Id. at *3

“As a threshold matter,” the dissent observed that “by purchasing all or substantially all of DKM’s assets in 2004, DKM would be left with no source of revenue going forward – thereby presenting a very real risk that DKM might not be able to pay indemnification claims made some 7½ years later.” Id.  To manage the risk that DKM might not be able to pay on indemnification claims, Town-line “retain[ed] part of the purchase price and [repaid] it gradually over a term exceeding the indemnification period.” Id. However, Town-Line forfeited that protection when it “elected to prepay the note in full,” in 2007. Thus, observed the dissent, Town-Line gave “up the only security it had for the payment by DKM of any future claim during the remainder of the indemnity period.”

Justice Chambers rejected Town-Line’s theory that Brookstein abused the corporate form by causing DKM to be dissolved in 2008, after the note was repaid in full, and without making adequate reserves to cover potential indemnification claims arising during the final years of the indemnification period. That theory, concluded Justice Chambers, “lack[ed] merit.” Id.

Equally important, noted the dissent, Brookstein “established, prima facie, that he had no involvement in the day-to-day operations of DKM and no personal knowledge of the operative facts underlying Town-Line’s indemnification claims against DKM.” Id. at *4. Justice Chambers rejected Town-Line’s position that it was entitled to contractual indemnification from DKM regardless of what Town-Line may or may not have known at the time of the sale through due diligence, and that Brookstein, regardless of his own state of mind, should be held liable simply because he caused the company to be dissolved before the end of the contractual indemnification period. Id.

Takeaway

Litigants should remain mindful that merely tracking the elements of veil piercing is not enough to withstand a dismissal challenge. Plaintiffs must do more; they must proffer facts. Town-Line is a good example of the fact-intensive nature of the veil piercing inquiry.

 

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