19 Apr Failure to Respect Corporate Formalities and Piercing the Corporate Veil
By: Barry E. Haimo, Esq.
February 19, 2018
Failure to Respect Corporate Formalities and Piercing the Corporate Veil
When it comes forming your business, you have options: disregarded sole proprietorship, general partnership, limited partnerships, limited liability partnerships, limited liability limited partnerships, corporations and limited liability companies (LLCs) (partnership, “C” and “S” corporations are merely tax designations). Most likely, you formed one of these entities for limited liability; mainly, to limit your investment to the amount you contributed as a shareholder. In most circumstances, the shareholders do enjoy limit liability from the liabilities, debts and creditors of the business. However, that is not always the case, especially if there is an intent to mislead or defraud creditors. When that happens, a court may disregard a corporation’s limited liability protection and hold the shareholders liable to the corporation’s liabilities. This is often referred to as piercing the corporate veil of limited liability. Here’s how that can happen. Stay tuned for a subsequent post on how to avoid it.
Elements Required to Pierce the Corporate Veil
Piercing the corporate veil is an equitable remedy so you cannot plead it like you can plead breach of contract, negligence or fraud. It becomes an option to a creditor when it cannot satisfy a judgment against the corporation. To successfully pierce the corporate veil of a corporation, a plaintiff must prove 3 elements. First, the plaintiff must prove that: (i) there exists a lack of separateness between the corporation and its shareholder(s); (ii) the shareholders engaged in improper conduct using the corporation; and (iii) the improper conduct was the proximate cause of the alleged loss. Solomon v. Betras Plastics, Inc., 550 So. 2d 1182, 1184-85 (Fla. 5th DCA 1989).
1. Alter Ego / Mere Instrumentality
The first element requires that the plaintiff prove that the corporation was the alter ego or a mere instrumentality of its shareholder(s). “Alter ego” theory refers to when “the shareholders dominate and control the corporation to such an extent that the corporation’s independent existence, was in fact non-existent and the shareholders were in fact alter egos of the corporation.” Gasparini v. Pordomingo, 972 So. 2d 1053, 1055 (Fla. 3d DCA 2008). In other words, “the personal affairs of the shareholder become confused with the business affairs of the corporation.” Solomon, 550 So. 2d at 1184.
The “mere instrumentality” theory is another avenue to prove the first element required to pierce the corporate veil. Under this theory, a subsidiary corporation can be disregarded and the parent corporation’s assets reached if the plaintiff establishes that the parent corporation’s control is to such a degree that the subsidiary is a mere instrumentality of the parent. Ocala Breeders’ Sales Co. v. Hialeah, Inc., 735 So. 2d 542, 543 (Fla. 3d DCA 1999);
Below are a few nonexclusive factors that Florida courts have expressed to aid in veil piercing analysis, using them mostly with respect to alter ego/mere instrumentality element. The failure to respect corporate formalities alone is insufficient to pierce the corporate veil. John Daly Enters., LLC v. Hippo Golf Co., Inc., 646 F. Supp. 2d 1347, 1353 (S.D. Fla. 2009).
- Domination by a single or few shareholder(s). This would include a wholly-owned subsidiary or a corporation with one or two individual shareholders). This is not conclusive though.
- Failure to respect the corporate formalities (i.e., failure to issue stock, elect a board of directors, and keep corporate records).
- Commingling of corporate and personal affairs (i.e., using the corporation as a personal piggy bank)
- Inadequate capitalization
To expand on the first bullet point above, Florida courts also consider the following factors with respect to parent-subsidiary relationships:
- Common Management: The same officers and directors manage the parent and subsidiary.
- Business Discretion: The subsidiary displays very little business discretion.
- Shared Facilities: The subsidiary and the parent share the same facilities, address, and telephone numbers.
- Use of Parent’s Employees: The subsidiary’s contracts are performed by employees of the parent.
- Shared Financial Accounts: The subsidiary shares bank accounts and financial obligations with the parent.
- Payment of Debts and Obligations: The parent pays the salaries, expenses, or losses of the subsidiary.
- Arms-Length Transactions: The subsidiary fails to deal with the parent at arms-length.
- Financing: The parent finances the subsidiary.
- Tax Treatment: The parent and subsidiary file consolidated income tax returns.
- Independent Profit Centers: The parent and subsidiary are not treated as independent profit centers.
2. Unfair or Inequitable Conduct
Even if insufficient separateness, Florida courts are not likely to pierce the corporate veil unless there is deliberate wrongdoing beyond mere negligence or recklessness. In re Hillsborough Holdings Corp., 166 B.R. 461, 469 (Bankr. M.D. Fla. 1984). see also Ally v. Naim, 581 So. 2d 961, 963 (Fla. 3d DCA 1991).
3. Proximate Cause
Even if the first two elements are proven, the plaintiff must prove that the improper conduct was the proximate cause of the harm. That means proving actual causation and legal causation.
Creditors may be successful piercing a debtor’s corporate veil, but it is a difficult journey to get there. It requires proving a lack of separateness and improper – even intentional – conduct that is directly responsible for the harm. It is better characterized as a remedy of last resort since it is not a direct cause of action. Seek competent counsel to advise you on the merits of the case before going down that path.
Barry E. Haimo, Esq.
Strategic Planning With Purpose®
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Originally posted 2018-02-19 13:47:33.