Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

Recently the Ohio Supreme Court issued yet another opinion regarding "piercing the corporate veil".  According to the Ohio Supreme Court's syllabus in Minno v. Pro-Far, Inc., 2009-Ohio-1247:

A corporation's veil may not be pierced in order to hold a second corporation liable for the corporate misdeeds of the first when the two corporations have common individual shareholders but neither corporation has any ownership in the other.

Well, duh.  As long-time followers of this blog know, I have something of a fascination with corporate veil piercing cases so this post on the Ohio Supreme Court's latest puttering with this legal concept should come as no surprise.

When last we considered the issue, the Ohio Supreme Court had just muddied the waters of the standard for determing if veil piercing was appropriate in a particular case by ruling in Dombroski v. Wellpoint, Inc., 2008-Ohio-4827, that the second prong of the famous test enunciated in  Belvedere Condominium Unit Owners' Assn. v. R.E. Roark Co., Inc. (1993), 67 Ohio St.3d 274, 617 N.E.2d 1075 included not just illegal acts, but also "similarly unlawful" acts, but did not encompass merely unjust or inequitable acts.  The Court found that insurance bad faith was not sufficent.  For more detailed analysis of Dombroski, visit my previous post "Potato, Potahto, Illegal, Unllawful - Dombroski and New Rules for Piercing the Corporate Veil".

While Dombroski involved a parent-subsidiary corporate relationship (and refused to allow veil piercing), Minno involved two small privately held companies owned by the same set of shareholders.  When Minno fell 19 feet while at a work site, he sued his employer See-Ann for failing to provide a safe working environment.  He also sued Pro-Fab, Inc., an affilated corporation, owned by the same shareholders as See-Ann, alleging that it was in control of the work site and was the alter ego of See-Ann.

Although the two companies had different incorporation dates, they shared common owners and officers, had identical business addresses, and engaged in similar lines of work.  See-Ann, Minno's employer, did not have any general liability insurance; Pro-Fab, Inc. did.  The trial court nevertheless granted summary judgment in favor of Pro-Fab, refusing to permit veil piercing.  The Court of Appeals reversed.   

The Supreme Court began by reciting the Belvedere test, as modified (?) by Dombroski.  It then upheld the trial court's determination that veil piercing was not appropriate, saying:

In contrast to a shareholder's ownership of a corporation or a parent corporation's ownership of another corporation, the common shareholder ownership of sister corporations does not provide one sister corporation the inherent ability to exercise control over the other.  Any wrongful act committed by one sister corporation might have been instigated by the corporation's owners, but it could not have been instigated by the corporation's sister....

Despite the element of common shareholder identity, sister corporations are separate corporations and are unable to exercise control over each other in the manner that a controlling shareholder can.  This lack of ability of one corporation to control the conduct of its sister corporation precludes application of the piercing-the-corporate-veil doctrine.  

I am pleased to see a trend by the Ohio Supreme Court of respecting well established principles of corporate law concerning the relationship between, and separateness of, affiliated companies.  At the same time, however, veil piercing is supposed to be an equitable remedy and if ever there was a case justifying treating two corporations as one, this might have been it.  Corporations can only act through their officers, directors and shareholders, and if those are few and identical, it stands to reason that the true decisionmakers really are the same. 

it is also interesting that there is no discussion about whether bank accounts and finances were comingled, something i've always thought was key to a determination of whether to permit veil piercing.  Nor is their any discussion of the extent to which the two companies followed corporate governance rules by hainv shareholder and director meetings, something else that has been important in prior veil piercing decisions. 

Does this signal a more conservative formalistic approach to veil piercing cases?  Maybe.  We'll have to wait and see.

The decision is relatively short, but for those with a very short atttention span, there is the usual excellent synopisis of the case prepared by the Ohio Supreme Court Office of Public Information.

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The recent Ohio Supreme Court's decision in Dombroski v. Wellpoint, Inc., 2008-Ohio-4827, has only further complicated the determination whether the corporate veil should be pierced in particular cases.  In holding that the second prong of the seminal Belvedere test did not include merely unjust or inequitable acts, but did include "similarly unlawful" acts, the Court did nothing to clarify the circumstances in which corporate veil piercing is appropriate.

I've posted before about Ohio law on piercing the corporate veil, as well as the legal and factual context in which the Dombroski case arises.  In a nutshell, the plaintiff alleged bad faith against an insurance company for denying her medical claim.  She also sought to hold the insurer's parent company liable on a piercing the corporate veil theory.  Because the case had gone up on appeal on the granting of a 12(B)(6) motion to dismiss, the Court assumed that the parent company did in fact control the wholly owned insurance company to such a degree that it had no separate mind, will or existence of its own, thereby satisfying the first prong of Belvedere. 

The issue certified for appeal was:

Does the second prong of [the test for piercing the corporate veil set forth in Belvedere Condominium Unit Owners' Assn. v. R.E. Roark Co., Inc. (1993), 67 Ohio St.3d 274, 617 N.E.2d 1075], which states that the corporate veil can be pierced when control of the corporation "was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity" also allow the corporate veil to be pierced in cases where control was exercised to commit unjust or inequitable acts that do not rise to the level of fraud or an illegal act?

In answering the question in a 6-1 decision (click here for Office of Public Information summary), the Court responded equivocally, rejecting the most liberal interpretation of the second Bevedere prong, but nevertheless adding additional verbage to the standard:

In view of the reality that shareholders could seriously misuse the corporate form and evade personal liability under the second prong as presentlyworded, we find it necessary to modify the second prong of the Belvedere test to allow for piercing in the event that egregious wrongs are committed by shareholders....

to fulfill the second prong of the Belvedere test for piercing the corporate veil, the plaintiff must demonstrate that the defendant shareholder exercised control over the corporation in such a manner as to commit fraud, an illegal act, or a similarly unlawful act.  Courts should apply this limited expansion cautiously toward the goal of piercing the corporate veil only in instances of extreme misconduct. (emphasis supplied)

The Court appears to want to choose a middle ground between the interpretations favored by the Courts of Appeal below.  While this conceptually may have been the proper determination, the result seems a bit clumsy and to have added nothing but further confusion.  I agree with the dissent of Justice Pfeifer when he concludes the Court has "muddied the waters" and adds:

The new language seems to be pulled from the air.  Is there a notable distinction between an"unlawful" and an "illegal" act?  Not that the majority identifies.  the words appear to be two ways of saying the same thing.  Potato, potahto, illegal, unlawful - let's call the whole thing off.

Based on the oral arguments in this case, I had hoped for much more from this decision. 

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Everyone hates insurance companies, especially when they deny individual policyholders coverage for medical treatment.  But does that mean that corporate formalities should be ignored to permit the unfortunate policyholder to bring an action against the parent company of the subsidiary denying coverage on the grounds of a bad faith breach of the insurance policy contract?  Is it enough if the Court finds that "unjust" or "inequitable" acts have occurred even if they don't rise to the level of fraud or illegal action?  On its face, that is what the Ohio Supreme Court is called upon to decide in Dombroski v. Wellpoint, Inc., et al., Case No. 2007-2162 when  it hears oral argument in the case on Wednesday (June 4, 9 AM, third case on the docket) this week.    

Interpreting Belvedere.  However, the Ohio Supreme Court has taken the opprtunity to resolve a conflict among Ohio Courts of Appeal concerning what is required to"pierce the corporate veil" and impose liability upon a corporation's shareholders or upon the parent company of a corporate subsidiary.  In a January 23, 2008 Entry, the Court ordered the parties to brief the following:

Does the second prong of Belvedere Condominium Unit Owners' Assn. v. R.E. Rourke Cos.. Inc. (1993), 67 Ohio St.3d 274, which states that the corporate veil can be pierced when control of the corporation "was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity" also allow the corporate veil to be pierced in cases where control was exercised to commit unjust or inequitable acts that do not rise to the level of fraud or an illegal act?

The Ohio Supreme Court's Communications Office has prepared a concise summary of the factual and procedural background of the Dombroski case, as well as the specific insurance-related issue presented.  You can see and hear the oral argument from the comfort of your own computer, either live or in the archives as early as close of business on the day of oral argument, through the use of streaming video technology. 

By consulting the Supreme Court's on-line docket, you can also review or download the briefs filed in the case, including an amicus curiae brief filed jointly in support of the appellant-defendant parent company by the Ohio Council of Retail Merchants, Ohio Chamber of Commerce,  the Ohio Chapter of the National Federation of Independent Business, and the Ohio Farm Bureau Federation.  The defendant-appellant's brief has a rather extensive survey of caselaw in Ohio and elsewhere addressing the proper standard for "piercing the corporate veil." 

Deciding What It Takes to "Pierce the Corporate Veil".  The Belvedere decision established a three prong test to be met before a corporate form may be disregarded and shareholders held personally liable for the misdeeds of a corporation, namely:

• Control over the corporation by those to be held liable so complete that the corporation had no separate mind, will or existence of its own.
• Control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity.
• Injury or unjust loss resulted to the person seeking to disregard the corporate entity from such control and wrong.   

Some courts, including the Seventh Appellate District Court of Appeals below in the Dombroski case (173 Ohio App.3d 508, 2007-Ohio-5054, 879 N.E.2d 225), have broadly interpreted Belvedere to include situations in which the corporate form was abused to the detriment of the plaintiff, but no illegal act or intent to defraud could be shown.  These cases include:

• Wiencek v. Atcole Co., Inc. (3d Dist. 1996), 109 Ohio App.3d 240, 671 N.E.2d 1339
• State v. Tri-State Group, Inc. 2004-Ohio-4441 (7^th App. Dist.)
• Stypula v. Chandler,  2003-Ohio-6413 (11^th App. Dist.)
• Sanderson Farms v, Gasbarro, 2004-Ohio-1460 (10th App. Dist.)
• Dalicandro v. Morrison Rd. Dev. Co., Inc., 2001 Ohio App. LEXIS 1765 (10th  App. Dist.)
• Robert A. Saurber Gen. Contractor v. McAndrews 2004-Ohio-6927 (12th App. Dist.)

• Collum v. Perlman, 1999 Ohio App. LEXIS 1938 (6th App. Dist.)
• Widlar v. Young, 2006-Ohio-868 (6th App. Dist.) 
• Nursing Home Group Rehab. Serv., LLC v. Suncrest Health Care, Inc., 162 Ohio App3d 577, 2005-Ohio-3945
• Siva v. 1138 LLC, 2007-Ohio-4677 (10th App. Dist.)

What Should the Standard Be?  Many of the cases involving "piercing the corporate veil" focus on smaller privately held corporations in which the individuals constituting the shareholders have not adequately capitalized the business enterprise, commingled corporate and personal funds, or otherwise ignored corporate formalities.  In these cases, it is fairly easy to reach the conclusion that the corporate form should be disregarded.

The Domboroski case presents a more difficult situation.  As explained in plaintiff Dombroski's brief:

The facts in Dombroski present the challenge of how the doctrine of piercing the corporate veil is to be applied in the realtiy of today's insurance organizations, which frequently includes a parent corporation that does business through many subsidiaries.... Multi-state insurers, such as WellPoint or "nthem", which run its insurance business through affiliates while utilizing an integrated and centralized web of policies and procedures seek to return to the "good old days" when they were free to refuse or pay claims - for good reasons, for bad reasons, for no reason at all - safe in the knowledge that regardless of the unjust resulta their decisions bring to their insured....

However, I agree with the appellant parent company and amici curiae that encouraging the expansive view of "piercing the corporate veil" advocated by plaintiff Dombroski is likely to result in shareholders, particularly in closely held companies, being added as defendants virtually anytime the company itself is sued.  As the amici curiae  brief puts it:

If the opinion below is upheld by this Court, shareholders of Ohio corporations would face being haled into court and held personally liable whenever a tort claim is asserted against the corporation, or the corporation is alleged to have violated a regulatory statute, or the corporation is portrayed as having engaged in conduct that is characterized by the plaintiff as "unjust or inequitable."  Such a result would have devastating consequences for the concept of limited shareholder liability and for the ability of small business owners to use the corporate form as a successful engine for economic growth, jpb creation, and social progress.   

The defendant-appellant parent company's brief makes the further point that:

Because it jettisons the most salient factor of proper veil-piercing analysis - that the shareholders must misuse the corporate form to perpetrate a fraud or an illegal act - the appellate court's interpretation will make veil piercing more common. That result, in turn, would make it less likely that entrepreneurs will form corporations and that investors, large and small, will invest in those corporations as they conduct business activities and help the economy to grow.

My concern here is that the desire to rein in insurance companies, and what some might perceive as their arrogance, will result in "bad law" being established in this area.  While it might seem attractive under the facts of this case to be less insistent upon requiring a demonstration of fraudulent or illegal intent, the result will certainly give both large and small businesses pause.  If the focus of the "piercing of the corporate veil" analysis shifts from the actions and motivations of the company's owners to the nature of the plaintiff's loss, the utility of the corporate form will become much less for businesses.  Ohio's business climate will be viewed even less favorably.

It will be interesting to see how this case unfolds.   

For more on the piercing the corporate veil concept and Belvedere, read my previous post on Piercing the Corporate Veil- What It Means and How to Avoid It. 

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What could be worse than having a judgment taken against your business?  Having the holder of that judgment going after your home and other personal assets.  If they are not careful, business owners can unexpectantly and unpleasantly discover that they are being held personally liable and responsible for what they thought were obligations of the company only.  This can happen when, in the press of everyday busy-ness, shortcuts are taken and the distinction between the company itself and its owner(s) becomes blurred.  Lawyers call this "piercing the corporate veil" and it can have disastrous effects.

Everybody understands the basic rule that generally speaking, the most important reason for setting a business up as a corporation or limited liability company in the first place is to protect its owners, shareholders, members, officers and directors (and their respective assets) from the consequences of any financial or legal misfortune of the business.  The corollary to this principle -- that individuals will remain liable for their own wrongful acts done as individuals even if a business is also involved -- is also an accepted tenet of everyday life.  Conceptually, the idea of "piercing the corporate veil" grew out of the desire to prevent individuals from escaping the consequences of their individually wrongful acts by using a corporate entity for criminal or fraudulent purposes.

Historical Background.  Historically, the limited liability now taken for granted, which use of a corporate or limited liability company business structure allows, is a relatively recent development.  In the early 1800's, there were very strict limits on the ability of a business owner to obtain limited liability; incorporation of a particular business typically required a special act of the state legislature.  To the extent general incorporation statutes existed, they usually imposed substantial limitations on their use by emphasizing significant minimum paid-in capital requirements, limited permissible purposes and limited duration.

In time, and especially following the Industrial Revolution in the last century, more businesses began to require substantial expenditures and infusions of capital well beyond the means of the typical entrepreneur.  Investors willing to provide these sums of money were, in the absence of limited liability, far less anxious to invest in businesses they neither operated nor were in a position to monitor closely.  As a result, state legislatures eventually removed virtually all of the restrictive limitations on the ability of corporations to organize and operate and the ability to avoid personal liability for debts of one's company became an accepted economic tenet of business life. 

By allowing people to participate in the ownership of businesses without risking their entire personal net worth, granting limited liability encouraged investment and the growth of businesses.  Thus, traditionally, the benefit of limited liability has been linked with the passive involvement by those granted the benefit.  The idea was that people could trade involvement in the management of the business for the security of having no personal liability for the obligations of the business beyond their investment. 

The Problem and Its Consequences.  Today, with the possible exception of businesses fortunate enough to have attracted venture capital, the distinction between passive investors and operating managment is often far less clear.  Typically, in a small or medium privately held owner-operated business, most or all of the owners are likely to have active roles in the day to day management of the company.  Unfortunately, this trend can be a trap for the harried unwary business owner who assumes that observing formalities imposed by Ohio law for operating his or her business is merely optional or "just not that big a deal".

Does this ever really happen?  Yes.  In a surprising number of cases, people suing a business have argued, and the court has agreed, that business owners displaying carelessness in following proper corporate procedures, or lax practices in separating the financial affairs of the business from their own, are personally liable for everything from environmental claims to breach of contract.

Consider the situation of a general building contractor, known as Bachinski Builders, Inc. whose sole shareholder was the president's wife.  Barbee Concrete Construction was a subcontractor hired by Bachinski Builders, Inc. to do concrete work for a residential subdivision being built by Bachinski Builders.  Upon completion of the residential development, Barbee Construction was not paid for all of its work.  After filing suit for breach of contract to recover the unpaid amounts, Barbee Construction amended its Complaint to include a claim seeking to recover against the president of the general contractor personally.  (Barbee Concrete Construction v. Bachinski Builders, et al.).  Among the transgressions important to the Court in deciding to impose personal liability on the president were:

• President testified that he alone made all decisions, including how corporate monies were to be spent and distributed

• President was unable to name any members of the company's board or say whether it had ever even met

• No corporate records could be produced

• A series of payments totaling more than $32,500.00 were made to one of the president's son, allegedly as compensation for work as a construction supervisor, but when questioned about specific payments, the president was unable to explain the amounts or what work was done to earn specific payments

• Payments totaling more than $56,000.00 were made to two other sons supposedly as repayment of loans made, but there was no documentation supporting the existence of the loans.

In still another case, a nursery rewholesaling business owner ran afoul of the "piercing the corporate veil" doctrine when sued by a nursery supplier in a breach of contract action.  (Willoway Nurseries v. Curdes).  Thomas and Rosemary Curdes had taken appropriate legal steps to set up their business, but later became thoroughly undisciplined in maintaining any separate existence for their company. 

Initially, appropriate incorporation documents were filed with the Ohio Secretary of State, shares were issued and paid for, Mr. and Mrs. Curdes were designated as the company's shareholders, officers and directors, and the first shareholders' and first directors' meeting were held.  Unfortunately, the Curdes' business began experiencing difficulties almost immediately.  Plans to make their existing lawn care and landscaping sole proprietorship a subsidiary of the newly formed corporation were never completed.  Instead the Curdes continued to use the sole proprietorship's checking account for both businesses.  In addition, in imposing personal liability on the Curdes, the Court found that:

• although salaries had  been paid to the Curdes, records and accounts for the new company were inaccurate and badly in arrears

• plants in the new company's inventory were used for the old landscaping business without any corresponding record of payment

• revenues generated by the new company were used to buy equipment for the old landscaping business and pay its employees

• no corporate formalities had been observed since the initial incorporation activities

• no corporate or state tax returns had been filed

• when the new company eventually ceased operations, the Curdes simply took the company's assets to their own home, viewing them as their own property

Belvedere Sets Ohio Standard.  In Ohio, the leading case describing the circumstances in which "piercing the corporate veil" is appropriate is Belvedere Condominium Unit Owners' Association v. R.E. Roark Companies, Inc., 67 Ohio St.3d 274 (1993).  This case involved a dispute between a Cincinnati condominium unit owner's association and a Columbus real estate developer (and its majority shareholder).  The association (whose board was controlled by employees of companies owned by the real estate developer's shareholders) and the real estate developer had entered into a lease with provisions highly favorable to the real estate developer as lessee and at an allegedly under-market rent.

After finding no fiduciary duty existed between the developer and the condo association, the Ohio Supreme Court nevertheless held the developer liable under a strict liability statute for failure to disclose to prospective purchasers relevant financial information concerning the condominium development.  The question then was whether the majority shareholder of the developer could be held individually liable for this violation by the developer.  In answering this question, the Ohio Supreme Court indicated that it intended to strike "the correct balance between the principle of limited shareholder liability and the reality that the corporate fiction is sometimes used by shareholders to protect themselves from liability for their own misdeeds." 

The Ohio Supreme Court set out the following guidelines for when individual shareholders could be held liable notwithstanding the corporate form of their business:

1. control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will or existence of its own, i.e. there was no separation between the business affairs of the company and the personal affairs of the owner

2. control over the corporation by those to be held liable was exercised in such a way as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and

3. injury or unjust loss resulted to the plaintiff from such control and wrong.

The Court also hastened to add that "mere control over a corporation is not in itself a sufficient basis for shareholder liability."  In analyzing the situation before it, the Ohio Supreme Court found it persuasive that the individual shareholder did not use his influence and control to injure or defraud the association.  Accordingly, it concluded that it was not appropriate to hold the shareholder individually liable.

Practical Applications.  What does this mean on a practical level?  The most important prong of the standard is the first which tests whether the owner and the corporation or LLC are distinguishable from one another.  Among the telltale factors considered by Ohio courts are 

• grossly inadequate capitalization

• failure to observe corporate formalities

• insolvency of the business entity at the time the debt was incurred

• owner acting in ways holding himself out as personally responsible for the company's obligations

• diversion of company funds or property for personal use

• company used as a mere façade for other operations of the owner

Thus, in the recent case of Kelley v. McComas, 2007 U.S. Dist. LEXIS (S.D. Ohio 2007), while the Court felt it was a "close question" whether the corporate veil should be pierced, the Court refused to impose personal liability on the company's owners based upon the fact that corporate meetings were held and that the company was the holder of the liquor permit, filed corporate tax returns, had employees, and was no more insolvent now than when the incident in question occurred. 

So what's the best way to avoid accidental personal liability?

1. Keep good corporate records.  If there is more than one shareholder or owner, have corporate meetings on a regular basis (monthly or quarterly) and keep minutes of those meetings

2. Make sure you keep some sort of record of revenue coming in, and expenses being paid by, the company.  If you bill clients or customers, make sure they make their check payable to the company, rather than you personally. 

3. Don't pay company bills from personal funds.  If the business is running short of money, deposit a personal check in the company banking account instead of paying even such essentials as employee paychecks or utilities from your own funds.  Make sure to have your bookeeper or accountant keep track of these "loans" to the company.  And while it probably goes without saying, make sure you DO have separate personal and company accounts. 

4. Don't pay personal bills from company funds.  Be sensible about which expenses the business is paying for you.  Car payments may (or may not, depending on the circumstances) be appropriate, but expensive vacation trips to the Carribean even if you did have that one business meeting, are likely to be pushing it.

5. Make sure you've completed ALL of the legal steps in Ohio for proper legal formation of the business.  For example, if a corporation, simply filing Articles of Incorporation with the Secretary of State without also attending to electing directors and officers and issuing shares of stock is not sufficient.

6. Use signage, business order forms, invoices, and business stationary with the company's name and address prominently featured when doing business with customers and clients.

While these guidelines are relevant to all privately held companies, individuals who are the sole owner of thier business should pay particular attention to adhering to them.

In general, the best way to stay out of trouble is to simply remember that the company IS NOT you, but has its own distinct identity and needs to be treated as a separate independent entity. 

• To learn how courts in another state look at the issue, read John Waller's post from earlier this year on "More on Piercing the Corporate Veil in Indiana and the UFTA" in his Indiana Commercial Foreclosure Law blog.

UPDATE: The Ohio Supreme Court heard oral argument in Dombroski v. Wellpoint, Inc., Case No. 2007-2162, on June 4, 2008 in which the certifed question related to the proper interpretation of Belevedere's second prong in a case involving a tort plaintiff and the parent corporation against whom veil piercing was sought.  For more on this, read my posts here and here.  In these posts, I also include links to the Ohio Supreme Court website where you can see the streaming video of the oral argument.

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