Veil Piercing: Plaintiff Left With No Recourse, and That’s Okay

Suppose you sue a corporation or a limited liability company and win, but the defendant has no money to pay your award and no other assets you can execute against. Is that a factor that justifies piercing the veil to make the owners of the company pay your award?  The Indiana Court of Appeals answered that question, and a couple of others related to veil piercing, in Country Contractors, Inc. v. A Westside Storage of Indianapolis, Inc.

Country Contractors was incorporated in 1983 as a seller of ready-mix concrete under the name Country Concrete, Inc.  In the 1990’s the company expanded its business to include construction work and excavation. Over the years, Country Contractors owned a substantial amount of assets in the form of construction equipment that it leased to other contractors.  In 2007 the corporation changed its name to Country Contractors, Inc. and amended its articles of incorporation to better reflect its expanded line of business.  Its two shareholders served as the board of directors, but three other people were responsible for running the company from day to day — preparing bids, executing contracts, and supervising the work.

In 2007, Westside engaged Country Contractors to perform excavation and construction services for the price of $235,000.  Country Contractors subcontracted much of the work, which began in 2008.  The two owners were not involved in the negotiation or execution of the contract, nor did they supervise the work.

Unfortunately, Country Contractors found itself in financial distress and stopped working on the project by the end of 2008, forcing Westside to hire another contractor to complete the work. In addition to $191,536 that Westside paid Country Contractors for work completed, Westside paid the new contractor $33.137 to complete the work.  Westside was also required to pay$38,182 to secure the release of a mechanic’s lien recorded by a subcontractor that Country Contractors failed to pay. All told, Westside paid $286,163 to complete the project that Country Contractors promised to perform for $235,000.

Westside sued Country Contractors and was awarded a judgment for $117,542, including $51,163 in direct damages (the difference between the price paid for complete performance of the work and the contract price) and additional amounts for consequential damages, prejudgment interest, and attorneys’ fees. The judgment was issued not only against Country Contractors but also against the two shareholders, holding them personally liable under the doctrine of piercing the corporate veil.

Under Indiana law, the shareholders of a corporation or the members of a limited liability company (LLC) are not ordinarily liable for the obligations of the business. Even so, a court will sometimes “pierce the veil” to permit a creditor of the company to reach the assets of the business owners, but only in unusual circumstances.  As the Indiana Supreme Court explained in Aronson v. Price,

While an Indiana court will impose personal liability to protect innocent third parties from fraud or injustice, the burden is on the party seeking to pierce the corporate veil to prove that the corporate form was so ignored, controlled or manipulated that it was merely the instrumentality of another and that the misuse of the corporate form would constitute a fraud or promote injustice.

The Aronson decision also held that, in whether whether a plaintiff has met this burden of proof, a court will consider

. . .whether the plaintiff has presented evidence showing (1) undercapitalization; (2) absence of corporate records; (3) fraudulent representation by corporation shareholders or directors; (4) use of the corporation to promote fraud, injustice or illegal activities; (5) payment by the corporation of individual obligations; (6) commingling of assets and affairs; (7) failure to observe required corporate formalities; or (8) other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form.

The same analysis applies to both corporations and to LLCs.

In Country Contractors, the trial court pointed to the following factors to support its decision to pierce the veil.

  • Undercapitalization. When Country Contractors began work on the Westside Storage contract, it was already in financial trouble. In fact, the trial court noted that it had essentially no net assets as of September 2008.
  • Corporate formalities. Country Contractors was unable to produce complete accounting records for the Westside Storage project and produced only scant minutes of shareholder meetings and had no records of corporate resolutions, ledgers, or stock certificates.

To further justify piercing the veil, the trial court wrote:

The corporation is now bankrupt. Westside has been damaged and has no other recourse. It would be unjust in this case to permit the [shareholders] to escape personal liability by not piercing the corporate veil.

The Court of Appeals reversed the judgment against the shareholders with three significant holdings.

A business must be adequately capitalized when it is formed.

First, the trial court erred by considering whether Country Contractors was undercapitalized when the work for Westside began.  Generally, the question is whether the company was adequately capitalized when it was formed in light of the type of business in which the company was engaged and the risks associated with that type of business. An exception is when a company later experiences a significant change, such as entering a new line of business.  In that situation, the relevant inquiry is whether the company was adequately capitalized at the time of the expansion.  In this case, the Court of Appeals considered Country Contractor’s financial situation not in 2008 when the work began but rather as of January 2007 when Country Contractors amended its articles of incorporation to reflect changes that it had made to its business in the 1990s.  The Court did not explain why that was the appropriate time frame for judging capitalization rather when the changes to the business were actually made.  Nonetheless, the Court of Appeals disagreed with the trial court that Country Contractors was undercapitalized.

There must be a causal link between an Aronson factor and injustice to the plaintiff.

Second, the trial court erred in relying on the neglect of corporate formalities to pierce the veil. The test is whether the company is “operated as a distinct and separate business and financial unit, with its own books, records, and bank accounts.”  Use of corporate funds for personal purposes or comingling of personal and business accounts and assets can be an indication that the company has not been respected as an entity separate from its owners. The Court of Appeals found no such evidence. The fact that Country Contractors operated its business out of a single bank account did not trouble the Court, which noted that many small businesses operate with only one account.

The Court of Appeals did not take issue with the trial court’s finding that Country Contractors’s corporate records were lacking.  Instead, it held that the lack of corporate records is, by itself, not enough to satisfy Aronson because there was no causal link between the lack of corporate records and any injustice to Westside. No harm, no foul.

The absence of a remedy for the plaintiff does not justify veil piercing.

The trial court seemed troubled by the fact that, without piercing the veil, the plaintiff would be left out in the cold because Country Contractors had no assets.  Of course that will always be the case whenever a plaintiff seeks to pierce the veil.  If the company had enough assets to satisfy a judgment, there would be no need to pierce the veil.  As the Court of Appeals wrote, “[l]ack of other recourse is simply not a proper basis for piercing the corporate veil.”