“Piercing the corporate veil” is one of those legal terms that makes a legal action seem more romantic than it really is. When a party to a legal dispute attempts to pierce the corporate veil of a corporate adversary, they are asking a court to move aside the metaphorical veil created by the adversary’s corporate structure and hold the owners of the corporate entity personally liable for the entity’s actions or debts.
Corporate veil piercing—or at least attempts to pierce a corporate veil—arise more frequently in closely held businesses than in other settings. That’s because the owners of closely held businesses tend to be intimately involved in their businesses’ operations and are more likely to attempt to use the limited liability created by their businesses’ corporate structures to shield them from legal liability for the wrongdoing they or their businesses engage in.
We haven’t discussed veil piercing much on the blog. But a recent Pennsylvania Supreme Court decision, in a case captioned Mortimer v. McCool, et al., provides us with an excellent excuse to do so. That’s because with its ruling, the court took a major step towards making closely held businesses more vulnerable to having their corporate veils pierced, and in turn making their owners more vulnerable to being held personally liable for their businesses’ wrongdoing.
A suspicious liquor license transfer
The Mortimer case arose from the collection of a judgment obtained in a personal injury action. Ryan Mortimer obtained a $6.8 million judgment against various individuals and corporate entities in connection with injuries she suffered after her car was hit by a drunk driver. McCool Properties, LLC, owned the restaurant in question that served the intoxicated driver. Another entity, 340 Associates, LLC, owned the liquor license used by the restaurant. Both entities had common owners.
During Mortimer’s personal injury lawsuit, 340 Associates transferred the liquor license to another entity, 334 Kayla, Inc.—an entity with no affiliation with the owners of McCool Properties or 340 Associates—in exchange for a $75,000 note. 334 Kayla also signed a lease with McCool Properties for the restaurant space.
After the entry of the judgment in her favor, Mortimer filed a lawsuit against 340 Associates and 334 Kayla, alleging the liquor license transfer was fraudulent and an attempt to shield it from Mortimer recovering it in her original lawsuit. Mortimer was successful in that action, took possession of the liquor license, and sold it for $415,000. Mortimer then filed actions against 340 Associates and McCool Properties to collect the rest of the judgment and to pierce 340 Associates’ corporate veil in order to reach both the McCool Properties assets and those of their shared individual owners.
An enterprising attempt to pierce a corporate veil
Historically, Pennsylvania has had a strong presumption against piercing the corporate veil, as the Pa. Supreme Court recognized: “There appears to be no settled rule . . . as to exactly when the corporate veil can be pierced and when it may not be pierced,” such that it “seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled.”
The trial court in this case, relying upon two separate decisions, recognized a series of factors to consider in Mortimer’s claims. The trial court noted a corporate structure may be disregarded “whenever one in control of a corporation uses that control, or uses the corporate assets, to further his or her own personal interests.” Additional factors include “undercapitalization, failure to adhere to corporate formalities, substantial intermingling of corporate and personal affairs, and use of the corporate form to perpetrate a fraud.” The trial court decided to apply these additional factors to Mortimer’s claims against 340 Associates, and determined none of them allowed her to pierce that entity’s corporate veil.
Regarding her claims against McCool Properties, Mortimer advanced two separate veil-piercing theories at the trial level: the “alter ego” theory and the “enterprise liability” theory. The trial court quickly dismissed the alter ego theory, which applies only where the individual or corporate owner controls the corporation to be pierced and the controlling owner is to be held legally liable for wrongdoing, as not applicable because McCool Properties had no ownership interest in 340 Associates.
Moving on to the enterprise liability theory, which allows two or more corporations to be treated as one if five factors are met, the trial court recognized that Pennsylvania had yet to adopt the theory. But it didn’t let that stop it. It considered the theory’s five factors:
- Identity of ownership;
- Unified administrative control;
- Similar or supplementary business functions;
- Involuntary creditors; and
- Insolvency of the corporation against which the claim lies.
While it indulged Mortimer and considered the enterprise liability theory, the trial court did not find in her favor. It ruled that she did not show there was identical ownership and unified administrative control among McCool Properties and 340 Associates.
The Pennsylvania Superior Court later affirmed the trial court’s rulings in all respects.
A moral victory for Mortimer
Mortimer appealed her case to the Pa. Supreme Court on multiple grounds, but the court only granted review of whether the court should adopt the enterprise theory of piercing the corporate veil “to prevent injustice when two or more sister companies operate as a single corporate combine.”
Mortimer re-emphasized the application of the enterprise theory’s five factors to her case, and cited cases from multiple jurisdictions that have already adopted enterprise liability as models for Pennsylvania’s adoption of the theory. After looking at decisions from courts in Alabama, Indiana, Connecticut, Massachusetts, Colorado, and South Carolina, among other states, the Pa. Supreme Court determined “most jurisdictions that recognize an enterprise liability variant also retain a requirement of wrongdoing and resultant injustice no less stringent than that which applies in any piercing case.” That being said, the court noted that “[e]nterprise liability cases in which relief is granted seem to be very few and far between, and typically involve some truly egregious misconduct.”
In laying out its version of the enterprise liability theory, the court explained that in its most logical form, it “requires an alter ego component” from which substantial common ownership can arise; effectively the affiliate corporations are “siblings – of common parentage.” Thus, according to the court, there must be “common owners and/or an administrative nexus above sister corporations.”
From there, the court said that “enterprise liability in any tenable form must run up from the debtor corporation to the common owner, and from there down to the targeted sister corporation(s)” in a “triangular” fashion. But the court noted this “requires a mechanism by which liability passes through the common owner to the sibling corporation” and acknowledged the theory of “reverse-piercing,” where a plaintiff suing the owner of a corporation must establish the misuse of corporate form to protect the owner’s personal assets.
The court then settled on a two-pronged test for using the enterprise theory to pierce a corporate veil. First, there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist, and adherence to corporate fiction under the circumstances would sanction fraud or promote injustice. Second, there must be some fraud, wrong, or injustice.
Unfortunately for Mortimer, the Pa. Supreme Court relied on the trial court’s findings and held that Mortimer did not satisfy either prong of the two-pronged test the court established. The court did, however, signal that lower courts in Pennsylvania were free to apply the two-pronged test in the future, stating that “it remains for the lower courts in future cases to consider its application” consistent with prior case law and the guidance provided by the court.
A new weapon in business divorce litigation?
While the Pa. Supreme Court has adopted what appears to be a broad version of the enterprise theory for corporate veil piercing, it remains to be seen whether lower courts in the state will take up the court on its invitation to apply it, and under what circumstances.
But based on the Pa. Supreme Court’s decision here in Mortimer v. McCool, it seems enterprise liability is now a viable theory in Pennsylvania through which a party to a business divorce lawsuit could attempt to pierce the corporate veil of an adversary. Interestingly, the enterprise theory may be an effective weapon with which to hold the owners of “just-out-of-reach structures”—which we covered on the blog a while back—liable for wrongdoing if an opposing party can show a unity of interest and ownership that eviscerates separate personalities of the companies and the individuals, and there is fraud, wrong, or injustice on their parts.
Corporate attorneys advising closely held businesses should be aware of the potential for enterprise liability to arise. They should strongly consider indemnification provisions and adequate insurance for directors and officers as necessary.
Additionally, litigators should also evaluate the viability of this theory in preparing their claims and choosing appropriate defendants. Litigators will need to conduct an in-depth investigation into their adversaries’ corporate ownership to allow their clients to show a court they’ve satisfied the shiny new two-pronged test for enterprise liability established by the Pa. Supreme Court in Mortimer v. McCool.