September 13, 2012

When Is a Business Owner Liable For Her Corporation's Debts? Piercing the Corporate Veil (II)

1280219_rocks_rocks_rocks.jpgIn our last entry we discussed how piercing the corporate veil can result in the owner of a New York corporation being personally responsible for the corporation's debts and obligations. We also set out the test for piercing the corporate veil: A Plaintiff must show that the owner of the corporation exercised complete domination of the corporation in the transaction the Plaintiff has complained about; that the owner's domination was used to commit a fraud or wrong against the Plaintiff which resulted in the Plaintiff's injury, and that the owner, through her domination, abused the privilege of doing business in the corporate form to perpetrate the wrong against the Plaintiff. See Morris v. New York State Dept. of Taxation & Fin., 82 N.Y.2d 135, 141-42, 623 N.E.2d 1157, 1160-61 (1993); E. Hampton Union Free Sch. Dist. v. Sandpebble Builders, Inc., 66 A.D.3d 122, 126, 884 N.Y.S.2d 94, 98 (2nd Dept. 2009) aff'd, 16 N.Y.3d 775, 944 N.E.2d 1135 (2nd Dept. 2011); Love v. Rebecca Dev., Inc., 56 A.D.3d 733, 868 N.Y.S.2d 125 (2nd Dept. 2008).

There are some interesting cases that illustrate just how difficult it is to pierce the corporate veil. One is E. Hampton Union Free Sch. Dist. v. Sandpebble Builders, Inc., 66 A.D.3d 122, 126, 884 N.Y.S.2d 94, 98 (2nd Dept. 2009) aff'd, 16 N.Y.3d 775, 944 N.E.2d 1135 (2nd Dept. 2011). There, the Plaintiff was a Long Island school district that sued not only a construction company, Sandpebble Builders, Inc., but also its president and principal owner, for breach of contract. The School District alleged that the construction company had negotiated the terms of a construction services contract in bad faith. According to the School District, the company came to an agreement in principal with it on the terms of the contract numerous times only for the company to try to negotiate better terms, and, when it could not, the company would refuse to execute the contract. The company, according to the School District, was trying to delay the project on which it was supposed to work, by prolonging the negotiations, and using that as leverage to negotiate a better deal, one closer to a previous contract which the School District evidently canceled. That, without more, would make the dispute nothing more than another example of why it is important to spell out all of the terms of the contract in writing and to make it clear that the parties involved in a transaction do not wish to be bound unless and until there is a written, executed agreement.

What makes E. Hampton Union Free Sch. Dist. v. Sandpebble Builders, Inc., supra, memorable, however, is that the School District tried to hold Sandpebble's president and principal owner, liable for the corporation's breach of contract. It basically argued that the owner was, in effect, Sandpebble, because there was no meaningful difference between them; that when Sandpebble acted in bad faith and employed unfair negotiating tactics, it was, in effect, the owner that did so; and since Sandpebble's actions injured the School District, the owner should have to pay those damages. The School District offered evidence that the owner did in fact dominate and control Sandpebble; that he was the sole officer, director, and shareholder of Sandpebble; that he controlled Sandpebble's activities related to all construction projects for the School District; and that he was the only Sandpebble representative the School District dealt with regarding the contract negotiations and was the one who made all important decisions regarding it. Despite this evidence, the court dismissed all claims against the owner; the important thing to remember is why it did so.

The court dismissed all the claims against Sandpebble's owner because, it held, there was no evidence, or even meaningful allegation, that the owner had abused the privilege of doing business in the corporate form. There might have been evidence that the corporation acted badly, and that the owner completely controlled and dominated the corporation, but there was nothing to show that the corporation was the owner and the owner was the corporation. There was nothing to suggest that the owner failed to respect the separate legal existence of the corporation, that he treated the corporate assets as his own, that he under-capitalized the corporation, or that he did not follow the requirements for operating a corporation. Without evidence that the owner and the corporation were one and the same, at least in the owner's mind as shown through his actions, the owner could not be found liable for the actions of the corporation.

It is that requirement, that in order to pierce the corporate veil you must show that the owner abused the privilege of doing business in the corporate form, which offers the most protection to the average New York business. Many businesses are owned by one shareholder, or maybe a few at most. In most of them, the owners/shareholders take the lead in running the company, making the important decisions and doing the hands on work to make the business succeed. Negotiating contracts is a key responsibility; what owner would not get involved in negotiating a contract, in deciding what work to do, what goods to buy, and at what price? If an owner of a corporation could be potentially personally liable for every alleged breach of contract, just because she is the only owner of the corporation, there would not be much meaningful benefit to forming a corporation. As it stands, there still is a meaningful difference, at least in New York, between doing business individually and doing business as a corporation, even for a corporation that is owned, and operated, by only one person.