Indiana Commercial Foreclosure Law

“Negative Value” Dooms Indiana Fraudulent Transfer And Direct Continuation Claims

Not infrequently, a borrower’s loan collateral will fail to fully satisfy a secured debt, particularly after the add-ons of default interest, attorney’s fees and other costs of collection.  In such cases, lenders must choose whether to pursue a recovery of the remaining, unsecured debt from either the borrower or a corporate or individual guarantor.  Sometimes, a pre-loan and post-judgment comparison of financial statements causes lenders to question whether there may have been fraudulent transfers of assets that could be avoided and become a source of recovery.  Guttierrez v. Kennedy, 2010 U.S.Dist. LEXIS 73053 (S.D. Ind. 2010) (.pdf) helps guide a judgment creditor’s decision of whether to incur the time and expense of pursuing suspected fraudulently-transferred assets. 

Fact sensitive.  No two fraudulent transfer/veil piercing cases are alike, and I’ve concluded that a detailed summary of facts in cases like Guttierrez adds little to the overall message.  For more about the assets and relationships at issue, I recommend that you read the opinion. 

Negative value.  The key asset in Guttierrez involved a contract previously held by the judgment debtor that was transferred (assigned) to a related corporate entity.  Indiana’s Uniform Fraudulent Transfer Act (“UFTA”) at Ind. Code § § 32-18-2-1 through 21 permits creditors to obtain avoidance of a fraudulent transfer to the extent needed to satisfy a claim.  Guttierrez specifically touched upon the amount of the potential recovery.  “The creditor may recover the lesser of the amount necessary to satisfy its claim or the value of the transferred asset.”  Valuation is determined at the time of the transfer but can be adjusted “as the equities may require.”  To the extent the asset may generate income from use, the liability of the transferee will be “limited in any event to the net income after the deduction of the expense incurred in earning the income.”  After an examination of the facts in Guttierrez, the Court concluded that the judgment creditor could not recover under the UFTA because the subject contract had negative value after the deduction of the expenses incurred in earning the income. 

Direct continuation.  The judgment creditor in Guttierrez also argued that the corporate assignee of the contract was a “direct continuation” of the judgment debtor and, as such, should be liable for the judgment.  I discussed this type of veil piercing claim on July 28, 2007.  Generally, in Indiana “when a corporation is clearly a direct continuation of the ownership and operations of another corporation, it will be liable to the other corporation’s creditors.”  The corporate entities in Guttierrez operated from the same location and performed the same jobs.  On the other hand, the targeted entity was not created immediately after the threat of judgment against the judgment debtor and indeed preexisted the judgment by twelve years.  Additionally, even though one of the principals of the judgment debtor had a stake in the targeted entity, two of the other principals did not.  Moreover, the judgment creditor did not offer evidence of the important factors of undercapitalization, comingling of personal and corporate assets, or corporate payment of personal obligations.  But the nail in the coffin was the “negative value” of the asset at issue:  “Plaintiffs were not harmed by the transfer because the [contract] turned out to be a losing proposition.”   

No harm, no foul.  From the perspective of judgment creditors, one lesson of Guttierrez is to ensure that the asset being chased is worth chasing.  Guttierrez centered upon the capture of an income-producing asset (a contract) that, on its face, appeared to have significant worth.  But the Court concluded that, after deducting operating/overhead costs, the contract had negative value.  The judgment creditor’s efforts to seize the contract were for naught.  While it may be understandable that a value determination cannot be made before a claim is filed, prompt post-filing discovery and investigation should be undertaken in order to assess what an income-producing asset may be worth.  In Guttierrez, the subject transfers and corporate entities were suspect, but in the end those circumstances didn’t matter because the targeted asset turned out to be a liability. 

Corporate Veil Pierced In Recent Decision

Last week, while discussing the G4S case, I suggested that efforts to collect judgments by piercing the corporate veil may be better left for post-judgment proceedings supplemental.  With facts and circumstances like those in Longhi v. Mazzoni, 2009 Ind. App. LEXIS 2093 (Ind. Ct. App. 2009) (.pdf), however, clearly a pre-judgment effort to pierce can be appropriate.  Unlike the G4S case, Longhi involved very specific allegations and evidence of fraud.  In fact, the plaintiffs did not even name as defendants the corporate entities in question.  The plaintiffs proceeded directly against the alleged bad actor (corporate agent/representative) under the veil-piercing theory. 

Facts, distilled to their essence.  Veil-piercing cases tend to be very fact sensitive, so I must gloss over the facts.  The underlying corporate entities were in the business of residential real estate development.  The defendant was a shareholder/officer in the entities.  The defendant negotiated to build the plaintiffs a house at a 50% discount.  The plaintiffs entered into a purchase agreement.  The executed documents provided that the $50,000 paid by the plaintiffs was an earnest money deposit.  But other facts showed that the corporate entities actually intended the $50,000 to be an investment in the development project and not a standard earnest money deposit.  The entities never built the plaintiffs’ house, never deeded the real estate to them and never refunded the $50,000.

Piercing issues.  Longhi has a nice outline of the general rules applicable to piercing the corporate veil, which rules and policies I have posted here before.  Of the eight factors typically weighed by Indiana courts in deciding whether to pierce the corporate veil, the Court of Appeals focused in detail on (1) undercapitalization and (2) whether the defendant used the corporate entities to promote fraud. 

Undercapitalization.  The Court cited to a definition of “inadequate capitalization” as “capitalization very small in relation to the nature of the business of the corporation and the risks attendant to such business.”  The Court stated that the adequacy of capital is measured “by evaluating the amount of capital the company had at the time of its formation, unless the company at some point substantially expands the size or nature of its business with an attendant increase in business hazards.”  Again, these veil-piercing cases tend to be very fact-sensitive, meaning that courts typically must evaluate many pieces of information and documentation.  One should read the opinion for a more in-depth analysis of the facts.  In the end, the Court affirmed the trial court’s findings, which included (1) that the developers needed, but didn’t have, $400,000 at the time of the venture’s formation and (2) that the developers hoped to raise sufficient capital through large down payments.  The main point here is that undercapitalization may be a factor in veil-piercing cases and that the Longhi case provides guidance on the issue. 

Promotion of fraud.  The Court also affirmed the trial court’s decision as to the fraud element of the veil-piercing claim.  The alleged fraud centered upon the plaintiffs’ belief that they were making an earnest money deposit on a house, not an investment in the development project.  One of the critical facts was that the purchase agreement required the plaintiffs’ $50,000 to be placed into a broker’s trust account, but the money instead went to a corporate account used to finance the development of the project. 

Although not mentioned in the opinion, I’m guessing that that the plaintiffs in Longhi knew the corporate entities were judgment-proof, so the plaintiffs focused all of their energies on recovering their 50k from the key player in the transaction through a direct veil-piercing suit.  The plaintiffs succeeded in obtaining a judgment, which included treble damages, that the Court of Appeals affirmed.

Veil-Piercing Claim Better Left For Proceedings Supplemental

A recent decision by Magistrate Judge Jane Magnus-Stinson in the Southern District of Indiana, G4S Justice Services, Inc. v. Correctional Program Services, Inc., 2009 U.S. Dist. LEXIS 88689 (S.D. Ind. 2009) (.pdf), explains, albeit indirectly, why efforts to collect judgments by piercing the corporate veil are more appropriate in the context of proceedings supplemental.   

Strategic decision.  In G4S, the plaintiff pursued a strategy I have seen but have never myself utilized.  The plaintiff filed a lawsuit against a defendant corporation seeking, among other things, damages for breach of contract.  The contract/debt was not personally guaranteed by the owners of the corporation.  Nevertheless, the plaintiff included a cause of action seeking to pierce the defendant’s corporate veil and named the corporation’s shareholders, personally.  I’ve posted about veil piercing before, most recently on January 19, 2009. 

Dismissal, on technicality.  The Court’s opinion arose out of the defendant shareholders’ pre-trial motion for judgment on the pleadings seeking a dismissal of the count asserted against them.  The Court held that the plaintiff’s veil-piercing allegations in the complaint were conclusory and did not contain any details “that would plausibly justify concluding that [defendant corporation] did in fact [fraudulently] pay the [shareholders’] personal obligations.”  The Court seemed to feel that the allegations were not based upon anything other than speculation.  The Court therefore dismissed the count related to the defendant shareholders:  there was a “complete absence of any allegations that would justify piercing [defendant corporation’s] corporate veil.”

Better strategy.  In dicta (legalese for “opinions of a judge which do not embody the resolution or determination of the court,” Black’s Law Dictionary), Judge Magnus-Stinson suggested that veil-piercing claims are better left for post-judgment proceedings.  In the event the plaintiff in G4S subsequently obtained a money judgment that the assets of the defendant corporation could not satisfy, the plaintiff would have the ability to conduct proceedings supplemental, a post-judgment proceeding I touched upon on June 29, 2007.  Proceedings supplemental, commonly referred to by lawyers as “pro supp,” are equitable in nature and “permit the judgment-creditor to discover and obtain property held by third-parties that ought to be used to satisfy the judgment.”  For example, in that process:

The judgment-creditor can obtain access to the judgment-debtor’s books and records.  See Fed. R. Civ. Pro. 69(a)(2); Ind. T.R. 69(E)(4).  Using information obtained from those sources, judgment-creditors can—and do—argue that a court should pierce the judgment-debtors’ corporate veil and make their shareholders’ assets available to satisfy the judgment.

Later, perhaps.  The Court made it clear that the dismissal of the defendant shareholders was without prejudice (not final or permanent) and that the plaintiff could revisit veil-piercing during proceedings supplemental “in the event it obtains a judgment against [defendant corporation], and assuming that it can obtain evidence to support the imposition of such a remedy.” 

The notion is that there is a time and place for piercing the corporate veil - during post-judgment proceedings, not during the litigation of the underlying claims.  Perhaps other judges or lawyers may feel differently, but I share the Court’s view in G4S.  Please e-mail or post a comment with your thoughts.

Effort To Pierce The “Corporate Veil” Denied

Judge Hamilton in MFP Eagle Highlands v. American Health Network, 2009 U.S.Dist. LEXIS 1915 (S.D. Ind. 2009) (MFP.pdf) rejected, as a matter of law, plaintiff’s efforts to pierce the “corporate veil” of an Indiana limited liability company.  The opinion granting the defendants’ motion for summary judgment demonstrates how heavy the burden is for a plaintiff attempting to reach the principals of a corporate entity in Indiana.  At its heart, the case involved the assignment of, and ultimate default on, a commercial lease. 

Aronson factors.  This blog has addressed veil piercing on two prior occasions:  May 15, 2007 More From Symons:  Piercing the Corporate Veil and July 28, 2007 More On Piercing The Corporate Veil In Indiana, And The UFTA.  The proof required to pierce the corporate veil is well-settled in Indiana, as are the following eight factors to be considered:

 1. Undercapitalization;
 2. Absence of corporate records;
 3. Fraudulent representation by corporate 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; and
 8. Other shareholder acts or conduct ignoring, controlling or manipulating the corporate form.

Judge Hamilton labeled these the “Aronson factors” after the Indiana Supreme Court’s decision in Aronson v. Price, 644 N.E.2d 864 (Ind. 1994).  The eight factors, which are non-exhaustive, are to be analyzed in determining whether “the corporate form was so ignored, controlled or manipulated that it was merely the instrumentality of another and that the misuses of the corporate form would constitute a fraud or promote injustice.” Although the entity in MFP Eagle was a limited liability company, “the same standards apply equally to corporations and to limited liability companies.”

6 of 8.  In MFP Eagle, six of the factors weighed against piercing the corporate veil, while two of the factors may have been present:  undercapitalization (#1) and use of the limited liability forum to promote fraud, injustice or illegal activities (#8).  As to the plaintiff’s contentions regarding those two factors, Judge Hamilton summed up the Court’s position as follows:

MFP is arguing in effect that it was entitled to have personal guarantees of the lease obligation.  The short answer is that if MFP or its predecessors wanted personal guarantees of the long-term obligations, then they should have bargained for them.  They did not.  MFP is not entitled to such guarantees merely because AHN exercised its rights under the lease to assign the long-term obligations from one limited liability company (AHN) to another (LALR).

The court assumes that a reasonable trier of fact could find that LALR was created for the purpose of allowing Dr. Reitz and Dr. Adams to avoid personal liability for the lease that AHN wanted to assign to them.  This is a perfectly legitimate business goal, particularly since neither Dr. Reitz nor Dr. Adams had been personally liable for the original lease.  Because of tension within AHN, AHN wanted to terminate its agreement with the two doctors and proposed assignment the lease to them as individuals.  At that point, Dr. Reitz and Dr. Adams proposed the creation of a limited liability company to receive the lease assignment.  This device reflected only sound economic planning.  A limited liability company is a perfectly permissible form for organizing a business in Indiana, and a primary benefit is that its members are not personally liable for the debts of the limited liability company.

Heavy burden.  Judge Hamilton seems to believe fairly strongly in the protections afforded by the corporate structure:

In most instances, parties who have observed the formalities of the corporate (or limited liability company) form should be able to count on the promise of limited liability, and there will rarely be a sufficient factual basis for avoiding summary judgment on the issue based on a claim by a party who knew it was dealing with a limited liability company.

The fact is, the plaintiff in MFP Eagle never had any right to personal guarantees of the underlying lease obligations, and the lease itself allowed the defendants to transact business as they did.  As such, the evidence did not permit the Court to impose, in effect, “new personal guarantee obligations on the [defendants].”  Take that, Indiana creditors! 

More On Piercing The Corporate Veil In Indiana, And The UFTA

This follows-up my May 15, 2007 posts (one and two) about Indiana law applicable to creditors that want to pierce the corporate veil and that wish to recover under Indiana’s Uniform Fraudulent Transfer Act.  On July 20, 2007, the Indiana Court of Appeals issued an opinion upholding the trial court’s piercing of the corporate veil, normally a difficult thing to do, as well as affirming liability based on the UFTA.  See, Four Seasons Manufacturing, Inc. v. 1001 Coliseum, LLC, 2007 Ind. App. LEXIS 1589 (Ind. Ct. App. 2007) (FourSeasonsOpinion.pdf ).

Indiana’s general principles on “piercing”.  Four Seasons, on page 12, sets out these guidelines:

1.  Indiana courts are reluctant to disregard the corporate identity and do so only to protect third parties from fraud or injustice when transacting business with a corporate entity.
2.  The process of piercing a corporate veil is equitable in nature, and courts necessarily engage in “a highly fact-sensitive inquiry.”
3.  Parties seeking to pierce the corporate veil bear the burden of establishing that the corporation 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.

Factors to be considered.  To get to individual owners, the following evidence may be considered (see, pp. 12 and 13):

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 forum.

To get to other entities, in addition to the eight factors above, Indiana courts consider these:

1.  Similar corporate names were used;
2.  The corporations shared common principal corporate officers, directors, and employees;
3.  The business purposes of the corporations were similar; and
4.  The corporations were located in the same offices and used the same telephone numbers and business cards.

Importantly, each of the above factors does not need to be proven in order to pierce a corporate veil.  The list is non-exhaustive.  There does not necessarily need to be evidence of every  factor.  Id. at 16.  In Four Seasons, the Court of Appeals held that the plaintiff commercial lessor (creditor) presented adequate evidence that the defendant entity basically orchestrated a fraudulent purchase agreement between two related entities (both of which were owned by the defendant) in order to shield those entities from liability associated with a lease default.   

Uniform Fraudulent Transfer Act.  Actions pursuant to the UFTA and proceedings to pierce the corporate veil sometimes go hand in hand.  Four Seasons is one of those cases.  Indeed the plaintiff was able to recover its damages from the corporate owner of the defaulting entity/lessee under the piercing theory and, alternatively, the fraudulent transfer theory.  One specific question in Four Seasons was whether the defendant was a “debtor” under the UFTA, Ind. Code § 32-18-2.  A “debtor” is “a person who is liable on a claim.”  I.C. § 32-18-2-6.  The Court of Appeals held that the defendant entity was a debtor because it coordinated the fraudulent transfer at issue.  Also important was the fact that the defendant was the 100% owner of both the defaulting lessee and the entity that “purchased” the lessee at the time of the default. 

The remedies provision of the UFTA, I.C. § 32-18-2-7, focuses on the amount of the fraudulent transfer – no more, no less.  In Four Seasons, the UFTA damages consisted of the value of assets the defendant entity fraudulently transferred between one entity to the other entity in order to avoid a judgment based on the lease breach.  Id. at 22-24.  That amount consisted of the value of the assets that the breaching entity (the corporate lessee) possessed upon default – the same amount of money fraudulently transferred out of that entity to the second, related entity. 

The Four Seasons case offers secured lenders guidance when faced with decisions concerning whether to pursue the assets of individuals or entities other than those of the actual borrower’s.  Piercing the corporate veil and UFTA actions can be expensive and time-consuming cases, not to mention difficult ones to win.  This and other recent Indiana cases demonstrate, however, that it can be done under certain circumstances. 

MORE FROM SYMONS: Piercing the Corporate Veil

The March 31, 2007 opinion in Symons International v. Continental Casualty Company, et al., 2007 U.S. Dist. LEXIS 27356 (S.D. Ind.) discusses Indiana’s common law theory of piercing the corporate veil.  (SymonsOpinion.pdf).  The legal principle, not unlike the principles in Indiana’s Uniform Fraudulent Transfer Act, which also is analyzed in the case, provides a method for collecting a debt from someone other than the actual, named borrower.  If applicable, the piercing doctrine provides a nice remedy for Indiana creditors victimized by shady debtors hiding behind the corporate shield.

Piercing the corporate veil.  It’s frustrating when a lender knows that there are assets to cover the debt but that the assets are protected from collection because they are in the hands of the individual owners of a corporate entity or by entities separate from the borrowing entity.  The theory of “piercing the corporate veil,” in rare circumstances, will permit lenders/creditors to chase the assets of the individuals or entities who actually have the money.   

Persons/Owners.  “Indiana courts are reluctant to disregard a corporate entity and extend the liabilities of one corporation and its affiliates, shareholders and/or officers; however, they may do so to prevent fraud or injustice to a third party.”  Symons at 56.  The issue is “highly fact sensitive.”  Id.  With regard to targeting individuals, here are eight factors Indiana courts look to, but the factors are not exhaustive or ranked:

1. Undercapitalization;
2. Absence of corporate records;
3. Fraudulent representation by a corporation’s 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; and
8. Other shareholder acts or conduct ignoring, controlling or manipulating the corporate forum.

Other entities.  In addition to these eight factors, Indiana courts look to at least four other factors when a plaintiff seeks to pierce the corporate veil in order to hold a corporation (or LLC, etc.) liable for another corporation’s debt:

1. Similar corporate names;
2. Common principal corporate officers, directors and employees;
3. Similar business purposes; and
4. The same offices, telephone number and business cards.

Id. at 57.  Again, this is not an exhaustive or ranked list.  On pages 57-62 of Judge Young’s opinion, he addresses many of the factors in detail and provides an excellent analysis of the remedy should you want a better understanding of what it takes to pierce the corporate veil.  He held there to be questions of fact and denied the defendants’ motion for summary judgment.  Symons is a favorable opinion for Indiana creditors.