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Indiana Collection Theories Of Piercing The Corporate Veil, Alter Ego, Successor Liability And Mere Continuation: Part I

Secured lenders and other creditors sometimes obtain useless judgments against assetless companies.  But occasionally there is hope for a recovery.  Ziese & Sons v. Boyer, 965 N.E.2d 713 (Ind. Ct. App. 2012) very nicely summarizes Indiana law on the matter of collecting a defendant company’s debt from a separate, yet related, company.  (This is similar to, yet distinguished from, how individuals can be liable for the debt of a company.)  There are two applicable theories:  (1) piercing the corporate veil and (2) successor liability.  Today’s post deals with the former while Part II will address the latter.

History.  The operative parties to the litigation were Ziese, the plaintiff, and Boyer Construction Group Corporation (“Group”), the defendant.  The issue was whether Group should be responsible for the debts of Boyer Construction Corporation (“Corporation”).  Corporation, a general contractor, failed to pay Ziese, a subcontractor, for work performed in 2003.  In 2006, Group, also a general contractor, was formed.  Group purchased some of Corporation’s assets for $100,000.00.  Group utilized a name almost identical to Corporation, and used Corporation’s website, trademark and logo.  Certain assets used by Group were Corporation’s even though those particular assets were not acquired under the purchase agreement.  Corporation ceased business operations and dissolved in 2008.  Ziese filed suit against both entities in 2009 for breach of contract.  Group filed a motion for summary judgment that the trial court granted.  For the reasons outlined below, the Court of Appeals reversed. 

Piercing corporate veil/alter ego doctrine.  Ziese zeroed in on the “subset” of veil piercing law labeled by some Indiana courts as the “corporate alter ego doctrine.”  The doctrine is one by which a plaintiff shows that two corporations are “so closely connected that the plaintiff should be able to sue one for the actions of the other.”  The doctrine’s purpose “is to avoid the inequity that results when one corporation uses another corporation as a shield from liability.”  Indiana’s so-called eight badges of fraud apply:

 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 corporation formalities; and
 8. Other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form. 

In addition to those eight badges, which apply to veil piercing to individuals, Indiana courts look to four additional factors when the target is an entity:

 1. Similar corporate names used;
 2. Sharing common principal corporate officers, directors and employees;
 3. Similar business purposes; and
 4. Utilization of same offices, telephone numbers and business cards.

The courts examine all twelve factors for an indication of “the intermingling of business transactions, functions, property, employees, funds, records, and corporate names in dealing with the public.”  The point of assessing the badges of fraud is to arrive at an inference of fraudulent intent.  The ultimate objective of the doctrine is to prevent fraud or unfairness to third parties. 

Remand.  Collection cases based upon these theories are, by their nature, very fact sensitive.  Please review the opinion for the details.  The Court in Ziese identified sufficient evidence that created a factual issue with respect to whether Group was the alter ego of Corporation.  In other words, the Court of Appeals remanded the case for a trial.

In Part II, I will discuss the successor liability/mere continuation theory of recovery explained in Ziese.

In Indiana Veil-Piercing Cases, There Must Be A “Causal Connection” Between The Misuse Of The Corporate Form And The Alleged Fraud

CBR v. Gates, 962 N.E.2d 1276 (Ind. Ct. App. 2012) is an important opinion on the issue of veil piercing, a method by which creditors can recover corporate debts from principals of the corporation.  The CBR decision is unique in that it very clearly adopts a “causal connection” requirement for fraud-related veil piercing theories. 

The trial court judgment.  The facts of CBR are dense.  Essentially, the trial court entered a judgment in favor of the plaintiff and against the shareholders of a corporation for the corporation’s breach of a purchase agreement and default on a promissory note.  In deciding to pierce the corporate veil, the trial court concluded that (1) the entity was undercapitalized and lacked corporate records and (2) the shareholders had fraudulently represented [to the plaintiff] in the purchase agreement that there were no representations, warranties or understandings other than those set forth and provided for in the purchase agreement.  As to (2), the trial court felt the shareholders “‘knowingly traded off any representations outside the agreement in return for obtaining limited liability of the corporate form,’ but they nonetheless ‘attempted to back out of the agreement based on oral representations outside the agreement . . . .’”  The trial court concluded that the shareholders had “abused the corporate form to promote both fraud and injustice” so as to render the shareholders individually liable. 

Shareholders’ contention.  Generally, in Indiana, “the party seeking to pierce the corporate veil bears the burden of establishing that:  (1) the corporate form was ‘so ignored, controlled or manipulated that it was the mere instrumentality of another’ and (2) ‘that the misuse of the corporate form would constitute a fraud or promote injustice.’”  Escobedo v. BMH Health Assocs., Inc., 818 N.E.2d 930, 933 (Ind. 2004).  On appeal, the shareholders contended that the plaintiff failed to establish element (2).  Their theory was that the trial court’s judgment ignored the underlying business transaction context, which was to create a corporate entity for a limited purpose.  The shareholders asserted that Indiana law requires a causal link, based upon the second prong of Escobedo, that where fraud is alleged it must be accomplished through misuse of the corporate form. 

Fraud?  CBR is unique in that it digs into the issue of whether the fraud or injustice alleged by the plaintiff must be caused by, or result from, misuse of the corporate form.  The following undisputed facts from CBR were outcome determinative:

[Plaintiff] was informed during the negotiation stage that [the corporate entity] was being formed for the sole purpose of purchasing his event-decorating assets.  As such, before entering into the agreement with [the corporate entity], [plaintiff] was aware, or should have been aware, that the fledgling corporation would possess many of the attributes [the corporate entity] would later point to as evidence of abuse of the corporate form, such as a lack of corporate records.  At the time of formation, [the corporate entity] possessed capital for the initial $100,000 down payment to [plaintiff].  Though the corporation also had an obligation to repay the amount due on the promissory note, [the corporate entity] had seven years to do so, and the first payment was not due until six months after closing.  The shareholders intended to capitalize future payments and contribute funds for operation of the business through capital contributions, a practice common in the corporate context.

No nexus.  The Court concluded that the “alleged fraud [did] not flow from any misuse of the corporate form; it had no nexus to the corporate form.”  In short, the alleged misrepresentation in CBR did not pertain to the defendant corporate entity’s corporate status.  The Court suggested that the only way the corporate veil could have been pierced in CBR would have been through proof that the shareholders formed the corporate entity with the intent - at the time - to later breach the subject purchase agreement and hide behind the shield of limited liability.  Since there was no such evidence, there was no basis for a finding of misuse of the corporate form constituting a fraud (or, in turn, for a finding to pierce). 

The CBR case speaks to the potential liabilities of individuals who routinely form SPEs (special purpose entities) or SAEs (single asset entities).  See also, January 19, 2009 post.  The case favors the investing individuals and not their creditors.  Because these cases are always highly fact sensitive, CBR should not be interpreted as some wide ranging shift under Indiana law.  But the opinion does highlight the causal connection standard.  Not every case of alleged fraud against a corporate entity will pierce the corporate veil. 

Garnishment Of Joint Bank Accounts In Indiana

If, following an Indiana mortgage foreclosure and sheriff’s sale, a deficiency judgment exists, plaintiffs/secured lenders have the option, in proceedings supplemental, to garnish certain property of the defendants/judgment debtors (such as a guarantor).  Trustees of the Teamsters v. Brown, 2012 U.S. Dist. LEXIS 15426 (N.D. Ind. 2012) (.pdf) involved the attempted garnishment of a bank account held jointly by a judgment-debtor and an innocent spouse. 

The targeted funds.  The plaintiff in Brown owned a judgment against Mr. Brown.  In proceedings supplemental, the plaintiff served interrogatories on two garnishee-defendant banks.  Bank A responded that Mr. Brown and his wife had a joint account and that all contributions to the account were for income from the wife’s employer.  Bank B responded that Mr. Brown and his wife had a joint account there as well.  A portion of the balance in Bank B related to Mr. Brown’s Social Security benefits, income from his wife’s employer and a tax refund owed to Mr. Brown.  The plaintiff filed a motion with the court requesting a turnover order of all funds in each bank.  Mr. Brown asserted that Indiana law protected the funds received from Social Security, as well as the funds contributed to the joint account by his wife.

Basics.  The Court in Brown noted that, under Indiana law, the plaintiff/judgment-creditor bore the burden of demonstrating that Mr. Brown, as the judgment-debtor, had property or income subject to execution.  An interest in property subject to execution may include property that the judgment-debtor owns that is in the hands of a third-party, such as a bank account.  But there are Indiana and federal statutes that exempt certain property a judgment-debtor owns from garnishment.  Ind. Code § 28-9-3-4(d)(3)(B) provides that certain sources of income deposited into an account are exempt and that those sources of income include “Social Security, Supplemental Security Income, veterans benefits, and certain disability pension benefits, and that there may be other exemptions from garnishment under federal or state law.”  See also 42 U.S.C. § 407(a).  Mr. Brown’s Social Security benefits were exempt.   

Joint account.  The evidence established that the bank accounts were joint accounts with survivorship, not tenants in common.  Ind. Code § 32-17-11-4 defines a joint account as “an account payable on request of one (1) or more of two (2) or more parties whether or not mention is made of any right of survivorship.”  In Indiana, the ownership of funds in a joint account is a question of fact during the lifetime of the parties. 

Tenants in common.  The plaintiff in Brown asserted that the agreement with each bank indicated an intent to hold the funds jointly, not by their respective contributions, because the documents stated “Joint Account – With Survivorship (And Not As Tenants In Common).”  In Indiana, tenants in common are presumed to own property in equal shares, although evidence may be submitted to prove the parties’ intent to the contrary for the purpose of determining how much property is owned by each tenant in common.  On the other hand, individuals who deposit money into a joint account are entitled to the opposite presumption.  The Court in Brown interpreted Ind. Code § 32-17-11-23 to mean “that the individual who made the contribution to the joint account retains ownership of the respective funds unless there is clear and convincing evidence of a contrary intent.” 

Presumption.  Since the agreements with the banks specifically stated that Mr. Brown and his wife did not hold the account as tenants in common, the Court could not assume that they held the money in equal shares.  Rather, they held the money as joint tenants, and the plaintiff had the burden to show that Mr. Brown and his wife intended for mutual use of all funds contributed to the account.  “The law is clear that the parties own the amount equal to their contributions absent clear and convincing evidence to the contrary.”  The Court concluded that there was nothing in the agreements with the banks that manifested an intent contrary to the presumption described in Ind. Code § 32-17-11-23. 

Withdrawal rights not dispositive.  To overcome the presumption, the plaintiff pointed to the couple’s use of the funds, which use indicated their intent to share.  Mr. Brown made withdrawals and signed checks from the accounts for his personal and business use.  In Indiana, “the right to withdraw and the right of ownership, however, are separate and distinct rights.”  While deposit agreements may give a joint tenant the right to withdraw funds, such agreement does not alter ownership.  A joint account holder does not own the funds deposited by another account holder unless there is proof that it was given by gift, contract or irrevocable trust.  As such, Mr. Brown’s use of the funds alone was not clear and convincing evidence that his spouse intended to relinquish ownership of the funds in their entirety. 

In the end, the Court limited the plaintiff’s garnishment to a tax refund check that Mr. Brown deposited.  No other funds in either bank were subject to garnishment.  A key point is that, under Indiana law, the contributions of an innocent spouse into a deposit account held jointly with a judgment debtor should be shielded from collection.

7th Circuit Holding Impacts Single Asset Entity Chapter 11 Bankruptcy Cases

While sophisticated bankruptcy issues fall outside the scope of my blog, the February 14th opinion by the Seventh Circuit in the matter of Castleton Plaza, LP, No. 12-2639 (.pdf) warrants a mention. 

Castleton dealt with the absolute-priority rule in 11 U.S.C. 1129(b)(2)(B)(ii), which provides that creditors "in bankruptcy are entitled to full payment before equity investors can receive anything."  The technical issue was "whether an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an 'insider,' as 11 U.S.C. 101(31) defines that term."  The Court said no. 

For more on the Castleton decision, including comments by attorneys involved in this important Southern District of Indiana case, please click on the following link to an article in The Indiana LawyerBankrupcty ruling locks out insiders.