Garnishment Of Joint Bank Accounts In Indiana
Indiana Collection Theories Of Piercing The Corporate Veil, Alter Ego, Successor Liability And Mere Continuation: Part I

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. 

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