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Creditor’s Lack Of Recourse Against Corporation Not A Proper Basis For Piercing The Corporate Veil

In County Contractors v. Songer, 4 N.E.3d 677 (Ind. Ct. App. 2014), a mechanic’s lien and breach of contract case, the plaintiff filed claims against the shareholders of an excavation contractor, a corporation, which was defunct.  Plaintiff sought to collect money owed by the corporation from its individual owners.  The trial court concluded that the shareholders were personally liable, and the shareholders appealed, resulting in the Country Contractors opinion that discusses the issue of piercing the corporate veil. 

Fundamental principle.  As the lawyer for the plaintiff creditor, you know you’re cooked when the Court of Appeals starts its opinion by citing to “fundamental principles” of American and Indiana corporate law.  The Court in Country Contractors stated “that corporate shareholders sustain liability for corporate acts only to the extent of their investment and are not held personally liable for acts attributable to the corporation.”  From the top, the Court pointed out that the burden on parties seeking to pierce the corporate veil is “severe.”  

Undercapitalization.  Indiana law is well settled on what courts must examine in deciding whether to pierce the corporate veil, and my post of 3/29/13 goes over those rules, including the Aronson factors.  One of the eight Aronson factors is undercapitalization.  “Capitalization is inadequate when it is very small in relation to the nature of the corporation’s business and risks attendant to such businesses.”  Importantly, the adequacy of capital generally is measured “as of the time of the corporation’s formation.”  A corporation that was adequately capitalized at the outset “but subsequently suffers financial reverses is not undercapitalized.”  In Country Contractors, the corporation originally was formed in 1983 and earned a profit for many years.  By the end of 2007, however, the corporation started operating at a loss.  The Court held:  “[plaintiff] failed to establish that [the corporation’s] dwindling capital was due to anything other than a general downturn in the economy and a specific downturn in the construction industry.”

Corporate formalities.  The second Aronson factor at issue was the alleged failure to observe corporate formalities.  Generally, “a corporation should be operated as a distinct and separate business and financial unit, with its own books, records, and bank accounts.”  The main argument against the shareholders in Country Contractors was that the corporation conducted all of its business from one bank account.  The Court found that it is not uncommon for small corporations to operate from one bank account.  Additionally, the record was devoid of any facts suggesting that the shareholders had comingled personal and corporate funds or used the bank account for personal purposes.  The Court ultimately held that the plaintiff “failed to establish a causal link between the corporation’s recordkeeping and any injustice resulting from it.” 

Causal connection.  The Court’s opinion highlighted the need for a “causal connection” between an Aronson factor and the fraud against the plaintiff before the veil can be pierced.  I discussed this principle in detail in my 3/20/13 post.  The general rule is that “the fraud or injustice alleged by a party seeking to pierce the corporate veil must be caused by, or result from, misuse of the corporate form.”  In Country Contractors, the Court concluded that there was no causal link between either the alleged undercapitalization or the abuse of corporate formalities, and any injustice resulting from them.  This doomed the plaintiff’s case.

Out of luck.  The trial court had ruled in the shareholders’ favor, in part, because the corporation had filed bankruptcy and the plaintiff had “no other recourse” except as against the shareholders.  Immaterial, said the Court of Appeals:  “lack of other recourse simply is not a proper basis for piercing the corporate veil.”  If it were, any entity contracting with a company that ends up in bankruptcy could pursue its owners individually.  This would be contrary to the fundamental principles of corporate law.  However frustrating, this is simply the risk you run in doing business with a corporation, as opposed to individuals, when the corporate owners do not personally guarantee the outcome.