George Bundy Smith and Thomas J. Hall
George Bundy Smith and Thomas J. Hall ()

New York is highly protective of corporate shareholders, shielding them from the liabilities of their corporations.1 Indeed, eliminating the potential personal liability of corporate principals is viewed as the primary “and completely legitimate” purpose of incorporating.2 If misused, however, this privilege is revocable. In rare circumstances, courts may pierce the corporate veil to impose a corporation’s liabilities on its shareholders to avoid fraud or other wrongful conduct.3 Although the party seeking to pierce a corporation’s veil bears a “heavy burden,”4 such an action may be justified when it is proven that (1) a principal of a corporation, through complete domination, abuses the corporate form, and (2) such abuse was used to commit a fraud, wrong or injustice against the plaintiff seeking to pierce the veil.5

As recent Commercial Division decisions make clear, abuse of the corporate form is not enough. Not only does a party seeking to pierce the corporate veil also need to prove a fraud, wrong or injustice committed against it, that party must also establish a causal connection between the abuse of the corporate form and the wrongful conduct for which relief is sought.

Abuse of the Corporate Form

The first element that must be proven to pierce the corporate veil is that the corporate form was abused by its principals. The factors that courts will consider in making this determination include (1) failure on the part of the entity to adhere on corporate formalities, (2) inadequate capitalization, (3) commingling of assets, and (4) use of corporate funds for personal purposes.6 Whether an abuse has occurred, however, is only part of the equation.

Abuse Must Cause the Wrong

A critical component of piercing the corporate veil is establishing that the abuse of the corporate form led to a fraud, wrong or injustice against the party seeking to pierce the corporation’s veil. Obviously, to begin to establish this element, a temporal relationship must be established between the corporate form abuse and the wrong. As the New York Court of Appeals held in Morris v. Department of Taxation,7 “[w]hile complete domination of the corporation is the key to piercing the corporate veil, especially when the owners use the corporation as a mere device to further their personal rather than corporate business, such domination, standing alone, is not enough; some showing of a wrongful or unjust act toward plaintiff is required.”

In Morris,the Court of Appeals reversed a veil-piercing finding against a corporation’s president and sole director where the New York Department of Taxation sought to impose on him liability for a use tax arising from the corporation’s purchase of two cabin cruisers allegedly used by the president for other purposes. Curiously, the corporation itself owed no such tax as it was entitled to a non-resident exemption. Its president, however, owning a New York apartment, had no such exemption. The lower court had pierced the corporate veil, finding the president dominated the corporation and, thus, was liable for the tax.

On appeal, the Court of Appeals found it unnecessary to review the lower court’s finding of abuse of corporate form because it found the second element—that the abuse of the corporate form accomplished a fraud or other wrong—to be lacking. The court held that the state had failed to establish that the president, “through his domination, misused the corporate form for his personal ends so as to commit a wrong or injustice on the taxing authorities of New York State.”8 Noting that piercing the corporate veil is not a cause of action independent of a claim against the corporation, the court found that there could have been no wrongful act committed through such alleged domination because the corporation, being a non-resident, owed no tax.

Wrong Not Linked to Abuse

Other recent Commercial Division cases drive this point home. For example, in Vivir of LI, v. Ehrenkranz,9 plaintiff homeowners had obtained a judgment against their contractor for claims arising from the construction of their residence. The plaintiffs sought to enforce that judgment against the contractor’s owner by piercing the corporate veil. In a July 2014 trial decision, Justice Emily Pines of the Suffolk County Commercial Division found that, even though the construction company failed to observe proper corporate form in its transactions with its owner and other entities, there was no connection between any of these abuses and the wrongs that were the basis for the homeowners’ judgment. The court further found that alleged improper distributions and other abuses of the corporate form occurred before the company and its owner even knew that both homeowners were contemplating a claim, and thus could not provide a justification for piercing the corporation’s veil.

Citing the Court of Appeals decision in Morris,Pines found that “[t]he mere fact that a corporation was completely dominated of the owners and acted as their ‘alter ego’ without more, will not suffice to support the equitable relief sought.”10 The court observed that a necessary element of piercing the corporate veil is that the complete domination of the corporation “was used to commit fraud or wrong against the plaintiff which resulted in plaintiff’s injury.”11

Indeed, although the court found that the principal had dominated and controlled the corporation, it found that “such is not only common in closely held corporations, but it is simply not sufficient to apply the remedy sought herein.”12 The court concluded that “this is not a case where these actions were done in order to commit a wrong or fraud on” plaintiffs.13

In A&M Global Management v. Northtown Urology Associates,14 a landlord sought to recover damages stemming from a medical practice tenant’s default in paying rent. The medical practice had been owned by two physicians. Several months before the non-payment, one physician owner resigned from the practice and moved out of state. In lieu of cash in return for his ownership stake, he accepted medical equipment and furniture from the practice upon his resignation. The Appellate Division, Fourth Department, affirmed the decision by Justice John Michalek of the Erie County Commercial Division not to pierce the practice’s corporate veil as to this departing owner.

The court found that the wrongful act at issue, failing to pay rent, was unrelated to that physician’s running of the company—even if he dominated and controlled the company prior to his departure—as he left the practice before the rent default. Moreover, the court found that the transfer to him of medical equipment and furniture was a bona fide payment for his ownership stake. As the landlord could not establish that it constituted a fraudulent transfer, it could not establish the wrongful act required to pierce the corporate veil.

The court did pierce the veil as to the remaining owner, finding that he abandoned the practice to join a larger medical group nearby, bringing his patients with him. In addition, in winding down the practice, that physician used his practice’s funds to satisfy a line of credit for which he was personally liable. The Appellate Division agreed with Justice Michalek that these transfers were fraudulent conveyances and, because the abuse of the corporate form was directly tied to the wrong against the landlord, affirmed the piercing finding as to him.

Recent Commercial Division cases that have pierced the corporate veil have found a clear link between the abuse of the corporate form and the wrongful act. For example, in 135 E. 57th St. v. 57th St. Day Spa,15 a landlord sued its tenant and its two corporate parents to recover for nonpayment of rent. The landlord claimed that a series of fraudulent conveyances between the tenant, its owners and their principals should be set aside and that the corporate veil between the tenant and its owners should be pierced to allow it to recover the judgment from the owners and their principals. In a July 7, 2014, decision, Justice Charles Ramos of the New York County Commercial Division granted summary judgment dismissing the case against one of the owner’s principals but denied dismissal of the other owner’s principal.

The court found that the tenant had committed routine abuses of the corporate form with respect to the other corporate owner, many of which were related to the conveyances the landlord claimed were fraudulent. Because that principal had allegedly received a $200,000 payment that the landlord alleged was fraudulent, that owner was denied summary judgment.

In Burberry v. RTC Fashion,16 the owner of the Burberry trademark obtained a judgment against a counterfeiter, which it thereafter sought to enforce against the counterfeiter’s shareholder. Justice Louis B. York of New York County Commercial Division found that the counterfeiter corporation failed to observe any substantive corporate form as it had no regular meetings or elections of directors or officers, was undercapitalized, and did not retain any corporate minutes or records. The counterfeiter corporation’s sole owner used corporate funds for personal use and the corporation was forced to obtain several loans to stay operational, suggesting that the corporation did not retain enough of its earnings and was undercapitalized.

The court found that the owner’s “license” of the counterfeiter corporation’s domain name to another of the owner’s companies for a nominal fee, which was never shown to have been paid, was a fraudulent conveyance that depleted the corporation of its assets and frustrated Burberry’s attempts to recover its judgment. Given the obvious link between the owner’s dominance of the company and the fraudulent conveyance that damaged the plaintiff’s ability to recover on its judgment, the court pierced the corporate veil.

In Webmediabrands v. Latinvision,17 the plaintiff invested money in the defendant corporation. After that investment failed, the plaintiff sued and obtained a judgment against that corporation. Thereafter, the investor sought to enforce this judgment against the corporation’s shareholder by piercing the veil.

Justice Marcy Friedman of the New York County Commercial Division found that the owner had failed to maintain any semblance of a corporate structure in either of his companies. As to the causal link between this abuse and the wrong to the plaintiff, the court found the owner frequently commingled funds between himself and the companies and between the companies themselves, repeatedly used corporate credit cards for personal use, and made more than 40 withdrawals from the company totaling approximately $120,000. On summary judgment, the court pierced the corporate veil.

Conclusion

Even where corporate principals or shareholders are found to have exerted complete and improper dominance and control over their corporations, used them as their alter egos or even misused the corporate form for their own personal gain, without a showing that such activity resulted in the fraud, wrong or injustice to the party that seeks relief for such wrong, New York courts have refused to pierce the veil. A causal connection between the abuse of the corporate form and the wrong to the plaintiff must be established to be entitled to such relief.

Endnotes:

1. 135 E. 57th St. v. 57th St. Day Spa, 2014 WL 3373434, 2014 NY Slip Op 31802(U), citing Retropolis v. 14th St. Dev., 17 A.D.3d 209, 210 (1st Dept. 2005).

2. Vivir of LI v. Ehrenkranz, 44 Misc.3d 1213(A), 2014 WL 3616205, 2014 N.Y. Slip Op. 51108(U).

3. 135 E. 57th St., at *10; see also Matter of Morris v. New York State Dept. of Taxation & Fin., 82 N.Y.2d 135, 140, 603 N.Y.S.2d 807, 810 (1993).

4. Webmediabrands v. Latinvision, 2014 WL 1052085 at *2, 2014 NY Slip Op 30700(U), citing ABN AMRO Bank v. MBIA, 17 N.Y.3d 208, 235 (2011).

5. Id.; see also ABN AMRO Bank, supra, Matter of Morris at 141, 135 E. 57th St. supra and Vivir of LI, supra.

6. Vivir of LI, at *11, citing Superior Transcribing Services v. Paul, 72 AD3d 675, 8978 N.Y.S.2d 234 (2d Dept. 2010).

7. Matter of Morris at 141 (citation omitted).

8. Id. at 143.

9. Vivir of LI, supra.

10. Vivir of LI, at *11.

11. Id., citing Matter of Morris.

12. Id. at *13.

15. Id.

14. A&M Global Management v. Northtown Urology Associates, 115 A.D.3d 1283, 983 (4th Dept. 2014).

15. 135 E. 57th St., supra.

16. Burberry Ltd. v. RTC Fashion, 2014 WL 1996353, 2014 N.Y. Slip Op 31232(U).

17. Webmediabrands, supra.