If you’re going to move money around from one project to another when your company is insolvent, i.e., “when the present fair salable value of his assets is less than the amount of that will be required to pay his probable liability on his existing debtors as they become absolute and matured,” you do so at your own peril.

“Why?” you ask.

Because a New York court may invalidate the transfers retroactively, finding that they are a fraudulent conveyance – even if these transfers were made innocently – if the conveyances were made without fair consideration.

And the danger doesn’t end there; if the court finds that the funds were commingled with individuals’ accounts (among other things), then the court may allow the plaintiff to pierce the corporate veil and hold those people behind it personally liable for these debts. (For more on this topic, please see “Piercing the Corporate Veil – Critical Facts that You Will Need to Prove Your Case Under New York Law“).

That’s not to say that a court will allow a corporate veil to be pierced lightly; as we pointed out previously, there are several facts that a plaintiff will need to prove in order to successfully pierce the corporate veil. And this is a difficult burden of proof.

But on the other hand, as happened in the recent decision of Fernbach, LLC v. Calleo, a court may also be disinclined to dismiss these claims out of hand at the beginning of the case.

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As noted in our earlier article, “Piercing the Corporate Veil – Critical Facts that You Will Need to Prove Your Case Under New York Law,” it is not an easy task to amass sufficient facts to survive an initial motion to dismiss a claim that seeks to pierce a corporation’s veil – let alone prove those facts at trial.

That’s why when a court allows those claims to survive – at least initially – the facts of those cases are noteworthy.

In Safety Management Systems, Inc.  v. Safety Software Unlimited, the defendant in this commercial litigation lawsuit sought court leave to amend its answer to assert additional counterclaims seeking to pierce the corporate veil. In support of its argument for allowing the amendment, the defendant claimed the following:

• That the plaintiff corporation was wholly owned by the individual plaintiff ;
• that the plaintiff paid herself and her employees unsustainably high salaries;
• That the plaintiff diverted corporate funds to her personal account;
• That the plaintiff co-mingled funds with her corporation.

Assuming these allegations are true is it any wonder that the court allowed this claim to survive?

I thought not.

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You may be wondering what valuable, relevant  lessons can possibly be gleaned by a small business with a comparatively simple breach of contract matter from the Bhopal disaster (remember that environmental disaster from years ago?).

The answer is, quite a bit.

For one thing, in Sahu v. Union Carbide, a New York federal judge recently denied the plaintiffs’ request for additional discovery on the issue of the relationship between all the assorted corporate entities that were involved.

Why is this significant?

Because it serves as an important reminder that a court will not give you wide latitude to conduct a fishing expedition in order to help you pierce the defendants’ corporate veil.

www.youtube.com/watch?v=qdvSBxFv6ko

Before you go down that path, you are likely going to need some good faith basis for asserting that the company was a sham, and essentially the alter ego of an officer or one of the other corporations involved.

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If the unsubstantiated claims of this plaintiff are actually true, then I feel bad for the plaintiff.

But, as noted by the Court, therein lies the problem: the allegations are unsubstantiated.

In Lecce Penn Co. SPA v. Adrenaline Marketing & Promotions, Inc., the plaintiff sued in breach of contract and fraud to recover over $300,000 that they were purportedly owed. Fair enough.

But the plaintiff took it a step further: they tried to sue one of the shareholders of the defendant corporation personally.  Unfortunately for the plaintiff, they had no competent proof that this individual did anything that should have resulted in his being held personally liable for the corporate debt; in fact, the plaintiff did not even allege that he did anything that should have entitled them to pierce the corporate veil.

The thing that troubles me about this case is simply this: while I can understand that there are instances where the proof you expected to become available to support your claim doesn’t materialize, I don’t understand how the complaint itself can even fail to have any of the requisite allegations to support a claim seeking to pierce the corporate veil. That’s just poor draftsmanship.

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In a strongly worded -- and educational -- opinion, a New York Federal Judge went out of his way to delineate what allegations suffice, and in White v. National Home Protection, Inc., what did not suffice, to survive dismissal on a claim seeking to pierce the corporate veil.

www.youtube.com/watch?v=qdvSBxFv6ko

In granting the defendants’ motions to dismiss these claims, the Court held as follows:

“[F]indings that corporation ‘fail[ed] to observe corporate formalities…had no contracts, no employees, and no independent office space…had no separate bank account…[and] no capital or assets at the time of trial’ insufficient to warrant finding of ‘domination’ … Indeed, plaintiff makes no allegation that the individual defendants intermingled personal and corporate funds, failed to deal with NHP on an arms-length basis, or in any meaningful way abused or disregarded the corporate form.

“Moreover, even if her allegations were sufficient with respect to domination, ‘complete domination of the corporation…standing alone, is not enough … Rather ‘[t]he party seeking to pierce the corporate veil must establish that the owners, through their domination, abused the privilege of doing business in the corporate form to perpetrate a wrong or injustice against that party such that a court in equity will intervene.’ Here, plaintiff makes no such allegation, contending solely that the corporation—as a corporation—perpetrated a fraud. Such allegations do not warrant veil piercing.”

Just another reminder why it is so difficult to pierce the corporate veil.

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In Geneva Capital Corp. v. American Lending Services, LLC, a decision that was reported in last week’s New York Law Journal, a New York County trial judge acted in Solomonic fashion: she dismissed some of the claims, while letting stand other claims, including the plaintiff’s claim seeking to hold the individual defendant personally liable for the corporate defendant’s alleged breach of contract.

The interesting part of the decision is not the particular holding in this case; it’s the Court’s succinct primer on the required elements to successfully plead the following claims in the breach of contract context:

• piercing the corporate veil;
• fraud;
• promissory estoppel; and,
• unjust enrichment.

(The latter two categories are known under their legal term, “quasi-contract”). Parenthetically, just because the judge dismissed part of the case, doesn’t mean she was wrong. To the contrary, her decision looks like it’s right on.

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In today’s edition of the New York Law Journal, there was an interesting decision from a New York County trial court in a breach of contract case, Garber v. Inter Capital Resources LLC. In this case, the plaintiff was a commission salesman who sought to recover the commissions that he purportedly earned – but was never paid – for the second and third quarters of calendar year 2008.

The underlying, earlier decision from which this more recent decision stems is even more important, because it serves an important reminder to attorneys litigating breach of contract and breach of employment agreement cases: make sure that your causes of action are not only supported with specific factual allegations, but that they are also separately and distinctly pled.

In short, since the Court found that the plaintiff had not particularized any specific violations of the Labor Law, but had only set forth enough facts to sustain a common law (as opposed to statutory) breach of contract claim, the plaintiff was not entitled to recover statutory damages under the Labor Law, and therefore, the Court dismissed the plaintiff’s claims seeking to recover liquidated damages and attorney’s fees based upon the defendants’ alleged violations of Labor Law § 198 (1-a), stating: “Breach of contract claims do not give rise to the relief afforded under Labor Law §198 (1-a). See Gottlieb v. Kenneth D. Laub & Co., Inc., 82 NY2d 457, 464 (1993); Pachter v. Bernard Hodes Group, 10 NY3d 609 (2008).”

One final note: since the plaintiff failed to allege enough factual particulars, his attempt to pierce the defendants’ corporate veil failed as well.

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Many small businesses’ recurring nightmare, particularly in this economy, looks something like this:

Debtor D (we’ll call him “D,” for short) owes you tens of thousands of dollars for product that you delivered months ago. When you inquire as to what the delay is in receiving payment, you get a run-around, and ultimately find out that D’s company was taken over by a small, closely held company whose priorities clearly do not include paying your bills.  By now, you’ve put them on formal notice that unless D pays the bills in full, a breach of contract suit will be brought.

Recognizing that he will have no viable defense to your claim, the principal of D does what many short-sighted executives do: he divests the company of as many assets as possible, as quickly as possible, transferring properties into the name of his wife and other family members for little or no consideration. While many people in your situation would throw up their hands at this point, that may prove to be a terrible mistake. And that is because they are likely unaware of the doctrine of constructive fraud – the cousin of the alter ego/piercing the corporate veil doctrine.

Unlike common law fraud principles, which require a showing of intent to defraud (which is difficult to prove), New York’s Uniform Fraudulent Conveyance Act (‘UFCA’), as codified in Article 10 of the Debtor and Creditor Law at §§ 270-281, has several provisions that do not require a claimant to prove that the defendant had actual intent to commit a fraud, and some of these provisions, such as section 273-a (entitled “Conveyances by
defendants”), was specifically drafted to prevent debtors from escaping their obligations in a lawsuit. This doctrine is commonly referred to as “constructive fraud.”

There is one important catch, however: in New York, as in other jurisdictions, “[A] transfer may not be challenged as fraudulent unless it prejudices the complaining creditor.” In other words, in determining whether a creditor has been prejudiced, courts consider what rights, if any, the creditor would have had to levy on the property had the challenged conveyance not occurred. And if the creditor (i.e., you) would never have been able to recover any of that money because your claim was so far back in line of the creditors, you will still be out of luck.

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Strange as it may sound, there are times that you can reap the benefit of a contract’s provisions even if you had nothing to do with the contract at the time it was signed. And this is exactly what happened in Corbett v. Firstline Security, Inc., et al.

In this case, the plaintiff sued to recover damages against her alarm company following a burglary.  At one point during the contract period, Firstline was acquired by ADT, a large home security alarm company. The Court’s decision which dismissed the claims against the defendants is significant for two (2) reasons:

1. The Court held that “courts applying New York law will enforce a shortened statute of limitations when it is reasonable and agreed to by contract.” (The Court also noted that reducing the claim period to one year is not unreasonable as a matter of law.) See, e.g., Cab Associates v. City of New York, 32 A.D.3d 229, 323, 820 N.Y.S.2d 21 (N.Y. 2006); and,
2. As a general rule, a party may not invoke the provisions of a contract to which it is not an original party. There are limited exceptions to this rule, however,  which include the following theories: (1) assumption;  (2) piercing the corporate veil or alter ego; (3)  incorporation by reference; (4) third-party beneficiary theories; or, (5) waiver [or] estoppel. Arthur Andersen LLP v. Carlisle, 129 S.Ct. 1896, 1902, 173 L.Ed.2d 832 (2009).

Here, the Court held that “assumption” was applicable.  Since the original Alarm Services Contract with Firstline Security Inc. specified that any lawsuit be brought within one year of the event that causing loss, damage or liability, ADT was also entitled to the benefit of that contractual provision, rendering plaintiff’s claim untimely.

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In light of my previous columns (see, e.g., Piercing the Corporate Veil – Critical Facts That You Will Need to Prove Your Case and, from earlier today, No Personal Liability For Corporate Fraud, Court Holds) setting forth some of the difficulties in piercing the corporate veil, here’s a “hot-off-the-presses” decision from a Federal judge in New York which highlights one fact scenario where the courts will allow these claims to proceed.

In Robles v. Copstat Security, Inc., the plaintiffs brought a proposed class action on behalf of a class of all security guards employed by Copstat Security Inc. (Copstat Inc.), Copstat Security LLC, and Andrews International Inc. after the defendants allegedly failed to pay the plaintiffs’ earned overtime pay in violation of the Fair Labor Standards Act (FLSA) and New York’s Minimum Wage Act.

Although the Court noted that the plaintiffs’ allegations in support of their claim that the corporate veil should be pierced were rather “general and vague” (suggesting that these claims may later be dismissed unless additional facts are fleshed out), the Court also refused to dismiss the claims against the individual defendant Bellistri at the initial pleading stage. The Court cited plaintiffs’ claim that the defendants’ corporate veil should be pierced because Bellistri, as the lone shareholder of Copstat, exercised complete domination and control over Copstat, and in that role, Bellistri left the company terribly undercapitalized when he unilaterally took nearly all of Copstat’s assets, and thereby left the corporate defendants unable to satisfy any adverse judgment.

From a practical standpoint, it remains to be seen what the plaintiffs gain by the denial of the individual defendant’s motion to dismiss, because unless the plaintiffs have, or later uncover, facts that support their contention that the corporate veil should be pierced, they may be merely prolonging the ultimate dismissal of these claims.

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