Friday, March 9, 2012
Kentucky Supreme Court Updates Piercing the Veil Analysis
In a tour de force opinion by Justice Abramson, the Kentucky Supreme Court has reviewed and updated the analysis to be applied in piercing cases. Inter-Tel Technologies, Inc. v. Linn Station Properties, LLC, 2012 WL 593194, 2009-SC-000819-DG (
Feb. 23, 2012). Ky.
Integrated Telecom Services Corp. (“ITS”) was a subsidiary of Inter-Tel Technologies, Inc. (“Technologies”), it in turn being a subsidiary of Inter-Tel, Inc. (“Inter-Tel”). ITS, prior to its acquisition by Technologies, entered into a lease with Linn Station Properties, LLC (“Landlord”). That lease was not guaranteed by ITS’ owner, and the Landlord never requested, after ITS’ acquisition by Technologies, that Technologies guarantee the obligation. ITS defaulted on the lease and abandoned the property. In response to Landlord’s suit against ITS, Inter-Tel’s general counsel offered a default judgment, aware that ITS was judgment proof. After entry of the default judgment, Landlord brought suit against Technologies and Inter-Tel, aiming to hold them liable on ITS’ obligation.
It was ultimately determined that ITS, after its acquisition, “no longer possessed any financial independence.” Slip op. at 6. As evidence thereof, ITS did not have its own bank account, and any funds realized from the sale of equipment by ITS went into a lock box controlled by Inter-Tel. All of the employees of ITS were in fact employees of Inter-Tel, paid by it from its headquarters in
. Vendors providing goods and services to ITS were paid by Inter-Tel, and all of ITS’ inventory was provided by another subsidiary of Inter-Tel, payment therefore being reflected by the means of intercompany transfers. Inter-Tel paid ITS’ rent on the Linn Station property, and both Inter-Tel and Technologies were named insureds on the property insurance for the ITS facility on Arizona Linn Station Road. Slip op. at 6. In addition, all of ITS, Technologies and Inter-Tel in some or all years at issue had identical boards of directors and officer slates, although there was a failure to hold annual meetings. The companies were treated interchangeably on various tax returns and financial statements. Slip op. at 8-9.
Relying in part upon Professor Stephen Presser’s treatise Piercing the Corporate Veil, the Supreme Court began its analysis by a general review of the development of piercing law nationwide, and from there focusing upon “Kentucky’s seminal and leading case on the subject,” namely White v. Winchester Land Development. Slip op. at 10-13. From there it reviewed in detail the White decision and its analytic antecedent, namely Professor Campbell’s article Limited Liability for Corporate Shareholders: Myth or Matter – of Fact, 63 Ky. L.J. 23 (1975), both reciting the alternative (although acknowledged to be overlapping) theories of instrumentality, alter-ego and equity as alternative basis for piercing the veil. However, where White focused upon a discreet list of five factors under the equity formula (Slip op. at 15-16), the Supreme Court has expanded that list to eleven, namely:
a) Does the parent own all or most of stock of the subsidiary?
b) Do the parent and subsidiary corporations have common directors or officers?
c) Does the parent corporation finance the subsidiary?
d) Did the parent corporation subscribe to all of the capital stock of the subsidiary or otherwise cause its incorporation?
e) Does the subsidiary have grossly inadequate capital?
f) Does the parent pay the salaries and other expenses or losses of the subsidiary?
g) Does the subsidiary do no business except with the parent or does the subsidiary have no assets except those conveyed to it by the parent?
h) Is the subsidiary described by the parent (in papers or statements) as a department or division of the parent or is the business or financial responsibility of the subsidiary referred to as the parent corporation's own?
i) Does the parent use the property of the subsidiary as its own?
j) Do the directors or executives fail to act independently in the interest of the subsidiary, and do they instead take orders from the parent, and act in the parent's interest?
k) Are the formal legal requirements of the subsidiary not observed?,
the Court noting that “We believe that these are the most critical factors and that Kentucky courts should consider the aforementioned expanded list instead of focusing solely on the five factors identified more than thirty years ago in White.” Slip op. at 19-20.
In further clarification of White, it was made express that while either “sanctioning fraud or promoting injustice” is a basis for satisfying, in part, the alter-ego test for piercing, it remains the rule that “the injustice must be something beyond the mere inability to collect a debt from the corporation.” Slip op. at 21. Still, proof or evidence of actual fraud is not required.
Applying these factors to the case at hand, the Court had no qualms about piercing both ITS and Technologies in order to hold Inter-Tel liable on the obligation at issue having stripped ITS of the opportunity to operate as a distinct legal organization holding assets with which to satisfy its obligations. In this respect, the Inter-Tel decision parallels the holding of the U.S. District Court in the Hornblower decision, it piercing where the subsidiary was stripped of all income by the parent while being left with exposure to third parties under its contractual obligations. Louisville/Jefferson
Government v. Hornblower Marine Services – Kentucky, Inc., 2009 WL 3231293 (W.D. Ky. 2009) County Metro
The Supreme Court disposed of argument by Technologies and Inter-Tel to the effect that they should not be bound by the default judgment entered against ITS on the basis they were not before the Court. The Court dismissed this argument, finding that, as ITS would be pierced to hold Technologies and Inter-Tel liable on its debts and obligations, such would include liability on the default judgment. Ergo, those subject to exposure on a piercing claim are not going to be afforded the opportunity to re-litigate the underlying liability.
One troubling aspect of this decision is that the Supreme Court noted (although it did not otherwise expand upon the holding by the trial court) that piercing was available on the basis that ITS was the instrumentality or alter-ego of its parents “operated by them to achieve tax benefits and avoid various liabilities.” See, e.g., Slip op. at 3; id. at 9 (“[Members of company management] explained ITS was continued as a separate entity after its acquisition by Technologies so that Inter-Tel could gain a tax advantage by offsetting income from other subsidiaries against ITS’ net operating loss.”) While manifestly dicta, these statements unfortunately perpetuate the views that the utilization of a distinct entity for the segregation of liabilities or for achieving desired consequences under the tax code is somehow suspect and justifies piercing. Hopefully, the point is no more than the utilization of a subsidiary to generate tax advantages for the parent even as creditors go unpaid is inequitable but not of itself sufficient to justify piercing.
Another quibble with the decision is the suggestion that the Kentucky Business Corporation Act, KRS 271B.-220(2), gives “statutory recognition to the veil-piercing doctrine.” Slip op. at 21. It is this provision of the Kentucky Business Corporation Act that provides that the limited liability normally afforded a shareholder does not protect a shareholder from “personal [liability] by reason of his own acts or conduct.” Simply put, this provision relates not to a piercing analysis, piercing being premised upon the misuse of the corporate form, but rather upon an agency analysis whereby one who acts on behalf of the business organization is not protected from personal liability for his own torts. See also Thomas E. Rutledge, The 2010 Amendments to Kentucky’s Business Entity Laws, 38 N. Ky. L. Rev 383, 384-88 (2011). Rather, at this time, piercing is and remains, in the context of a business corporation, purely an equitable doctrine arising under the common law.