Friday, November 2, 2012

Does the Rednour Decision Have Any Continuing Viability?

Does the Rednour Decision Have Any Continuing Viability?

      I have on several occasions been asked whether the Rednour decision continues, after Inter-Tel, to have any continuing viability.  Cutting to the chase, I believe the Rednour decision should be now a dead letter with no continuing effect on Kentucky law. 
      Rednour is a decision of the Kentucky Court of Appeals in which a divided panel upheld a trial court’s determination to pierce the veil of an LLC.  The decision is, at best, weak.  Without engaging in any analysis, and particularly failing to identify what fraud or injustice had taken place vis-à-vis the plaintiff, the veil of the LLC was set aside on factors including that the LLC had a single member, that the single member was the registered agent, and that the LLC had been set up for liability protection and for tax planning purposes.  A detailed exposition of the decision and its failings has been published in a three-part review available here:  LINK 1, LINK 2 and LINK 3.
Inter-Tel Technologies v. Linn Station Properties
      In February of this year, the Kentucky Supreme Court issued its unanimous decision (written by Justice Abramson) in Inter-Tel Technologies v. Linn Station Properties, 360 S.W.3d 152 (Ky. 2012), thereby adopting a new test in Kentucky for piercing the veil, and in so doing superseded White v. Winchester Land Development, 584 S.W.2d 56 (Ky. App. 1979). Under the new test, a series of eleven factors are examined as the first step in determining whether the veil of a corporation should be pierced, 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?  360 S.W.3d at 163-64.
      Assuming some subset of those factors have been sufficiently satisfied (the Supreme Court’s decision does not identify either a minimum number of the factors that must be satisfied or contain a weighting between them, although it did indicate that grossly inadequate capital, egregious failures to see to required formalities and disregard of the subsidiary’s separateness and domination of day-to-day decisions were most crucial; 360 S.W.3d at 164), the second step of the analysis can be undertaken, namely whether there has been a fraud or injustice perpetuated upon the plaintiff.  360 S.W.3d at 163-65. Only if such a fraud or injustice is shown is piercing then permitted.
Responses to Rednour
      The plaintiff applied to the Kentucky Supreme Court for discretionary review of the Rednour decision.  The Supreme Court denied discretionary review but did order that the decision of the Court of Appeal’s not be published; why the Supreme Court did not remand the case for reconsideration in light of Inter-Tel is simply beyond me, but that is a discussion for another day.  In addition, the 2012 General Assembly enacted amendments to both the business corporation and LLC acts, each amendment providing, inter alia, that the fact that a corporation has a single shareholder or that an LLC has a single member is not of itself justification for setting aside the otherwise applicable rule of limited liability.  See 2012 Ky. Acts, ch. 81, § 88 (creating KRS § 271B.6-220(3)); id. § 105 (amending KRS § 275.150(1)).
      As matters stand today as to the Rednour decision:
·                     The Kentucky Supreme Court has ordered the opinion not to be published;
·                     The General Assembly has expressly precluded (The Rednour decision was expressly identified to the Kentucky General Assembly in the course of the explanation of the need for the statutory amendments.) treating single shareholder/single member status, of itself, as a justification for piercing;
·                     The factors set forth in Inter-Tel justifying piercing do not include planning for liability protection;
·                     The factors set forth in Inter-Tel justifying piercing do not include tax planning; and
·                     The notion that piercing is justified because the sole member is as well the registered agent is so preposterous that it never should have been uttered but, again, the Inter-Tel decision did not identify that as a factor that justifies piercing.

Note, however, that there is unfortunate dicta in Inter-Tel that may be read to support tax planning as a justification for piercing.  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, this language unfortunately perpetuates the view 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.
      None the less, it is my assessment that the Rednour should be treated as an aberration having no further precedential value. 

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