Thursday, February 23, 2017

Kentucky Court of Appeals Affirms Piercing the Veil

Kentucky Court of Appeals Affirms Piercing the Veil

      In a decision rendered last Friday, the Kentucky Court of Appeals affirmed the determination that the veil of an LLC should be pierced, primarily on the basis, it would appear, that the company was undercapitalized. Roscoe v. Angelucci Acoustical, Inc., No. 2012-CA-001933-MR, 2014-CA-000536-MR, 2017 WL 655488 (Ky. App. Feb. 17, 2017).
      In 2006, Lexhold Partners II Lot 14-A Exclusive, LLC (“Lexhold Partners”) was awarded the contract to construct a building now occupied by Hewlett-Packard. Although, apparently, the property is owned by the University of Kentucky, Lexhold Partners holds the lease vis-a-vis Hewlett-Packard. In order to affect this project, another LLC, Lexhold Premier Commercial Contractors, LLC (“Premier”), was formed. Upon completion of the project, Premier was dissolved. Roscoe, one of the defendant in this action, was one of the two “managing partners” of each of Lexhold Partners and Premier. It should be noted that, throughout this opinion, partnership and corporate terminology is intermixed even as the decision is about an LLC.
       Premier subcontracted with Angelucci Acoustical, Inc. (“Angelucci”) for the installation of drywall and acoustical ceilings. That subcontract had a price of $396,240.30. The building was completed, and occupancy undertaken, even as Angelucci continued to complete certain tasks. Angelucci alleged that it incurred an additional $88,053.70 in completing those additional task, while Roscoe alleged that they were simply additional punchlist items included in the original purchase price. Angelucci filed suit against Premier, Lexhold Partners and Roscoe seeking those additional amounts. Angelucci sought and was awarded partial summary judgment; that ruling became final, and Roscoe did not appeal.
       Nearly a year later, on bases not fully identified in this decision, the trial court pierced the “corporate” veil of Premier (the general contractor) to hold Roscoe liable on the $88,053.70 (plus interest) judgment. This appeal followed. However, in connection therewith, Roscoe did not file a supersedeas bond. Roscoe thereafter failed to comply with requirements as to judgment discovery and, notwithstanding having entered into a settlement agreement in the amount of only $30,000, he failed to discharge that obligation. After hearing, the trial court issued a judgment against Roscoe totaling $334,785.34, which amount included compensatory and punitive damages and attorney’s fees. Roscoe then filed this appeal.

      With respect to the piercing claim, the decision of the Court of Appeals is somewhat cryptic as to why that was permitted. It appears that facts justifying piercing were as follows:
·         “the two managing members of the Lexhold Partners are the same to managing members of Lexhold Premier, Roscoe and Oliver. They developed Lexhold Premier Commercial Contractors, LLC solely for the purpose of serving as the general contractor for the project. This construction project was the only asset of Lexhold Premier.”; and
·         in two instances, Lexhold Partners was identified as the “owner” of the property (Angelucci was not a party to either of these agreement).
Quoting from the trial court, the Court of Appeals observed that:
As in Inter-Tel, Lexhold Partners caused Lexhold Premiere to be obligated to pay Angelucci for work performed on the subject property and then rendered it unable to pay. Lexhold Partners limited the value of the sole asset of Lexhold Premiere and caused it to bear the brunt of the failure to pay subcontractors while Lexhold Premiere derive the benefit of the improvements to real property by its lease agreement with the landowner and agreement with HP.
Similarly, it appears that the second scenario identified in Inter-Tel applies as all assets that could or should have been part of Lexhold Premiere were moved beyond the reach of legitimate creditors and have been retained largely by Lexhold Partners. Roscoe concedes that Premiere was formed for the sole purpose of trying to escape the hassles and liabilities associated with being a general contractor[,] and he and Oliver wanted to keep the money “in house.” Premiere had no assets other than the $5,247,000 contract with Lexhold Partners and was in Roscoe’s terms a “pass-through.” Moreover, Partners has reaped all of the benefits from this construction project and currently receives revenue from its lease with the sole tenant of the building, Hewlitt-Packard. That was the purpose of its original lease with “Commonwealth of Kentucky for the use and benefit of the University of Kentucky acting by and through the Board of Trustees of the University of Kentucky.” To allow Partners and Roscoe to escape liability under these circumstances would, in fact, sanction fraud and promote injustice against Angelucci and the other subcontractors.
      What steps were undertaken by Roscoe in order to render Lexhold Premier unable to satisfy its obligations, thereby effectuating a fraud, was not detailed by the Court of Appeals. In the underlying opinion and order issued by the Fayette Circuit Court (Judge Goodwine), it had been found that:
[B]oth Lexhold Premier and Lexhold Partners worked on the same project and had no other business. Lexhold Premier’s sole asset was its contract with Lexhold Partners. The two companies have the same member-managers and nearly identical operating agreements. Minutes were not kept for company meetings. Bill Boshong performed work for both entities but Lexhold Partners paid the entire amount of his bill. Derek Roscoe only performed work for Lexhold Partners but was paid by Lexhold Premier as well. Lexhold Partners paid cost attributable to Lexhold Premier, and vice versa. Slip op. at 8.
Then, after reciting a number of other circumstances in which the companys’ assets were apparently intermingled, it was observed that:
It is clear to this Court that Lexhold Partners and/or Roscoe exercise complete dominion and control over Lexhold Premier. Roscoe and/or Oliver provided for or guaranteed 100% of the startup costs to fund Lexhold Premier. They set the contract amount of $5,247,000 that they would pay Lexhold Partners, i.e themselves. There is no evidence that Lexhold Premier followed any corporate formalities; Roscoe and/or Oliver used the companies’ that funds interchangeably and funds from one paid the expenses of the other. Whether premier was paid the $5,247,000 due under its contract with Partners was solely within the discretion of Partners. Roscoe conceded that Premier paid him certain “expenses which connected to his work" on the project. He also conceded that he directed Premier to pay his son sums that he believed were due him. Slip op. at 10.

      The court would go on to find that the assets of Lexhold Premier, the general contractor, had been “moved beyond the reach of legitimate creditors and have been retained largely by Lexhold Partners,” with the result that “Partners has reaped all of the benefits of this construction project and currently receives revenue from its lease with the sole tenant of the building, Hewlett-Packard. … to allow Partners and Roscoe to escape liability under these circumstances would, in fact, sanctions fraud and promote injustice against Angelucci and the other subcontractors.” Slip op. at 11-12. Again, how the assets were moved so as to be unavailable to Angelucci and other creditors is not detailed.
      From that same order it becomes clear that the question of the name of the property owner relates to a challenge to Angelucci’s mechanics lien.
      From the perspective of the law of piercing, this decision is in several respects disturbing. First, while on the facts piercing may have been justified, the Court of Appeal’s affirmance without a detailed recitation of those facts leaves the reader wondering what truly happened. Second, the continued reference to the “corporate” veil in the context of an LLC is simply incorrect and as well glosses over the problem that the courts have not identified whether and to what extent the Inter-Tel Technologies test for piercing will be different for LLCs versus corporations. Third, justifying, at least in part, the piercing of an LLC based upon the failure to satisfy “corporate formalities” is at best confusing. While corporations are obligated to have meetings and keep minutes, the LLC Act does not require either meetings or minutes. If, in this particular case, the operating agreement dictated that meetings would be held and minutes kept, then there may have been a failure to follow a contractually assumed obligation. If that was the case, it was not detailed by either the Court of Appeals or the trial court. Conversely, if there was no such contractual obligation, supporting a ruling on piercing based upon the failure to do what is not required is nonsensical.
      More broadly, the courts’ language with respect to related special-purpose business organizations is very troubling. Blanket statements to the effect that the companies were related and had the same members/management structure, and on that basis piercing was justified, dangerously simplifies proper piercing analysis. It has long been the law that the organization of various business ventures for the purpose of limiting liability (i.e., partitioning various asset pools into different ventures with the intent and objective of exposing each to only a certain class of creditor claims) is an accepted business practice. There is no question that the utilization of these structures in an abusive manner should not be allowed and that piercing should be a possible remedy for that abuse. The structures themselves are not, however, ab initio abusive or improper, and flippant language to the effect that related ventures should, for that reason, be pierced is unjustified. Rather, while related, special-purpose entities may be particularly at risk for violating the rules as to when piercing is justified, there should not be any implication that piercing is justified because of relatedness.

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