New Developments

Illinois on direct participation theory of parent corporation liability

In a case of first impression, the Supreme Court of Illinois has held that a parent corporation may be liable for its subsidiary corporation’s debt under the direct participation theory. In Forsythe v. Clark USA, Inc., plaintiff’s decedent was killed while working at an oil refinery owned and operated by Clark Refining and Marketing (Sub),a wholly owned subsidiary of Clark USA, Inc. (Parent). After recovering workers’ compensation payments from Sub, plaintiff sued Parent.

Plaintiff’s theory of the case was that Parent’s business strategy at the time of the accident consisted of being in “survival mode” and adopting a policy of reducing spending to “minimum sustainable levels” until Parent’s cash reserve reached $200 million. Plaintiff alleged that implementing this strategy resulted in foreseeable reductions in safety at Sub, which reductions were a proximate cause of the accident. Parent’s defense was that it owed no duty to plaintiff’s decedent simply because it owned all the stock of Sub.

Justice Garman distinguished direct participant liability from piercing theories and noted that parent corporations owe no duties to third parties to ensure that subsidiaries act with due care. However, relying on inapposite federal and state cases, Justice Garman held that a parent may be liable as a direct participant where the parent specifically directs or authorizes the manner in which an activity of the subsidiary is undertaken, that direction or authorization surpasses the control exercised as a normal incident of ownership in disregard for the interests of the subsidiary, and the harm is sufficiently foreseeability.

Here, summary judgment for Parent was precluded because evidence suggested that Melnuk, Parent’s president and Sub’s CEO, might have planned the budget cuts in his capacity as Parent’s president, might have directed or authorized the manner in which those cuts were implemented knowing that safety at the refinery might be compromised, and that he did those things superseding the discretion and interest of Sub.

To the extent that this case combines Agency law with director/officer liability under the direct participation theory (e.g., Saltiel v. GSI Consultants, Inc., casebook page 307), it seems to me to be on solid ground. The court doesn’t talk about Agency, however, but it could readily be implied by any decent business entities prof. Further, if there’s really evidence here that Melnuk’s actions as Parent’s agent were intended to cause Sub to reduce safety (or that Melnuk should have known that they would have that effect) then liability is fine with me. What this case sounds like, though, is a claim for relief for malbudgeting. That is, it may well be that Melnuk, acting as agent for Parent, devised or required a budget for Sub that required cutbacks in many areas and that costs that do not directly constrict revenues or net profits, including safety costs, would be the most natural items to cut. In the absence of more, that does not seem to me to be appropriate facts on which to hold Parent (or Melnuk, for that matter) liable.

Delaware Court of Chancery on piercing the corporate veil

The Delaware Court of Chancery has pierced the corporate veil of a corporation after finding that the sole shareholder used the corporation to perpetrate a fraud. In Midland Interiors, Inc. v. Burleigh, Burleigh formed Window Treatment & Carpet, Inc. in 1994 and was the sole shareholder, director, officer, and employee. Burleigh obtained carpet and window treatment installation jobs in Window Treatment’s name and hired subcontractors, including Midland, to perform the work. Apparently Window Treatment owned only a bank account through which the business’s money was run. The business was unsuccessful.

In March 1996 Window Treatment was declared inoperative and void for failure to pay franchise taxes. Burleigh became aware of this fact in June but thereafter caused Window Treatment to enter into additional contracts with Midland. Window Treatment defaulted and Midland sued Window Treatment in the Delaware equivalent of small claims court. At the hearing, Burleigh represented Window Treatment, acknowledged that Midland’s claim was valid, asserted that Window Treatment was going to pay the claim, and agreed to a stipulated judgment against Window Treatment of about $7,000. When payment was not made, Midland sued both Window Treatment and Burleigh in the Court of Chancery. After a trial on the merits, Vice Chancellor Parsons entered judgment against Burleigh for the original stipulated judgment.

The result here is surely right but the case is noteworthy on two grounds. First, it is one of the few Delaware piercing cases to go through trial and one of only a handful to allow piercing. Second, although Vice Chancellor Parsons disregards the corporate form, he does so using the traditional Delaware standard, which is more stringent than the standard applied by a few recent Delaware cases. Delaware has historically been reluctant to pierce and the standard requires fraud (see casebook page 282-83). However, a few Delaware federal cases have applied a more general standard of “unfairness” or “equity”, which has been referenced in a couple of Court of Chancery opinion.

Vice Chancellor Parsons quotes both standards (without acknowledging that two approaches exist) and concludes that the piercing decision requires “[C]onsideration of any fraudulent action committed under the guise of the corporate form”. The Vice Chancellor epitomized the standard by framing his inquiry as “Whether Burliegh Used the Corporate Status of Window Treatment to Perpetrate a Fraud”. He found four aspects that constituted “fraud committed by Burleigh in the name of the defunct Window Treatment”. First, Burleigh did not honor any of the corporate formalities. Second, Window Treatment was insolvent. The Vice Chancellor recognized that these, alone or combined, were not sufficient to pierce. Third, Burleigh committed fraud when he negotiated contracts with Midland knowing that Window Treatment had become inoperable and void. Fourth, Burleigh intentionally misled Midland and the small claims judge when he represented that Window Treatment would be able to pay the stipulated judgment. In a nod to the less stringent standard, Vice Chancellor Parsons held that it would be unjust to allow Burleigh to escape personal liability.

Quaere whether piercing was necessary to impose personal liability on Burleigh. When he contracted on behalf of Window Treatment, knowing that Window Treatment had been declared inoperative and void, he presumably rendered himself personally liable on those contracts. Certainly a corporation by estoppel defense would be unavailing.

Francis Pileggi also has a good post on this case (here) and a post on an earlier opinion in the case dealing with discovery problems (here).

Washington State Supreme Court on dissolution

The Washington State Supreme Court has held that an action on a post-dissolution claim must be filed within two years after dissolution. In Ballard Square Condominium Owners Association v. Dynasty Construction Co., Dynasty developed and built Ballard Square Condominiums. Dynasty was administratively dissolved and almost six years later Ballard Square’s COA sued Dynasty for breach of contract alleging that shoddy construction resulted in extensive water damage.

Justice Madsen held that a statutory amendment adopted after oral argument barred the action. The amendment created a two year statute of repose for suits against dissolved corporations and Justice Madsen held that the statute was intended to apply retroactively.

At the time the lawsuit was filed, Washington had a survival statute, based on the pre-1984 MBCA, that did not cover post-dissolution liabilities. The Washington Court of Appeals applied the common law rule that dissolution ends the corporate existence and thus bars post-dissolution suits. Justice Madsen, however, held that the legislative intent in adopting the current MBCA was to preempt the common law rule, thus the six year statute of limitations for contract actions would apply. Arguably plaintiff’s claims were timely.

However, the Washington legislature amended the survival statute in response to the Court of Appeals decision in this case. The amendment added post-dissolution lawsuits to those that must be brought within two years of dissolution. Plaintiff almost won.

MBCA §  14.07 would impose the result Justice Madsen reached before considering the legislative amendment. That is, post-dissolution claims are governed by the underlying claim’s statute of limitation. Section 14.07 also permits a corporation to limit the filing of post-dissolution claims to three years if it publishes a particular notice. The DGCL has a comparable, though more prolix, system. See DGCL §§ 278, 280, and 281.

Pedagogically, this case might be interesting to teach if you wanted to cover the question of pre- and post-dissolution litigation. See casebook page 305-306.

Colorado Supreme Court on Reverse Piercing

The Supreme Court of Colorado has held that reverse piercing of the corporate veil is a viable claim for relief. In In re Phillips (June 26, 2006), the court answered a certified question from the United States District Court for the District of Colorado. The trustee in bankruptcy of Phillips, an individual sought to recover property transferred from a corporation controlled by Phillips. To recover the property the trustee alleged that the corporation was Phillips’ alter ego and thus that the corporate transfers were actually transfers by Phillips. The court held that reverse piercing is a viable theory because its goals are parallel to those of ordinary piercing: achieving equity by disregarding the distinction between a corporation and its shareholders. The court cautioned that innocent shareholders and corporate creditors must be adequately protected before reverse piercing is imposed.

Tennessee case on the internal affairs doctrine

The Tennessee Court of Appeals had a brief discussion of an interesting question: Is piercing the corporate veil subject to the internal affairs doctrine? If so, then owners of Delaware corporations have strong protection against piercing. Delaware caselaw imposes a fairly high standard, probably requiring a showing of fraud, in piercing claims. In  Boles v. National Development Co., the court held that piercing is not subject to the internal affairs doctrine because the underlying claim was on a Tennessee judgment, therefore Tennessee law should apply.