Are You Protected?
We see it happen a lot. A business will set up a LLC, assume they are totally shielded from personal liability and go about business as usual. And while there is no doubt that proper use of a corporate form is essential to shield owners from liability, it is not foolproof. The courts have the power to pierce the corporate veil under certain circumstances. For more information, feel free to read the article we wrote on piercing the corporate veil. Based on a recent New Mexico case, Morrissey v. Krystopowicz, we decided to look at this important concept again.
Piercing the Corporate Veil
If you are not familiar with the concept: here is a brief refresher:
A corporation is a distinct legal entity. Generally speaking, it is treated separately from its shareholders. Because of this, owners are not usually liable for the corporation’s debts. In certain circumstances, however, a court can require shareholders to answer for a corporation’s liability. This is called “piercing the corporate veil.”
Piercing the corporate veil has been called an “extraordinary” remedy, and it is only available under special circumstances. To pierce the veil, a plaintiff must show:
- The corporation was not operated legitimately, but was operated and controlled for the purposes of some dominant party,
- The corporation was used for an improper purpose, and
- There was a relationship between the defendant’s actions and the injury to plaintiff.
Morrissey v. Krystopowicz
In Morrissey, a nursing home patient died and the estate obtained a $4.8 million judgment against the nursing home. The nursing home was owned by a LLC, which was owned by a holding company that was wholly owned by Mr. Krystopowicz. The estate sought to pierce the corporate veil and hold Mr. Krystopowicz personally liable for the $4.8 million.
In setting up his corporate structure, Krystopowicz had done a number of things right. He was the owner of ten nursing homes. Each nursing home was owned by a separate LLC, and each of these LLCs was in turn owned by the holding company. Thus, a judgment against one LLC would not harm the other nine LLCs. Krystopowicz also created another entity to provide management services to the nursing homes, thus (apparently) separating much of the cash flow from the real estate assets. This was not an unreasonable way to go about protecting the significant cash and other assets associated with the nursing homes, which at one point collectively generated almost $50 million per year.
The Morrisey plaintiffs sought to pierce the corporate veil and hold Krystopowicz personally liable for tye $4.8 million judgment. The district court found that two of the three requirements for piercing the veil were present: that Krystopowicz had exercised improper domination of the corporate structures, and that he had used them for improper purposes. But the court determined that there was no evidence to show that Krystopowicz’s domination of the entities for improper purposes caused the decedent to receive improper care (and, ultimately, to die). Without causation, the court was unwilling to pierce the corporate veil.
The Court of Appeals reversed, reframing the causation issue. The question was not whether there was a direct link between Krystopowicz’s conduct and the patient’s death, but “whether Krystopowicz’s abuse of the corporate form caused some injury to the Plaintiff.” The court of appeals held that it had, explaining that the inadequate capitalization of the LLCs and the failure of the LLCs to obtain insurance, among other things, has resulted in plaintiff being unable to recover from her injuries. In other words, when the owners dominate the entities and deliberately manipulate them to shield assets from judgment, that by itself can satisfy the third prong if the plaintiff would not be able to recover without piercing the corporate veil.
What Does Morrissey Mean for your Business?
Morrissey is a reminder that businesses should be careful to follow best practices at all times to be sure there will never be a question of domination or acting with an improper purposes. The Morrissey decision demonstrates that the causation requirement is far less important than domination and improper purpose requirements. It is difficult to imagine many scenarios in which domination to achieve improper purposes will not make it more difficult for plaintiffs to recover from the corporation. Conversely, it seems likely that it will generally be easy for plaintiffs to successfully argue that domination for an improper purpose lead to the inability to recover. After all, piercing the corporate veil would not be at issue if recovery against the corporation were possible. Owners will need to win on the first two requirements, domination and improper purposes, to avoid personal liability.
As a business owner, you should consider reviewing your practices regularly to ensure that you aren’t inadvertently putting your personal assets at risk. As Morrissey reminds us, proper capitalization and insurance are two important components of this. Our prior article on this topic lays out additional best practices your business should consider.
Law 4 Small Business. A little law now can save a lot later.
