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Analysis: The recent Tennessee Court of Appeals
decision of Robert Thomas
Edmunds v. Delta Partners, LLC, No. M2012-00047-COA-R3-CV, 2012 WL 6604580
(Tenn. Ct. App. December 18, 2012) discussed the concept of piercing the
corporate veil under Tennessee law. This
case, in part, dealt with what is required to be established under Tennessee
law in order to pierce the veil of a corporation. In short, the doctrine of piercing the
corporate veil allows, in certain circumstances, individual members or
executives of a corporation (including an LLC - Limited Liability Company) to
be personally responsible for the liabilities of the corporation. This cased involved a dispute between an
employer and a former employee over back pay (see detailed prior
post on this same case on what constitutes an employment contract under
Tennessee law).
Edmunds at 1 - 3. The employee was ultimately awarded damages
by the trial court which were affirmed by the Appellate Court for back pay
pursuant to an employment contract. Edmunds at 4 - 5. The plaintiff
tried to hold the owner of the company personally responsible under the
doctrine of “piercing the corporate veil”.
The Tennessee Court of Appeals in this
case discussed that a corporation is presumed to be a distinct legal entity
that is separate from its members, shareholders, officers, as follows:
There is a
presumption that a corporation is a distinct legal entity, wholly separate and
apart from its shareholders, officers, directors, or affiliated corporations.
In an appropriate case and in furtherance of the ends of justice, the separate
identity of a corporation may be discarded and the individual or individuals
owning all its stock and assets will be treated as identical to the
corporation. Discarding the fiction of
the corporate entity, or piercing the corporate veil, is appropriate when the
corporation is liable for a debt but is without funds to pay the debt, and the
lack of funds is due to some misconduct on the part of the officers and
directors.
In those
circumstances, courts may pierce the corporate veil to find the “true owners of
the entity” liable, or “to impose liability against a controlling shareholder
who has used the corporate entity to avoid his legal obligations.” Our courts
will disregard the corporation as a separate entity upon a showing that the
corporation is a sham or dummy or such action is necessary to accomplish
justice.
(citations omitted) Edmunds at 11. The Tennessee Court of Appeals discussed the
fact the doctrine of piercing the corporate veil applies equally to situations
involving a LLC (Limited Liability Company) as well as a corporation. In this case, the employer was a limited
liability company, not a corporation, and the court found as follows:
As a general rule,
members, owners, employees or other agents of a Tennessee limited liability
company have no personal liability for the debts or obligations of the company.
See Tenn.Code Ann. §
48–217–101(a)(1);
Tenn.Code Ann. § 48–249–114(a)(1)(B). Under an equitable remedy known as
“piercing the corporate veil,” however, “the separate legal entity of a
corporation may be disregarded upon a showing that it is a sham or a dummy or
where necessary to accomplish justice.” Despite
the inapplicability of the remedy's name, the “corporate veil” of a Tennessee
limited liability company may also be pierced, utilizing the same standards.
(citations
omitted). The court went on to the note
that the doctrine of piercing the corporate veil should only be applied in
"extreme circumstances to prevent the use of a corporate entity to defraud
or perform illegal acts”. Edmunds at 12. (citing Pamperin v.
Streamline Mfg., Inc., 276 S.W.3d 428, 437 (Tenn. Ct. App. 2008). The Tennessee Supreme Court had set forth
three elements required to pierce the corporate veil as between a parent corporation
and a subsidiary. These three elements
are as follows:
1) The parent corporation, at the time of the transaction complained of,
exercises complete dominion over its subsidiary, not only of finances, but of
policy and business practice in respect to the transaction under attack, so
that the corporate entity, as to that transaction, had no separate mind, will
or existence of its own.
2) Such control must have been used to commit fraud or wrong, to
perpetuate the violation of a statutory or other positive legal duty, or a
dishonest and unjust act in contravention of third parties' rights.
3) The aforesaid control and breach of duty must proximately cause the
injury or unjust loss complained of.
Edmunds at 12. (citing Continental
Bankers Life Ins. Co. of the South v. The Bank of Alamo, 578 S.W.2d 625 (Tenn.
1979). In a subsequent decision the Tennessee Court
of Appeals Tennessee Racquetball Investors, Ltd., v. Bell, 709 S.W.2d
617 (Tenn. Ct. App. 1986) recognized that these three elements are also
required to hold an individual owner of the corporation or LLC liable for the
debts of the corporation under the alter ego theory. Edmunds at 12.
There is a list of factors that Tennessee
courts use to determine whether to pierce the corporation veil. These were originally set forth in Federal
Deposit Ins. Corp. v. Allen, 584 F. Supp. 386 (E.D. Tenn. 1984) and the factors are as follows:
Factors to be
considered in determining whether to disregard the corporate veil include not
only whether the entity has been used to work a fraud or injustice in
contravention of public policy, but also: (1) whether there was a failure to
collect paid in capital; (2) whether the corporation was grossly
undercapitalized; (3) the nonissuance of stock certificates; (4) the sole
ownership of stock by one individual; (5) the use of the same office or
business location; (6) the employment of the same employees or attorneys; (7)
the use of the corporation as an instrumentality or business conduit for an
individual or another corporation; (8) the diversion of corporate assets by or
to a stockholder or other entity to the detriment of creditors, or the
manipulation of assets and liabilities in another; (9) the use of the
corporation as a subterfuge in illegal transactions; (10) the formation and use
of the corporation to transfer to it the existing liability of another person
or entity; and (11) the failure to maintain arms length relationships among
related entities.
Numerous Tennessee
Courts of Appeals decisions have cited to these factors and they are often
referred to as the "Allen factors". See Edmunds at 13. No specific factor is conclusive
but rather the courts are allowed to rely upon a combination of factors to
decide the issue. Edmunds at 13.
Ultimately, this
case provided an excellent summary and review of the Tennessee cases on the
doctrine of piercing the corporate veil and a claim to hold an individual
member of a corporation or LLC personally liable for the debts of the
company. In this case the court found it
was not appropriate to pierce the corporate veil. This is a lengthy opinion and if you have any
case or situation involving an attempt to hold an individual owner or member of
a corporation or LLC personally liable, then this case should be reviewed in great
detail. However, for purposes of this
post, the facts and discussion in this case is too lengthy to recite but I recommend
you review it carefully if you are handling any type of case involving this
situation.
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