After years of work, and in total disregard of the laws of physics, Buoyant, Inc. has invented “Floatzar,” a material stronger than steel but lighter than air. An object of any size made from Floatzar effortlessly rises skyward. Aware of the potential value of this discovery, Buoyant’s officers and employees treat all information about the development of Floatzar as a trade secret. Buoyant intends to market Floatzar to military and aerospace clients.
Unfortunately, across town, Jimmy Jo Bob, CEO of Bob’s Big Balloons, Inc., hears of the new miracle material and envisions limitless balloon-related opportunities. A former NSA operative and direct mail marketer, Bob hacks Buoyant’s computers and steals Floatzar’s secret formula. Buoyant executives suspect a security breach when they see a child holding a string tethered to a large, very solid, floating taxi cab.
Buoyant successfully sues Bob’s Big Balloons for misappropriation of trade secrets, obtaining a $10 million judgment against the company. Unfortunately, Bob’s Big Balloons is “judgment proof,” having only $12.50 in assets. Bob, on the other hand, has significant personal wealth, as does the company’s other shareholder, Peggy Sue Rob, a chemical engineer who also heads the company’s balloon animal division. But Buoyant failed to name Bob or Peggy, individually, as a defendants in its lawsuit, even though their personal involvement in the trade secret theft would have made them individually liable for the corporation’s misdeeds. Buoyant can’t file a new, separate action against Bob or Peggy because the statute of limitations for a trade secret claim has long since expired.
In a last ditch effort, Buoyant brings a second lawsuit, this time against Bob and Peggy, personally. In this case, Buoyant does not seek a new judgment against Bob or Peggy for theft of trade secrets. Instead, it seeks to hold them personally liable on the judgment already obtained against Bob’s Big Balloons, arguing that the court should disregard the company’s corporate identity and “pierce the corporate veil” so as to rule that a judgment against the company is really a judgment against Bob and Peggy, individually.
In support of its effort to pierce the veil, Buoyant argues that it would be inequitable to allow Bob and Peggy to escape liability for company misconduct which they orchestrated. Buoyant claims that the court should ignore the corporate structure of Bob’s Big Balloons because: (1) Bob and Peggy were in total control of the company; (2) the company was insolvent when Buoyant sued it for theft of trade secrets, (3) Bob and Peggy under-capitalized Bob’s Big Balloons because their initial investments in the company were not enough to cover both operating expenses and any judgment Bob’s Big Balloons was likely to have to pay after stealing Buoyant’s trade secrets, and (4) they used the company to promote fraud (i.e., to steal trade secrets). Can Buoyant recover its judgment against Bob’s Big Balloons from Bob and Peggy, personally? Probably not.
Factors relevant to piercing the corporate veil under Massachusetts law.
Generally, a corporation is a separate legal entity from its shareholder and the shareholder is not liable for corporate debts, including judgments against the corporation. However, under Massachusetts law, a court may disregard the corporate form only in very limited circumstances. Evans v. Multicon Const. Corp., 30 Mass. App. Ct. 728, 732 (1991). A plaintiff seeking to pierce the veil “must meet a very high standard.” The George Hyman Construction Company v. Gateman, 16 F.Supp.2d 129, 157 (D. Mass. 1998). Such piercing of the corporate veil,
arises when (1) there is active and pervasive control of related business entities by the same controlling persons and there is a fraudulent or injurious consequence by reason of the relationship among those business entities; or (2) there is “a confused intermingling of activity of two or more corporations engaged in a common enterprise with substantial disregard of the separate nature of the corporate entities, or serious ambiguity about the manner and capacity in which the various corporations and their respective representatives are acting.”
Id. at 732-33, quoting My Bread Baking Co. v. Cumberland Farms, Inc., 353 Mass. 614, 620 (1968) (Emphasis in original). See also Lipsitt v. Plaud, 466 Mass. 240, 252-53 (2013).
In Pepsi–Cola Metropolitan Bottling Co. v. Checkers, Inc., 754 F.2d 10 (1st Cir. 1985), the United States Court of Appeals for the First Circuit used the rules stated in My Bread to derive twelve factors which should be considered in deciding whether to pierce the corporate veil:
(1) common ownership; (2) pervasive control; (3) confused intermingling of business activity assets, or management; (4) thin capitalization; (5) nonobservance of corporate formalities; (6) absence of corporate records; (7) no payment of dividends; (8) insolvency at the time of the litigated transaction; (9) siphoning away of corporate assets by the dominant shareholders; (10) nonfunctioning of officers and directors; (11) use of the corporation for transactions of the dominant shareholders; (12) use of the corporation in promoting fraud.
Id. at 14–16. (Emphasis added). The Massachusetts Appeals Court in Evans adopted the Pepsi-Cola factors as Massachusetts law. Massachusetts courts apply a more stringent standard for veil piercing than is applied by federal courts and those of many other states. Newman v. European Aeronautic Defence and Space Company EADS N.V., 70 F.Supp.2d 156, 166 (D. Mass. 2010) (Massachusetts standard more stringent than federal). Platten v. HG Bermuda Exempted Ltd., 437 F.3d 118, 127 (1st Cir. 2006) (“Massachusetts Courts have been somewhat more ‘strict’ than other jurisdictions in respecting the separate entities of different corporations”); Noonan v. The Winston Company, 135 F.3d 85, 94 (1st Cir. 1998) (describing Massachusetts standard as “stringent”); Salvail v. Relocation Advisors, Inc., 2011 WL 1883861, *1 (D. Mass. 5/17/11) (“especially strict”); Rondout Valley Central School District v. Coneco Corp., 339 F.Supp.2d 425, 441 (N.D.N.Y. 2004) (evidence must be “compelling” to pierce veil under Massachusetts law).
Although the 12 Pepsi-Cola factors need not all be satisfied in order to justify piercing the corporate veil, Buoyant is unlikely to succeed in its action against Bob and Peggy because it bases its claim on only four factors and will have difficulty proving even those.
With regard to the second factor, while Buoyant may be able to show that Bob and Peggy had full control over Bob’s Big Balloon’s, “control, even pervasive control, without more, is not a sufficient basis for a court to ignore corporate formalities.” OMV Associates, L.P. v. Clearway Acquisition, Inc., 82 Mass. App. Ct. 561, 566 (2012), citing Scott v. NG U.S. 1, Inc., 450 Mass. 760, 768, (2008). Further, “The ownership of all the stock and the absolute control of the affairs of a corporation do not make that corporation and the individual owner identical, in the absence of a fraudulent purpose in the organization of the corporation.” Gordon Chem. Co. v. Aetna Cas. & Sur. Co., 358 Mass. 632, 638 (1971). Although Buoyant might claim that Bob’s Big Balloons was formed for the fraudulent purpose of stealing trade secrets, Bob and Peggy can convincingly refute this contention by showing that their company existed, and provided real services to real clients, for many years.
The fourth factor, “thin capitalization,” also is not present in this case. Buoyant acknowledges that Bob and Peggy funded Bob’s Big Balloons sufficiently to cover the company’s relatively low everyday operating expenses. Buoyant contends, however, that Bob and Peggy were also required to capitalize Bob’s Big Balloons to the extent required to defend a lawsuit and pay a judgment for theft of trade secrets, because Bob and Peggy should have anticipated that Bob’s Big Balloons would be sued if it stole trade secrets.
However, even if Bob and Peggy had reason when they first capitalized their company to expect it to be sued for theft of trade secrets, itself a debatable proposition, Buoyant’s argument will likely fail because, as a matter of law, the incorporators of a business are not required to capitalize it sufficiently to cover any potential litigation and adverse judgment. So long as a business is provided sufficient capital so that it can meet the ordinary expenses which arise in the normal operation of its business, it is not undercapitalized. According to one commentator:
Are the risks to be perceived only those that are normal for a business, or do they include a highly unusual tort claim that greatly exceeds the firm’s liability insurance? Does the test demand that the total amount the shareholders invest must literally equal the present value of all future liabilities of the firm or does it entail some lesser amount that is simply necessary to launch the firm such that its future cash flows will meet its normal operating expenses? The former is clearly an unreasonable demand because no company can be expected to endow its future operating expenses and liabilities as a precondition to opening its doors. …It would therefore appear that inadequate capitalization has correctly assumed a limited role in veil-piercing cases, that of being a surrogate for the probable bad faith of the firm’s promoters.
James D. Cox and Thomas Lee Hazen, Inadequate Capitalization as a Factor for Piercing the Veil, 1 Treatise on the law of Corporations §7.11 (3d) (2011) (Emphasis added).
In Gottlin v. Herzig, 40 Mass App. Ct. 163 (1996), the Appeals Court noted that it would be unreasonable to require a business to capitalize to the extent necessary to cover potential tort judgments:
In their reply brief, the plaintiffs, without citation to any authority, argue that the corporation “had a duty either to maintain adequate capitalization or in the alternative to maintain liquor liability insurance.” In this case, the corporation-a neighborhood tavern-would have had to maintain an unlikely net worth in the range of three million dollars to cover the judgment rendered against the corporation, and continue in business. Thus the question comes down to the issue of the absence of insurance coverage.
Id. at 169 n.11. The court went on to rule that failure to maintain adequate liability insurance was not grounds for piercing the corporate veil.
Courts from other jurisdictions agree that the incorporators of a business need not consider potential tort judgments when determining the adequacy of capitalization. In In re: Hydroxycut Marketing and Sales Practices Litigation, 810 F.Supp.2d 1100 (S.D. Cal. 2011), the court stated:
The Court also does not find that Iovate USA was inadequately capitalized…. Although Iovate USA’s capital may not have been enough to satisfy multimillion dollar judgments, the capital was sufficient for Iovate USA to operate its normal business. See Laborers Clean–Up Contract Admin. Trust Fund. v. Uriarte Clean–Up Service, Inc., 736 F.2d 516, 524 (9th Cir.1984) (explaining that a corporation is undercapitalized when it is unable to meet debts that may reasonably be expected to arise in the normal course of business); Sheppard v. River Valley Fitness One, L.P., 2002 WL 197976, at *12 (D.N.H.2002) (“But the proper measure of the sufficiency of a corporate entity’s capitalization is not whether it can pay a potential judgment in a lawsuit but, rather, whether it had sufficient assets to meet the obligations incurred by conducting ordinary business in the industry in which it operates.”).
Id. at 1122-23. (Footnote reference omitted).
In like manner, the court in Arch v. American Tobacco Co., Inc., 984 F.Supp. 830 (E.D.Pa. 1997), said:
[T]he possibility that a plaintiff may have difficulty enforcing a judgment against a defendant is not enough to justify piercing the corporate veil. Courts do not pierce the corporate veil unless the corporation is so undercapitalized that it is unable to meet debts that may reasonably be expected to arise in the normal course of business.
Id. at 840. (Citations and internal quotation marks omitted). See also Laborers Clean-Up Contract Admin. Trust Fund v. Uriarte Clean-Up Service, 736 F.2d 516, 524 (9th Cir. 1984); Sheppard v. River Valley Fitness One, L.P., 2002 WL 197976, at *12 (D.N.H.2002); ___ Assist LLC v. East Coast Lot & Pavement Maintenance Corp., 913 F.supp.2d 612, 631 (N.D. Ill. 2012); Bank of Montreal v. S.K. Foods, LLC, 476 B.R. 588, 598-99 (N.D. Cal. 2012).
Thus, a court will probably not be convinced that Bob’s Big Balloons was undercapitalized.
Bob’s Big Balloons was not insolvent at the time of the litigated transaction.
The eighth Pepsi-Cola factor focuses on whether the corporation was insolvent “at the time of the litigated transaction.” In Buoyant’s case against Bob and Peggy, the “litigated transaction” must be Bob’s Big Balloons’ theft of trade secrets. However Buoyant has only asserted that Bob’s Big Balloons was insolvent when it, Buoyant, obtained its judgment in the trade secrets case. Buoyant cannot prove that Bob’s Big Balloons was insolvent at the time of the theft. In fact, as discussed above, Bob’s Big Balloons was adequately capitalized to meet its normal operating expenses.
Was Bob’s Big Balloons used “in promoting fraud?”
Buoyant contends that by causing Bob’s Big Balloons to steal trade secrets, Bob and Peggy used Bob’s Big Balloons “in promoting fraud” for purposes of the veil piercing analysis. However, the mere fact that Bob’s Big Balloons acted wrongfully under Bob and Peggy’s direction does not, by itself, establish that it was used “in promoting fraud.” The twelve factors identified by the First Circuit in Pepsi Cola, and adopted by the Massachusetts courts in Evans and Lipsitt, are considered in order,
to form an opinion whether the overall structure and operation misleads. There is present in the cases which have looked through the corporate form an element of dubious manipulation and contrivance, finagling, such that corporate identities are confused and third parties cannot be quite certain with what they are dealing.
Evans, 30 Mass. App. Ct. at 736. Thus, the focus of the twelve factors is on the misleading or confusing nature of the corporate form or structure, not on whether the corporation itself has committed a fraud or wrong. In Evans, the court found that piercing the corporate veil was not appropriate because the corporation, “did not masquerade as something it was not” and there was no evidence that the corporation was established or operated “so as to misrepresent or divert assets.” Id. See also Lothian v. Mumford, 2006 WL 1745064, *7 (Mass. Super. 6/9/06) (“This doctrine was devised to assist those who are confused about which corporation they are dealing with”).
Consistent with the focus on use of the corporate form to deceive, misrepresent or confuse, courts have made clear that in order to have “use[d] the corporation to promote fraud” or to satisfy the first prong of the My Bread formulation (“active and pervasive control of related business entities by the same controlling persons and there is a fraudulent or injurious consequence by reason of the relationship among those business entities”), it is not enough that the corporation commit a fraud. That fraud must be accomplished by using the corporate form; the confusing or deceptive inter-corporate relationship must be an essential part of the fraud.
In Adelphia Agios Demetrios LLC v. Arista Dev., LLC, 2013 WL 936608 (D. Mass. 3/12/13), the court explained:
Adelphia argues that disregarding the corporate form is appropriate here because the Members used Arista to commit a fraud. See Att’y Gen. v. M.C.K., Inc., 432 Mass. 546, 736 N.E.2d 373, 380 n. 19 (Mass.2000) (listing “use of the corporation in promoting fraud” as one of twelve factors that favor piercing the corporate veil). But the mere fact that Arista is a corporate person accused of fraud does not justify piercing the veil. Adelphia does not allege any facts showing that the Members fraudulently abused Arista’s corporate form or its limited liability.
Id. at *3. (Emphasis added).
Similarly, in Tech Target, Inc. v. Spark Design, LLC, 746 F.Supp.2d 353 (D. Mass. 2010), the court declined to pierce the corporate veil because the plaintiff did not allege any “fraudulent or improper use of Spark Design’s corporate form relevant to the contractual relationship at issue here.” Id. at 357. The court noted that the only fraud alleged was Spark Design’s issuance of a check drawn on an account with insufficient funds. “This fraud, however, was not related to any corporate manipulation. Moreover, Tech Target has not – and cannot – allege that it was deceived or misled about Spark Design’s corporate posture at the time it entered into the contract.” Id. (Emphasis added).
In The George Hyman Construction Company v. Gateman, 16 F.Supp.2d 129 (D. Mass. 1998), the court also declined to disregard the corporate form. In that case, the plaintiff construction company brought suit against two corporations, Jackson and Calvesco, and their principals, Gateman and Moretto. The court held that “use of the corporation in promoting fraud” meant that a corporation “was established or operated so as to misrepresent or divert assets.” Id. at 156. (Emphasis on “or operated” removed). The court found no evidence that the corporation was established or operated as a fraudulent enterprise, or was “the kind of inherent sham suggested by the cases. [It] did not masquerade as something it was not….” Id. Notably, the court added that “the fact that something went wrong with this deal, and even the fact that Gateman and Moretto may have caused it, does not mean that Jackson was a fraudulent enterprise for the purposes of the law of corporate veil piercing.”
Cases interpreting the fraud aspect of the first prong of the My Bread formulation also require that the fraud be accomplished by, or flow from, the corporate form. In Birbara v. Locke, 99 F.3d 1233 (1st Cir. 1996), the Court of Appeals held that even if statements by a corporation’s management constituted fraud, that was not sufficient to justify piercing the corporate veil where the fraud did not involve the corporate form. The court stated:
Moreover, plaintiffs have failed to show any “fraudulent or injurious consequence of the intercorporate relationship.” Plaintiffs argue that the settlement offers were misleading and fraudulent, because defendants attributed the decision to retain investment returns to TFG’s prior management, when it had been the decision of the new management to continue the policy of violating investment contracts.
Even assuming this misrepresentation might have supported fraud or unfair practices claims against the defendants (claims the jury and court here rejected), we think plaintiffs’ argument misses the point of the corporate disregard doctrine. The phrase “fraudulent or injurious consequence” is limited in My Bread by the phrase “of the intercorporate relationship.” There was no failure to “make clear which corporation [was] taking action” or “to observe with care” the corporate form. My Bread, 233 N.E.2d at 752. The Massachusetts Appeals Court has put this point well: “There is present in the cases which have looked through the corporate form an element of dubious manipulation and contrivance, finagling, such that corporate identities are confused and third parties cannot be quite certain with what they are dealing.” Evans, 574 N.E.2d at 400; cf. Oman Int’l Fin. Ltd. v. Hoiyong Gems Corp., 616 F.Supp. 351, 364 (D.R.I.1985) (noting that the better reasoned cases under Rhode Island law only pierce the corporate veil when the injurious consequences are a direct result of the misuse of the corporate form). Plaintiffs were never misled about which corporate entity-CRI or TFG-was obligated to them or was dealing with them.
Id. at 1240. (Emphasis added).
To the same effect is Hiller Cranberry Products, Inc. v. Koplovsky Foods, Inc., 2 F.Supp.2d 157 (D. Mass. 1998), where the court, applying the first prong of the My Bread formulation, said:
Plaintiff contends that Edward M. Koplovsky’s statements to plaintiff with respect to KFI’s intention to pay its outstanding invoices constituted misrepresentation and unfair trade practices. The alleged fraud must pertain to the intercorporate relationship, however, Birbara, 99 F.3d at 1240.
Id. at 162. (Emphasis added). In like manner, the court in Giuliano v. Nations Title, Inc., 938 F.Supp. 78, 82 (D. Mass. 1996), a case in which the plaintiff sought to hold a corporate parent liable for the debts of its subsidiary, held that the first prong of the My Bread formulation is not satisfied simply by the occurrence of fraud. Rather, the relationship between the two corporations (the corporate form or structure) must be an integral part of accomplishing the fraud.
If buoyant could establish that Bob and Peggy used Bob’s Big Balloons to promote fraud simply because they caused the company to steal trade secrets, then the promoting fraud factor of the veil piercing analysis could be established in almost any case, because cases where veil piercing is an issue commonly involve wrongful conduct of the corporation for which the plaintiff seeks to hold an individual shareholder liable.
Because any alleged wrongdoing on the part of Bob’s Big Balloons or Bob and Peggy did not rely upon, and was not facilitated or made more successful by, any misuse of the company’s corporate form, Buoyant will not be able to establish that Bob and Peggy used Bob’s Big Balloons in promoting fraud.
Bob and Peggy’s personal wrongdoing is irrelevant to piercing the corporate veil.
While Bob and Peggy’s personal wrongdoing, in causing Bob’s Big Balloons to steal Buoyant’s trade secrets, would have been enough to render them liable had they been named defendants in Buoyant’s original lawsuit against Bob’s Big Balloons, it is not relevant to the veil piercing analysis. There are two entirely separate approaches to holding a corporate officer individually liable for wrongs committed by his or her corporation. One such approach is to pierce the corporate veil. Separate and apart from piercing, a corporate officer may sometimes be held personally liable for corporate torts in which the officer was personally involved. Townsends, Inc. v. Beaupre, 47 Mass. App. Ct. 747, 751-52 (1999).
However, a claim against Bob and Peggy based on their personal participation in their company’s theft of trade secrets should have been asserted in Buoyant’s earlier action against Bob’s Big Balloons. Such a claim cannot be made in Buoyant’s second lawsuit seeking to pierce the corporate veil. The only issue in that case is whether Bob and Peggy, individually, should be held responsible for the corporate judgment debt of Bob’s Big Balloons. The courts have made clear that the piercing and personal involvement approaches to imposing personal liability on a corporate officer are separate. In Alves v. Daly, the court pointed out that a “plaintiff does not need to pierce the corporate veil to hold an officer of a corporation personally liable for a tort committed by the corporation that employs him, if he personally participated in the tort ….” 2013 WL 1330010, *8 (D. Mass. 3/29/13). (Internal quotation marks omitted). See also Ray-Tek Services, Inc. v. Parker, 64 Mass. App. Ct. 165, 177-78 (2005) (holding that plaintiff has not satisfied requirements for piercing the veil but could still hold corporate officer liable due to his personal involvement in tortious conduct); Townsends, 47 Mass. App. Ct. at 751-52 (similar to Ray-Tek); McCarthy v. Slade Assoc., Inc., 24 Mass. L. Rptr. 603, 2004 WL 4739775, *4 (Mass. Super. 8/21/08) (citing Cash Energy, Inc. v. Weiner, 768 F.Supp. 892, 895 (D. Mass. 1991), for the proposition that personal liability is usually precluded unless “grounds are shown either for piercing the corporate veil or finding active personal involvement in a tortious act.”).
Piercing the veil is highly fact-dependent.
As the foregoing discussion indicates, a Massachusetts court will pierce the corporate veil only in rare cases. The 12 factor analysis is highly fact-dependent and requires a detailed examination of the evidence.