McTexLaw McPherson and Associates Real Estate Asset Protection Law Firm Attorney

PIERCING THE VEIL: 2 RECENT CASES HOLDING OWNERS LIABLE FOR BUSINESS DEBTS (posted 6-1-02)

In 1977 Wyoming became the first US state to establish limited liability companies. It is the "mother state." And so it was "big doings" on May 15, 2002, when the Wyoming Supremes ruled that the remedy of piercing the veil is available even in the absence of fraud, under Wyoming statutes. Kaycee Land and Livestock v. Flahive, Case No. 00-328 (Wyoming, 2002). A similar result recently came out of Louisiana. The question is, would this result be the same in Texas? Click the headline to find out our opinion.

Roger Flahive was the managing member of Flahive Oil & Gas, LLC, a Wyoming limited liability company which owned no assets. FO&G, LLC entered into a contract with Kaycee Land & Livestock to use the surface of some real estate it owned. Unfortunately, in the process of this use, FO&G, LLC, caused environmental contamination to Kaycee's land. Given our federal environmental laws, cleanup costs, fines and other damages were quite substantial, and while Kaycee probably wanted blood, it was willing to settle for money. Lots of money. But this posed some problem, however, because FO&G, LLC, had no assets. So, Kaycee and its lawyers, in their quest for money, targeted Roger and his assets. It was every business owner's nightmare: Kaycee wanted to pierce the company's veil, to impose a debt of the LLC on its owner.

Basically, Kaycee argued that an LLC should be no different than a corporation when it comes to piercing the corporate veil. Wyoming has no statute that states when a corporate veil can, or cannot, be pierced. When and whether to pierce a corporate veil and impose a corporate debt on an individual owner is, in Wyoming, established by a line of cases (basically, judges wrote additional provisions into the Wyoming corporate statutes).

The Wyoming Supremes agreed with Kaycee that the same rules apply to corporations and LLCs when it comes to piercing the entity's veil. Here is the rule in Wyoming:

The corporation must not only be influenced and governed by that person, but there must be such unity of interest and ownership that the individuality, or separateness, of such person and corporation has caused, and the facts of the case are such that adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice.

Promote injustice? Now, that's a very broad, subjective rule, and it is applied on a case by case basis. Worse yet, since it is so subjective, it is almost impossible for a defendant business owner to win short of a full blown trial. If the trial happens to be a jury trial, a jury will decide whether it is "equitable" to enforce a company debt on an owner. If the company has done something that has caused damages, and it does not have the assets to pay the damages, the plaintiff has sympathy on its side as well. All of these factors, along with general uncertainty, which is never good, increases the pressure on the individual defendant business owner to settle the case, irrespective of the merits.

This is not the only recent case on this issue. In Louisiana, the Orleans Regional Hospital, a Louisiana limited liability company, suffered financial setbacks due to medicaid policy changes. It ultimately closed. The employees brought a lawsuit against Orleans Regional Hospital under the federal Worker Adjustment and Retraining Notification Act (appropriately anacronymed "WARN"). WARN requires at least 60 days prior notice to employees of a plant closing or mass layoff. Orleans did not provide the 60 day notice. Most employees got about 14 days notice instead. Since Orleans Regional Hospital obviously didn't have enough assets to pay any judgment, the plaintiffs sued everyone in sight using every "pierce the veil" theory Louisiana law allowed.

Before the case was over, not only was Orleans Regional Hospital, LLC, on the hook, but so was North Louisiana Regional Hospital, Inc., Precision, Inc. (both were members of Orleans Regional Hospital), John C. Turner, William Windham, and Richard W. Williams, (the major individuals behind all these entities), North Louisiana Regional Hospital Partnership, Magnolia Health Systems, LLC, Spectrum Community Counseling, LLC, Success Counseling Services, LLC (also owned by Turner, Windham and Williams directly or indirectly), and Brentwood Behavioral Healthcare, LLC (a successor entity to North Louisiana Regional Hospital Partnership). Total damage was $334,046.28, plus pre-judgment interest, PLUS $305,992.61 in attorneys fees to the winner.

So now the plaintiffs and their lawyers can pick and choose among the assets of all of these people and entities to satisfy that judgment. Hollowell v. Orleans Regional Hospital, 217 F.3d 379 (5th Cir. 2002).

As an aside, in determining where to incorporate or organize a business entity, wise clients will consult with their attorneys to look at cases like these, and avoid organizing in states that so liberally allow the veil to be pierced.

Would either of these cases be the same under Texas law? Probably not. In 1987 the Texas Supremes issued a very poorly rationalized decision known as the infamous "Castleberry case." It so confused the law concerning piercing the corporate veil, and arguably made it so easy, that the Texas Legislature stepped in and passed a law in 1989 to basically overturn that decision. They wanted Texas to be known as "business friendly," and not risk having entities incorporated here move to another state.

This statute, Article 2.21 of the Texas Business Corporation Act, substantially restricts a plaintiff's ability to pierce a corporation's veil. A plaintiff can succeed only if the plaintiff shows the person or entity upon whom liability is alleged: (1) caused the corporation to be used for the purpose of perpetuating and did perpetrate an actual fraud on the obligee (plaintiff) primarily for the direct personal benefit of such person or entity; or (2) expressly agreed to assume liability, such as in the case of signing a guaranty of corporate debts, or (3) is otherwise liable to the obligee under the Texas Business Corporation Act or another applicable statute.

Over the next few Email Alerts I will look at the Castleberry case, along with Section 2.21, and explain each of the ways a veil can be pierced under Texas law.