United States Court of Appeals,

Fifth Circuit.

No. 94-20774.

Jerome P. ALBERTO, et al., Plaintiffs-Appellants,

and

Roderick Earl Hall, et al., Movants-Appellants,

v.

DIVERSIFIED GROUP, INC., et al. Defendants,

Diversified Group, Inc., Defendants-Appellees.

Stephen C. CRAWFORD, Plaintiff-Appellant,

v.

DIVERSIFIED GROUP, INC., Defendant-Appellee.

June 21, 1995.

Appeal from the United States District Court for the Southern District of Texas.

Before DAVIS, SMITH and WIENER, Circuit Judges.

WIENER, Circuit Judge:

Plaintiffs-Appellants Jerome P. Alberto, et al. (Alberto et al.), judgment creditors of JohnsonLogins, Inc. (JL), appeal a summary judgment granted in favor of Diversified Group, Inc. (DGI),

arguing that the district court erred in deciding to apply the substantive law of De laware, and i n

concluding under Delaware law that DGI and JL were not alter egos and thus that DGI could not be

held liable for the debts of JL. Finding no reversible error, we affirm.

I

FACTS AND PROCEEDINGS

Alberto et al., a group of 143 individuals each of whom was a hom eowner in one of three

subdivisions in Texas (the "Atascocita Properties), filed suit against DGI, a shareholder in JL (and

in another corporati on which held JL stock), seeking to hold DGI li able fo r default judgments

previously entered against JL totalling more than $58 millio n. Alberto et al. had obtained thosejudgments in state court tort suits in which they had alleged that the foundations of their homes failed

as a result of soil subsidence. JL, one of the original owners and developers of the properties, was

a defendant in those suits. JL had filed for Chapter 7 protection before the tort suits were

commenced, but the bankruptcy court lift ed the automatic stay to permit the plaint iffs to pursue their

claims against JL in Texas state court.

JL had been incorporated in the early 1970s under the laws of Delaware as a wholly owned

subsidiary of First Realty Development Corporati on (First Realty). By the mid-70s, JL had begun

to lose money, and First Realty decided to sell the company. First Realty contacted DGI (at that time

IDSO Investments, Inc., a holding company incorporated under Louisiana law in 1967 by H.D.

Hughes (Hughes) and his wife, Ida) to determine whether DGI was interested in the acquisition.

DGI claims that even though JL was losing money at that time, DGI decided to invest in the

company in the belief that the fair market value of JL's real estate holdings was higher than their book

value. Alberto et al. dispute this contention, contending that Hughes acquired JL solely to use its tax

losses as offsets against the taxable earnings of DGI's pro fit able subsidiary corporations. In any

event, DGI agreed to purchase an interest in JL.

To facilitate the acquisition of such an interest, a new corporate entity , Z Corporation, was

formed in Texas. The purchase of JL was structured so that Z Corporation would own all of JL's

stock, and the stock in Z Corporati on, in turn, would be shared by DGI and several other investors.

DGI insists that it structured the acquisition in this manner because it did not want to acquire 100%

of JL and therefore needed a "common currency," i.e., stock in Z Corporati on, to accommodate the

interests of the various investo rs. DGI explains that Ken Watler and Leon Dorsey, two of the

investors in JL, exchanged stock in another company, Weatherby Engineering Company, for stock

in Z Corporati on, while some of First Realty's stockholders who had acquired JL stock in a spin out

exchanged it for stock in Z Corporation. Alberto et al. dispute this contention as well, contending

that Hughes formed Z Corporation as a shell to insulate himself and DGI from JL's liabilities.

Pursuant to the purchase agreement, DGI, through Z Corporati on, immediately contributed

$2.4 millio n to JL's existing capitalization and agreed to advance another $2 millio n as required. This1 The creditor, First City National Bank of Houston (FCNB), had demanded that (1) JL be

liquidated, (2) one of FCNB's representatives, Reuben Askanase, be installed as CEO and

Chairman of JL's Board of Directors, (3) JL increase its capital stock from 1000 to 1250 shares

and issue the 250 new shares to Askanase, and (4) Askanase be given an irrevocable proxy over

the remaining 1000 shares. JL complied with all of FCNB's demands, thereby diminishing Z

Corporation's interest in JL to 80%. Askanase proceeded to wind down JL's business, he sold the

majority of JL's assets, used that money to reduce JL's liabilities, had fired all of JL's employees,

and closed JL's office. After Askanase had, for the most part, completed JL's wind down, he

resigned from the company and his shares were canceled.

2 DGI controlled 83% of the voting power in Z Corporation, giving it 86.4% of the voting

power in JL. capital infusion was insufficient to remedy JL's dire financial condition, however, and not long after

Z Corporati on acquired JL, one of JL's creditors effectively took over the operations of JL and

proceeded to wind down the company's affairs. By September 1978, that creditor had substantially

completed the winding down of JL and relinquished control of the company. 1 Soon thereafter, JL

authorized the issuance of 250 new shares and sold those shares to DGI, as a result of which JL stock

was o wned 20% by DGI and 80% by Z Corporation. As DGI then owned 63% of the issued and

outstanding stock in Z Corporation, DGI held beneficial ownership in 70.4% of JL. 2 By this time,

Hughes had become the sole director of DGI, Z Corporation, and JL.

JL had owned an interest in the Atascocita P ropert ies in the mid-1970s, long before the

company was acqu ired by Z Corporation. JL, however, did not finally dispose of the last of its

interests in the properties in those subdivisions until November 1978—ab out a week after DGI

acquired its 20% direct stock ownership in JL. DGI insists that it had nothing to do with JL's sale

of its last remaining interest in the subdivisions. Moreover, none of the 143 individual plaintiffs

comprising Alberto et al. purchased their properties until the 1980s—years after JL had completed

its disposal of all interest in the Atascocita Properties and had been substantially wound down.

Alberto et al. originally filed suit in Texas state court seeking a declaratory judgment that DGI

was liable for the judgments against JL on the theory that JL and DGI are alter egos. DGI removed

the suit to federal court on grounds of diversity and fi led a mo t io n for summary judgment. The

district court granted summary judgment in favor of DGI based on the finding that JL and DGI are

not alter egos under Delaware law. This finding was grounded in the failure of Alberto et al. to3 Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 1021, 85 L.Ed.

1477 (1941).

4 T EX .B US .C ORP .A CT .A NN . art. 8.02 (West Supp.1994). proffer evidence from which a reasonable factfinder could fi nd that recognition of JL and DGI as

separate corporate entities would result in unfairness or injustice.

Alberto et al. filed a mot io n fo r reconsideration, which the court denied, and this appeal

followed. On appeal, Alberto et al. contend that the district court erred in concluding that (1) the

substantive law of Delaware, rather than Louisiana, applies; and (2) under Delaware law DGI is

entitled to summary

judgment due to the failure of Alberto et al. to proffer summary judgment

evidence of overall injustice or unfairness.

II

ANALYSIS

A. C HOICE OF L AW

As this suit was removed to the district court on the basis of diversity jurisdiction, the district

court had to apply

t he co nflict of laws rule of the state in which it sits to determine which state's

substantive law should be applied. 3 The district court, sitting in Texas, applied Texas' conflicts rule

on choice of law, and concluded that the substantive law of Delaware should be applied. We agree.

Under Texas law,

[O]nly the laws of the jurisdiction of incorporation of a foreign corporati on shall govern ... (2) the liabilit y, if any, of shareholders of the foreign corporati on for the debts, liabilit ies, and

o bligations of the foreign corporati on for which they are not otherwise liable by stat ute or

agreement. 4

Alberto et al. are seeking to enforce the judgment debts of JL, a Delaware corporati on, against DGI,

both a direct and indirect shareholder of JL stock. Applying the plain language of the statute,

therefore, the liabilit

y of DGI, as shareholder of a foreign corporati on, i.e., JL, is governed "only [by]

the laws of the jurisdiction of [JL's] incorporation," which, in this case, is Delaware. We agree with

the district court that "it is clearly the intent of the st at ut e to apply the laws of the jurisdiction of

incorporation of the foreign corporati on [JL], not the laws of the jurisdiction of a shareholder [DGI]."

Alberto et al. claim that the district co urt erred in its analysis, urging that the R estatement5 892 F.2d 900 (5th Cir.1992).

6 R ESTATEMENT (S ECOND ) C ONFLICT OF L AWS § 306.

7 Alberto et al. argue that DGI was the majority shareholder as it dominated and controlled Z

Corporation. For the limited purposes of addressing their conflict of laws argument, we assume

without deciding that Alberto et al. could prove that DGI and Z Corporation were alter egos,

resulting in DGI having the majority interest in JL.

8 Id. § 306 cmt. c.

9 982 F.2d 900 (5th Cir.1992).

10 718 F.Supp. 260 (D.Del.1989). (Second) of Conflict of Law s, our decision in United States v. Clinical Leasing Service, Inc., 5 and

a decision of a district court sitting in Delaware all support the proposition that the correct choice of

law is the substantive law of the state of incorporation of the parent/shareholder (DGI), rather than

the state of incorporation of the subsidiary (JL). As DGI is a Louisiana corporation, Alberto et al.

argue, the district court should have applied the substantive law of Louisiana, not Delaware. We are

not persuaded.

Restatement (Second) of Conflict of Laws § 306, "Liabilit y of Majority Shareholder," provides

that:

[t]he obligations owed by a majority shareho lder to the corporati on and to the m i nori ty

shareholders will be determined by the local law of the state of incorporation, except in the

unusual case where, with respect to the particular issue, some other st a te has a more significant relationship under the principles stated in § 6 to the parties and the corporation,

in which event the local law of the other state will be applied. 6

Alberto et al. insist that this is just such an "unusual case," requiring application of the substantive law

of Louisiana—the state with a "more significant relationship" than Delaware. 7 But § 306 does not

apply here, as (1) it addresses only "obligations owed by a majority shareholder to the corporation

and to the minority shareholders " (not to creditors, such as Alberto et al.), and (2) it applies only

"in the absence of an applicable loc al statute" 8 —but this issue is governed by such a local statute,

Texas Business Corporation Act article 8.02.

Neither do Clinical Leasing Service 9 or M obil Oil Corporation v. Linear Films, Inc. 1 0

persuade us to ignore the plainly applicable Texas statute. C linical Leasing Service was brought in11 Clinical Leasing Serv., 982 F.2d at 902 n. 5.

12 Mobil Oil Corp., 718 F.Supp. at 268.

13 F ED .R.C IV .P RO . 56(c).

14 Harco Nat'l. Ins. Co. v. Green Farms, Inc., No. 1131, 1989 WL 110537, at *5 (Del.Ch.

Sept. 19, 1989) (quoting United States v. Golden Acres, Inc., 702 F.Supp. 1097, 1104

(D.Del.1988), aff'd, 879 F.2d 860 (3d Cir.1989)).

15 Id. (quoting Golden Acres, Inc., 702 F.Supp. at 1104). a federal district court in Louisiana, so Louisiana's choice-of-law rules—not those of Texas—were

at issue. Moreover, the parties "agree[d]" that Louisiana law provided the rule of decision, so choice

of law was not at issue. 11 Mobil Oil Corporation is also inapposite, as jurisdiction in that case was

based on a federal question, not diversity. And, as in C linical Leasing Service, the court avoided the

conflict of laws issue entirely, stating that, "[the court] is convinced that regardless of which law is

applied to the alt er ego question—whether federal, Delaware or Oklahoma common law—the

outcom e is the same." 12 In short, we are convinced that here the district court was correct in applying

Texas' conflict of laws statute and in concluding that under the Texas statute, Delaware's substantive

law governs this dispute.

B. P IERCING THE C ORPORATE V EIL

Not to be deterred, Alberto et al. argue that even under Delaware law the district court erred

in granting summary judgment in favor of DGI based on its conclusion that Alberto et al. failed to

proffer sufficient summary judgment evidence to support a finding that DGI and JL were alter egos.

Summary judgment is proper "if the pleadings, deposit ions, answers to interrogatories, and

admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any

material fact and that the moving party is entitled to a judgment as a matter of law." 13

Under Delaware law, numerous factors are pertinent to an alter ego analysis, but " "no single

factor [can] justify a decision to disregard the corporate entity.' " 14

"These factors include whether the corporati on was adequately capitalized for the corporate undertaking; whether the corporation was solvent; whether dividends were paid, corporate

records kept, officers and directors functioned properly, and other corporate formalities were observed; whether the dominant shareholder siphoned corporate funds; and whet her, in

general, the corporation simply functioned as a facade for the dominant shareholder." 1516 Alberto et al. point to the fact that some of JL's records were apparently missing to argue

that there is a fact issue whether the companies maintained separate books and records. The lack

of some corporate records raises an issue of the adequacy of JL's records, but is not probative

whether JL and DGI maintained separate books and records.

17 Irw in & Leighton, Inc. v. W.M. Anderson Co., 532 A.2d 983, 989 (Del.Ch.1987) ("[T]he

cases inevitably tend to evaluate the specific facts with a standard of "fraud' or "misuse' or some

other general term of reproach in mind.").

18 Harco Nat'l Ins. Co., 1989 WL 110537 at *5 (quoting Golden Acres, Inc., 702 F.Supp. at

1104); see Sears, Roebuck & Co. v. Sears plc, 744 F.Supp. 1297, 1304 (D.Del.1990) ("In order

to reach a parent corporation under the alter-ego theory, the plaintiff must show fraud, injustice,

or inequity in the use of the corporate form."); Mobil Oil Corp., 718 F.Supp. at 269 ("The law

requires that fraud or injustice be found in the defendant's use of the corporate form."); cf. In re

Sims, 994 F.2d 210, 218 n. 11 (5th Cir.1993) (noting that to pierce corporate veil, "Delaware

requires "fraud or something like it' "), cert. denied, --- U.S. ----, 114 S.Ct. 702, 126 L.Ed.2d 669

(1994).

19 Pauley Petroleum, Inc. v. Continental Oil Co., 239 A.2d 629, 633 (Del.1968) (observing

that corporate entities as between parent and subsidiary may be disregarded "only in the interest

of justice, when such matters as fraud, contravention of law or contract, public wrong, or where

equitable consideration among members of the corporation require it are involved."); see Harper

v. Delaw are Valley Broadcasters, Inc., 743 F.Supp. 1076, 1085 (D.Del.1990) (noting that

Delaware courts "will not disregard separate legal entities absent a showing that equitable

considerations require such action"), aff'd, 932 F.2d 959 (3d Cir.1991); Mobil Oil Corp. v.

Linear Films, Inc., 718 F.Supp. 260, 271 n. 15 (D.Del.1989) (rejecting "notion that a parent

company can be held liable for the obligations of a subsidiary purely on the basis of dominion and The uncontroverted summary judgment proof establishes that several of these factors, both pro and

con, were present here: (1) JL sold the Atascocita Properties pursuant to a creditor's order to wind

down business; (2) JL was substantially wound down by 1978, when it was acquired by Z

Corporati on; (3) JL was undercapitalized before Z Corporation ever purchased it; (4) DGI, through

Z Corporati on, periodica lly infused capital into JL; (5) JL and DGI kept separate books and

records 16 ; and (6) JL, Z Corporation, and DGI shared common officers and directors only after 1978,

by which time JL had been substantially wound down. Although some of these factors might militate

in favor of a finding of alter ego, most do not. More significantly, one element that is essential under

Delaware law is palpably absent: injustice or unfairness.

Delaware law makes clear that to pierce the corporate veil on an alter ego theory, a plaint iff

must demonstrate a "misuse" of the corporate form 17 or " "an overall element of injustice or

unfairness.' " 18 This is because Delaware courts of chancery will not disregard the corporate form of

a subsidiary unless equity so d emands. 19 Although this equitable power is "broad" 2 0 and can becontrol, without an additional finding of fraud or injustice in using the corporate form.").

20 See Golden Acres, Inc., 702 F.Supp. at 1104 (opining that "Delaware test for piercing the

corporate veil" is "broader" than federal analysis); Martin v. D.B. Martin Co., 10 Del.Ch. 211,

215, 102 A. 373 (1913) (stating that corporate fiction will "never [be] resorted to when it would

work an injury to any one").

21 See Pauley Petroleum, Inc., 239 A.2d at 633 (corporate entities as between parent and

subsidiary may be disregarded "only in the interest of justice"); see, e.g., Warren v. Warren, 460

A.2d 526, 528 (Del.1983) (affirming chancellor's decision to disregard corporate veil, in direct

contravention of remedy provide by law, "for the limited purpose of fashioning an appropriate

remedy").

22 Martin, 10 Del.Ch. at 214, 102 A. 373; accord Harco Nat'l Ins. Co., 1989 WL 110537 at

*4 (stating that to persuade "a Delaware Court to disregard the corporate entity is a difficult

task").

23 J.E. Rhoads & Sons, Inc. v. Ammeraal, Inc., No. 83C-NO-95, 1988 WL 32012, at *6

(Del.Super.Ct. Mar. 30, 1988) (discussing differences between legal and equitable claims); see Mobil Oil Corp., 718 F.Supp. at 271 n. 15 (discussing legal and equitable remedies under

Delaware law). Alberto et al. cannot prevail under the legal theory of agency, however, as the

record makes clear that there is no "close connection between the relationship of the two

corporations and the cause of action." Sears, Roebuck & Co., 744 F.Supp. at 1305.

24 Compare United States v. Jon-T Chems., 768 F.2d 686, 692 (5th Cir.1985) (stating that "in

contract cases[,] fraud is an essential element of an alter ego finding[,]" but "we do not require a

finding of fraud in tort cases"), cert. denied, 475 U.S. 1014, 106 S.Ct. 1194, 89 L.Ed.2d 309

(1986) w ith Mobil Oil Corp., 718 F.Supp. at 267 (requiring showing of "fraud or something in

the nature of fraud" to hold parent liable for torts of subsidiary based on alter ego theory). invoked whenever justice demands, 21 Delaware courts "require[ ] a strong case to induce a court of

equity to consider two corporations as one." 22

Thus Delaware distinguishes the eq uit able remedy of piercing the corporate veil from the

legal concept of "agency," which under Delaware law does not require a finding of injustice o r

inequity. 23 The requirement that an overall element of injustice or inequity be proved also

distinguishes Delaware's equitable veil-piercing standard from federal alter ego law, under which a

finding of injustice or inequity is necessary in cases sounding in contract, but not in those sounding

in tort. 24 Consequently, any reliance on cases applying federal alter ego law would be misplaced.

As we have noted, the district court granted DGI's motion for summary judgment based on

the conclusion that Alberto et al. failed to adduce proof from whi ch a reaso nable factfinder could

conclude that an overall element of injustice or unfairness would re sult if the separate corporate

existence of JL and DGI were to be recognized. Our review therefore is limited to the narrow issue25 United States v. Golden Acres, Inc., 702 F.Supp. 1097, 1104 (D.Del.1988) (quoting DeWitt

Truck Brokers v. W. Ray Flemming Fruit Co., 540 F.2d 681, 685 (4th Cir.1976)), aff'd, 879 F.2d

860 (3d Cir.1989). whether a Delaware court would agree that Alberto et al. did not proffer sufficient summary judgment

evidence of injustice or unfairness to clear the summary judgment hurdle. In this regard, Alberto et

al. purport to identify two injustices that would go unavenged should we not disregard the separate

corporate forms of JL and DGI.

1. Undercapitalization

The primary equitable argument made by Alberto et al. is that it would be unfair to recognize

JL's separate corporate form because that company was undercapitalized from the time it was

purchased for DGI and others by Z Corporati on until JL went bankrupt. Alberto et al. point out that,

when determining whether to pierce a corporate veil, "[o]f all the [ ] factors ... the one "that all the

authorities consider significant in the inquiry, an d part icularly in the case of ... a closely held

corporation' is inadequate capitalization." 25

Although Alberto et al. are factually correct that JL was undercapitalized from purchase to

bankruptcy, we cannot agree that this truth provides the necessary proof from which a reasonable

factfinder could find the existence of an overall element of injustice or unfairness. The record makes

clear that when JL was acquired it was already in desperate financial straits and had been for some

time. Pursuant to the purchase agreement, DGI and its fellow investors in Z Corporation infused $2.4

millio n of new capital into JL and obligated themselves to advance up to $2 millio n more. Thus, this

is not a case in which a parent failed to capitalize its corporate offspring from its inception; neither

is it a case in which the parent sub sequent ly siphoned off the economic lifeblood of its subsidiary,

thereby depriving creditors of the subsidiary's assets. Indeed, precisely the opposite is true.

Here, the subsidiary, JL, was not bled white for the benefit of its new "grandparent," DGI;

to the contrary , DGI, through Z Corporation, attempted to resuscitate JL by funnelling millio ns of

dollars of capital into the struggli ng company. In fact, Alberto et al. concede that JL was able to

survive as long as it did only because of constant finan cial transfusions from DGI. Under these

circumstances, we fail to see that any unfairness or injustice would result by honoring JL's separate26 Compare Edw ards Co. v. Monogram Indus., Inc., 730 F.2d 977, 984 (5th Cir.1984) (en

banc) (concluding that subsidiary was not undercapitalized vis-a-vis parent when parent poured

over $2 million into subsidiary).

27 Low ell Staats Mining Co. v. Pioneer Uravan, Inc., 878 F.2d 1259, 1265 (10th Cir.1989)

(citations omitted). corporate existence merely because DGI's honored commitment to infuse more than $4 millio n into

JL ultimately proved to be too little and too late to prevent JL's corporate ship from sinking. On the

contrary, failure to recognize the separate corporate existences of DGI and JL would be far more

inequitable: It would indeed be an ironic injustice to hold DGI liable for JL's debts merely because

DGI's substantial funding efforts to save JL from its impending bankruptcy were unavailing. 26 We

therefore decline Alberto et al.'s invitation to disregard the separate corporate existences of JL and

DGI; we opt instead to let DGI's good deeds go unpunished.

2. Income Tax Write-Offs

Alberto et al. also perceive so me inequity in an alleged dispute between DGI and JL over

which company could write off some $3.3 millio n o f JL's losses. But by attribution DGI owned

eighty percent of JL and quite properly employed consolidated financial statements and consolidated

tax returns for itself and its subsidiaries, including JL. We are satisfied that there is nothing improper,

much less unfair or unjust, in DGI's inclusion of JL's losses in those consolidated tax returns to offset

income from other, profitable corporations owned by DGI.

N evertheless, Alberto et al. complain that, as DGI acquired JL merely as a tax write-off,

equity demands that DGI be held liable for JL's debts. We discern nothing inequitable about acquiring

a business that has tax losses for the purpose of using such losses to offset th e profits of other

concerns. As the Tenth Circuit observed in a similar context:

The Internal Revenue Code allows a parent corporati on to file consolidated income tax

returns with its subsidiaries when the parent owns at least eighty percent of the subsidiary.

Sect ion 1501 allows a parent corporation to shelter taxable income from a profitable

subsid iary by o ffsetting it against losses from an unprofitable subsidiary. It is a common

business practice. 27

3. Other Inequities

In addition to reviewing these two purported inequities, we have scoured the record for any28 Mobil Oil Corp., 718 F.Supp. at 268 (noting that "any tort—such as patent infringement—is,

in some sense, an injustice" but "the underlying cause of action does not support the necessary

fraud or injustice"). other wrongdoings or inequities, either separate or in combination, but have found none. Although

Alberto et al. are understandably disappointed that some of their judgments against JL may go unpaid,

that is clearly not the kind of unfairness or injust ice t hat will satisfy Delaware law and provoke

disregard of the corporate form. 28 Rather, this is truly nothing more than an effort by Alberto et al.

to find a deep pocket from which to recover on their judgments against a defunct judgment debtor.

In sum, the district court erred neither in applying Delaware's substantive law nor in finding,

under that law, that Alberto et al. failed to produce sufficient summary judgment evidence from which

a reasonable factfinder could find an overall element of injustice or unfairness. As such a finding is

an indispensable prerequisite to piercing the corporate veil under Delaware law, the district court's

grant of summary judgment in favor of DGI is

AFFIRMED.