United States Court of Appeals,

Fifth Circuit.

No. 91–5747.

FIDELITY & DEPOSIT COMPANY of MARYLAND and Fidelity Deposit Company,

Plaintiffs–Appellees,

v.

COMMERCIAL CASUALTY CONSULTANTS, INC., Defendants,

Commercial Casualty Consultants, Inc., M. Brant Ward and Larry J. Benson,

Defendants–Appellants.

Nov. 2, 1992.

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

Before REYNALDO G. GARZA, DAVIS, and BARKSDALE, Circuit Judges.

W. EUGENE DAVIS, Circuit Judge:

Appellants M. Brant Ward (Ward) and Larry J. Benson (Benso n) appeal from the district

court's judgment casting them personally for their corporation's debt. Appellants assert that the

evidence was insufficient to support the jury's findings that the corporate entity should be disregarded

and that Ward and Benson knowingly breached a fiduciary duty owed to Fidelit y. Ward and Benson

also assert that the district court erred in awarding attorney fees to appellees. We find the evidence

insufficient to support the judgment on the theory of corporate disregard, but sufficient to support

the finding that Ward and Benson knowingly participated in the breach of a fiduciary duty. Because

we affirm the judgment solely on the tort theory, the attorney fee award must be reversed.

I.

During 1986, Ward and Benson were the sole shareholders of Commercial Casualty

Consultants, Inc. (Commercial), an independent insurance agency. In May 1986, Fidelity & Deposit

Company (Fidelity) entered into an Agency Agreement with Commercial. Under the agreement,

Fidelity authorized Commercial to receive applications for b o nds and insurance policies to be

underwritten by Fidelit y. The contract allowed Commercial to collect t he premiums due on the

Fidelity policies and retain commissions earned on the gross premiums collected. The agreement also1

Number 5. Do you find from a preponderance of the evidence that Defendants Ward and Benson

knowingly participated in a breach of a fiduciary duty, if any, by defendant Commercial

Casualty Consultants....

Mr. Ward. Yes.

Mr. Benson. Yes.

Number 6. Do you find from a preponderance of the evidence that Defendants,

Ward or Benson, used Commercial Casualty Consultants, incorporated as a sham

to perpetuate a fraud on Fidelity and Deposit Company?

Defendant Ward. Yes.

Defendant Benson. Yes. required Commercial to segregate and hold as a fiduciary Fidelit y's premiums and remit those sums

promptly to Fidelity.

Commercial never segregated Fidelit y's funds as the agreement required. Instead, it kept

those funds with its other gross receipts in a single account. To establish that Ward and Benson

participated in this breach of a fiduciary duty, Fidelity produced substantial evidence that Ward and

Benson were aware that a separate account was never established. A more detailed discussion of that

evidence is included later in this opinion.

On its corporate disregard theory against Ward and Benson, Fidelity produced evidence that

Ward and Benson used Commercial as a sham to perpetrate a fraud. Ward and Benson drew on the

Commercial account to pay personal debts and never reimbursed the agency for these expenditures.

Ward and Benson did not pay premiums on personal insurance policies Commercial issued to them.

Benson wrote hot personal checks to Commercial in exchange for checks drawn on the Commercial

account. Benson also pledged Commercial's accounts receivable as security for a $20,000 personal

loan.

The case was tried to a jury. At the close of the evidence, the district court granted Fidelity's

motion for directed verdict against Commercial o n t he breach of contract claim for $227,383.91.

Comm ercial does not contest that ruling. The case continued as to Ward and Benson. In their

answers to special interrogatories, the jury found Ward and Benson liable on both the tort theory and

the corporate disregard theory

. 1 The court entered judgment against appellants on the verdict.Following a separate hearing, the court ordered Ward and Benson to pay Fidelit y's attorney s

fees in the amount of $75,000. In this appeal, Ward and Benson challenge t he judgment on three

grounds: (1) the evidence was insufficient to pierce the corporate veil; (2) the evidence was

insufficient to support the finding that appellants participated in Commercial's breach of its fiduciary

obligation to Fidelit y; and (3) the court was without aut ho rit y t o cast appellants for Fidelity's

attorney fees. We consider each of these arguments below.

II.

Ward and Benson argue first that the evidence was insufficient to support the jury's finding

that Commercial's corporate veil should be disregarded. We review the sufficiency challenge under

the familiar Boeing standard:

If the facts and inferences point so strongly and overwhelmingly in favor of one party that the

Court bel ieves t hat reasonable men could not arrive at a contrary verdict, granting the

motions [for judgment notwithstanding the verdict] is proper. On the other hand, if there is

substantial evidence

... of such quality and weight that reasonable and fair-minded men in the

exercise of impartial judgment might reach different conclusions, the mo t io ns should be

denied.

Boeing Co. v. Shipman, 411 F.2d 365, 374 (5th Cir.1969).

Texas provides three broad theories of corporate disregard. The corporate veil is pierced

when: (1) the corporation is the alter ego of its owners or shareholders, (2) the corporation is used

for an illegal purpose, and (3) the corporati on is used as a sham to perpetrate a fraud. P an Eastern

Exploration Co. v. Hufo Oils, 855 F.2d 1106, 1131–32 (5th Cir.1988); Castleberry v. Branscum,

721 S.W.2d 270, 272–73 (Tex.1986), superseded on other grounds by Tex.Bus.Corp.Act Ann. art.

2.21 A (We st Supp.1992). Fidelity sought to recover against Ward and Benson under the third

theory, "sham to perpetuate a fraud."

The underlying purpose of corporate disregard generally is to "prevent use of the corporate

entity as a cloak for fraud or illegalit y or to work an injustice." I d. at 273. The focus under the sham

to perpetrate a fraud theory is on "injustice or unfairness to the claimant caused by the corporation

and its owners." P an Eastern, 855 F.2d at 1133 (emphasis added). For a claimant to establish such

unfairness, he must ordinarily demonstrate that he relied on the financial backing of the owners.

"Without reliance, the contract claimant cannot avoid the risk of insolvency that it originally acceptedas part of the bargain." Id.

The district court properly instructed the jury that Fidelity was required to establish its

reliance on Ward and Benson's credit to prevail on its corporate disregard theory. The court

explained that without reliance, Fidelity could not avoid the risk of Commercial's insolvency. Ward

and Benson assert on appeal, as they did in the district co urt , t hat Fidelity adduced insufficient

evidence to support the jury's implied finding of reliance.

We now turn to the evidence Fidelit y relies on to support this critical element of its claim.

Fidelity points first to testimony by its witnesses that they relied on Commercial's owners to comply

with the agency agreement to segregate and remit Fidelity's funds when due. Fidelity presented no

evidence that its representatives dealt with Ward and Benson when Fidelity negotiated its contract

with Commercial. The record does not reflect that Fidelity was ever aware of Ward and Benson's

financia l co ndit io n or the extent of their involvement with Commercial. Fidelity unquestionably

expected Commercial's representatives to segregate and forward Fidelit y's premiums and property

when due. But we find no record evidence suggesting that Fidelity specifically relied on Ward and

Benson to personally perform these functions or guarantee Commercial's performance.

Fidelity also contends that it relied on Benson and Ward to pay Commerci al's operating

expenses so the corporati on would remain solvent. We can safely assume that any party to a contract

relies on the other party to engage in sound business practices (i.e., pay its bills) so that it can perform

its part of the bargain. But this falls short of the specific reliance on the stockholders of a corporation

that is required to disregard the corporate form under a sham theory. Without such specific reliance

on Ward and Benson's financial backing, Fidelity cannot avoid the risk of insolvency that it originally

accepted as part of its agency agreement.

Finally, Fidelity argues that had it known that Commercial was not being backed by it s

owners, it would have demanded payment from the agency or billed its insureds directly. Fidelit y's

lack of interest in Ward and Benson when it entered into the contract belies this argument. Also, the

testimony of Fidelit y's witnesses does not support this argument. They testified that they would have

demanded payment or billed insureds directly if they had known that the ag ency was insolvent.Fidelity essentially argues that it assumed under its agency agreement that Ward and Benson would

stand be hind t he agency's debts should it become insolvent. Without any evidence that this

assumption was part of Fidelity's agreement with Commercial, such an assumption is insufficient to

support a finding of reliance.

The type of specific evidence of reliance suggested in ot her cases to establish corporate

disregard is not present in this case. For example, Fidelity has not shown that the business affairs of

Benson and Ward were indist inguishable from those of the agency; that Fidelity relied on the

person al financial statements of Benson and Ward; that it obtained a guarantee from Benson and

Ward; or that it did not know that it was dealing with the agency as a corporate entity or to the

exclusion of the owners. See Gibraltar Sav. v. LDBrinkman Corp., 860 F.2d 1275, 1294 & n. 23

(5th Cir.1988), cert. denied, 490 U.S. 1091, 109 S.Ct. 2432, 104 L.Ed.2d 988 (1989). Because

Fidelity produced i nsufficient evidence to establish its reliance on appellants' credit, the judgment

against Ward and Benson predicated on a corporate disregard theory can not stand.

III.

Ward and Benson next argue that the evidence was insufficient to support the judgment

rendered against them in tort for knowingly breaching a fiduciary duty owed to Fidelit y. Appellants

argue t hat Fidelity's rights flow strictly from the agency agreement and that the record does not

support Fidelity's recovery against them personally on a tort theory.

Commercial cites cases such as Southw estern Bell Tel. Co. v. DeLanney, 809 S.W.2d 493

(Tex.1991) for t he proposition that a party to a contract who seeks redress because another party

violated a contractual obligation is relegated to an action for breach of contract. But if the contract

creates a special relationship imposing a duty, breach of that duty may give rise to an independent tort

action. Id. at 494 n. 1.

The agency agreement created a fiduciary relationship between Co mmercial and Fidelity.

Douglas v. Aztec Petroleum Corp., 695 S.W.2d 312, 318 (Tex.App.—12 Dist.1985). Appellants do

not dispute the existence of this relationship. The jury concluded t hat Commercial breached its

fiduciary obligation to Fidelity and that Ward and Benson knowingly participated in that breach. The2 The jury also found that Commercial breached a fiduciary duty by failing in 1988 and 1989 to

timely disclose material facts to Fidelity concerning the financial condition of Commercial

Casualty, and by failing in or about January 1989 to escrow renewal premiums as promised. court correctly charged the jury that if it found such part icipation by Ward and Benson they were

liable in tort directly to Fidelit y. S ee Grierson v. Par ker Energy Partners, 737 S.W.2d 375, 377

(Tex.App.—Houston 1987). The principle dispute therefore is whether the evidence supports the

jury f i nding of Ward and Benson's knowing participation in Commercial's breach of a fiduciary

obligation.

The jury found that Commercial breached a fiduciary duty owed to Fidelity in three ways.

The breach we focus on toda y is Co mmercial's failure to keep premiums for insurance issued by

Fidelity "separate and distinct" from Commercial's general revenues. 2

Ward and Benson argue that they had no knowledge of Commercial's accounts and could not

have knowingly failed to keep Fidelit y's premiums separate from Commercial's general accounts. The

record reveals, however, that Ward and Benson received a recommendation from a consultant in July

1987 to set up a separate account for premiums due insurers. Ward and Benson did not act on this

recommendation to require Commercial to establish separate accounts for the insurers' funds.

During late 1987 and 1988, Commercial experienced severe cash flow problems. Ward

injected $40,000 into the agency. Key personnel in the agency were replaced. In November 1988,

the new president of the agency told Ward and Benson that Commercial owed substantial sums to

insurers. He recommended that a separate account be established in which to deposit the insurers'

premiums so that these funds would not be commingled with Commercial's funds. Ward and Benson

did not see that separate accounts were established.

As of February 1 989, Ward and Benson took control of the agency's finances including

payment of accounts receivable. The jury was certainly entitled to infer that after this date, Ward and

Benson kne w t hat t he insurers' funds were deposited into the same account that was used to pay

Commercial's general expenses.

We find, therefore, that the evidence is sufficient to support a finding that Ward and Benson

knowingly participated in bre aching Commercial's fiduciary duty to Fidelity. This is adequate tosupport the personal judgment against Ward and Benson on a tort theory.

IV.

In view of our holding that the evidence is insufficient to support Fidelit y's recovery against

Ward and Benson on a theory of corporate disregard, we agree with appellants that the attorney fee

award can not stand. Texas authorizes recovery of attorney fees in limited circumstances. S ee Green

Tree Acceptance, Inc. v. Pierce, 768 S.W.2d 416, 425 (Tex.App.—Tyler 1989), citing International

Security Life Ins. Co. v. Finck, 496 S.W.2d 544, 546–47 (Tex.1973). The tort theory of recovery

on which Fidelity's judgment must now rest does not merit an award of attorney fees.

V.

For the reasons stated above, we affirm the judgment against Ward and Benson solely on the

tort theory. Because Texas law does not authorize recovery of attorney fees to a party who prevails

in an underlying tort action, we reverse Fidelity's award of attorney fees against Ward and Benson.

AFFIRMED IN PART and REVERSED IN PART.