Opinion ID: 546102
Heading Depth: 1
Heading Rank: 4

Heading: disregarding the corporate fiction

Text: 10 The Texas Supreme Court recently summarized and discussed the various theories for disregarding the corporate form. See Castleberry v. Branscum, 721 S.W.2d 270, 271 (Tex.1986). The Castleberry court began its discussion by stating generally that the corporate form will be disregarded when it has been used as part of a basically unfair device to achieve an inequitable result. Id. at 271 (footnote omitted). The court then listed several theories through which the corporate form may be disregarded: 11 (1) when the fiction is used as a means of perpetrating fraud; 12 (2) where a corporation is organized and operated as a mere tool or business conduit of another corporation; 13 (3) where the corporate fiction is resorted to as a means of evading an existing legal obligation; 14 (4) where the corporate fiction is employed to achieve or perpetrate monopoly; 15 (5) where the corporate fiction is used to circumvent a statute; and 16 (6) where the corporate fiction is relied upon as a protection of crime or to justify wrong. 17 Id. at 272 (citations and footnotes omitted). 4 18 The Castleberry court distinguished between the general concept of disregarding the corporate fiction and more specifically treating a corporation and its shareholder as alter egos of each other. Alter ego was recognized as a distinct legal basis for disregarding the corporate fiction. See Castleberry, 721 S.W.2d at 272. In analyzing the doctrine of corporate disregard in light of Castleberry, our court has endeavored to isolate analytically the strands of the doctrine.... Gibraltar Savings v. LD Brinkman Corp., 860 F.2d 1275, 1288 (5th Cir.1988), cert. denied, --- U.S. ----, 109 S.Ct. 2432, 104 L.Ed.2d 988 (1989). 19 The district court found three separate bases, including alter ego, illegal purpose, and sham to perpetrate fraud, for disregarding the corporate fictions of Mudin and Dar Al-Hikmah. Appellants claim that the court erred in disregarding their corporate fictions because the taxpayers did not own Mudin or Dar Al-Hikmah or serve as officers or directors of Dar Al-Hikmah. Appellants also point out that the Government's theory of corporate disregard, holding corporations liable for the taxpayers' individual obligations, is unique. The Government asks us to affirm and hold two corporate entities accountable for the tax obligations of individuals who are not record shareholders of those corporations. A. Reverse Piercing 20 The Texas Supreme Court in Castleberry indicated that the traditional goal for disregarding the corporate fiction is to hold individuals liable for the debts of the corporation: 21 The corporate form normally insulates shareholders, officers, and directors from liability for corporate obligations; but when these individuals abuse the corporate privilege, courts will disregard the corporate fiction and hold them individually liable. 22 Castleberry, 721 S.W.2d at 271 (citations omitted). Owners that fail to maintain full legal formalities cannot expect to enjoy the limited liability that flows from the corporate form. Gibraltar Savings, 860 F.2d at 1288. 23 In this case, however, the Government sought to apply the alter ego doctrine in reverse--to hold a corporation's assets accountable for the liability of individuals who treated the corporation as their alter ego. 1 W. Fletcher, Cyclopedia of the Law of Private Corporations Sec. 41.70, at 458-59 (1983 & Supp.1989). E.g. American Petroleum Exchange, Inc. v. Lord, 399 S.W.2d 213, 216-17 (Tex.Civ.App.--Fort Worth 1966, writ ref'd n.r.e.) (where debtor held majority of stock individually and as trustee for minor daughter and treated corporation as alter ego, court disregarded corporate fiction and held corporation accountable for debtor's liability). The ultimate goal in a reverse piercing case is unique; rather than merely disregarding the corporate fiction and holding the shareholders accountable, the court treats the individual and the corporation as one and the same. See 1 W. Fletcher, supra, Sec. 41.70, at 458. The remedy is equally available to hold the corporation liable for debts of the controlling shareholders where the shareholders have formed or used the corporation to secrete assets and thereby avoid preexisting personal liability. 1 W. Fletcher, supra, Sec. 41.70, at 213 (Supp.1989) (citing Estudios, Proyectos E Inversiones De Centro America, S.A. (EPICA) v. Swiss Bank Corp., 507 So.2d 1119 (Fla.Dist.Ct.App.1987)). Upon a sufficient showing that the corporation is the alter ego of the debtor, the corporation is treated as the debtor and its property may be attached.... Id. 24 The reverse piercing theory urged by the Government has been recognized in other tax cases. See, e.g., Shades Ridge Holding Co. v. United States, 888 F.2d 725, 728 (11th Cir.1989) (court found that corporation was alter ego of taxpayer and held corporation liable for taxpayer's obligation), cert. denied, --- U.S. ----, 110 S.Ct. 1472, 108 L.Ed.2d 609 (1990); Valley Finance, Inc. v. United States, 629 F.2d 162, 171-73 (D.C.Cir.1980), cert. denied, 451 U.S. 1018, 101 S.Ct. 3007, 69 L.Ed.2d 389 (1981). The Government does not, however, cite any specific Texas authority in support of disregarding the corporate existence of Dar Al-Hikmah and Mudin in reverse, nor does Castleberry indicate whether each basis it identifies for piercing the corporate veil might operate in reverse. Nevertheless, a few Texas cases shed light on this unusual application of corporate disregard. 25 In American Petroleum Exchange, Inc. v. Lord, the court allowed creditors to reach corporate assets to satisfy an individual debtor's liability where the debtor owned the great majority of the stock and treated the corporation as his alter ego. Lord, 399 S.W.2d at 216-17. Additionally, in dividing marital property upon divorce, the Texas courts have had occasion to disregard the corporate fiction in reverse under the alter ego theory and to treat the assets and earnings of the corporation as if they were those of the individual. E.g. Dillingham v. Dillingham, 434 S.W.2d 459, 462 (Tex.Civ.App.--Fort Worth 1968, writ dism'd). In Zisblatt v. Zisblatt, for example, the Texas court of appeals in Fort Worth stated that [i]n an action for divorce, [alter ego] is applied to properly characterize corporate assets as part of the community estate. 693 S.W.2d 944, 952 (Tex.App.--Fort Worth 1985, writ dism'd); see also Dillingham, 434 S.W.2d at 462 (court affirmed trial court's division of property, which awarded portion of increased value of husband's wholly owned corporation, based on finding that corporation was alter ego of husband). 26 Although the Zisblatt and Dillingham courts discussed several bases and factors for disregarding the corporate fiction, both courts utilized the alter ego theory to treat corporate assets or earnings as those of an individual. See Zisblatt, 693 S.W.2d at 955; Dillingham, 434 S.W.2d at 462. In Texas, therefore, it would appear that a reverse piercing case rests upon a finding that the individual (debtor) and the corporation should be treated as alter egos. 27 Thus, the district court was correct insofar as it held that Texas law would allow the Government to reach the assets of Dar Al-Hikmah and Mudin upon showing an alter ego relationship between the taxpayers and the corporations. Although the illegal purpose and sham to perpetrate a fraud strands of Castleberry may provide bases for disregarding the corporate fiction, a reverse piercing case requires the creditor to establish an alter ego relationship between the individual debtor and corporation in order to treat them as one and the same. See Zisblatt, 693 S.W.2d at 955; Dillingham, 434 S.W.2d at 462; Lord, 399 S.W.2d at 216-17. 5 We now consider whether the district court correctly found that the appellants were the alter egos of the taxpayers. B. Alter Ego 28 The Castleberry court explained that the alter ego theory provides a basis for disregarding corporate form where a corporation is organized and operated as a mere tool or business conduit for another entity. 721 S.W.2d at 272. In determining whether an alter ego relationship exists, the court should focus on the relationship between the corporation and the entity or individual that allegedly abused corporate formalities. See id. The factors relevant to the court's inquiry include: the total dealings of the corporation and the individual, including the degree to which corporate formalities have been followed and corporate and individual property have been kept separately, the amount of financial interest, ownership and control the individual maintains over the corporation, and whether the corporation has been used for personal purposes. Id. (citing Lucas v. Texas Indus., Inc., 696 S.W.2d 372, 374 (Tex.1984); Gentry v. Credit Plan Corp., 528 S.W.2d 571, 573-75 (Tex.1975)). 29 The district court found that Mudin was formed for the purpose of holding title to property as nominee of the taxpayers, that Mudin conducted no other business except to hold title to real estate, and that the taxpayers' family resided on Mudin's property without a lease agreement or any rental obligations. Additionally, Muneera Haeri was the president, secretary and director of Mudin. The court also found that funds were transferred between the taxpayers' individual checking accounts and the accounts of Mudin, over which Muneera Haeri was a signatory. The court further found that the taxpayers' and Mudin's financial transactions were extensively intertwined without observance of proper corporate formalities so as to render it unjust to consider the corporation a separate entity. 30 The district court also provided detailed findings as to the extensive control the taxpayers exercised over Dar Al-Hikmah. Fadhlalla Haeri was Dar Al-Hikmah's registered agent in Texas and held a power of attorney for the corporation. The taxpayers lived in homes owned by Dar Al-Hikmah without a lease agreement or rental obligations. The purchases and transfers of property were made with funds from Project Development Corporation. Dar Al-Hikmah funds were used to pay the personal expenditures of the taxpayers. The taxpayers negotiated the purchase of several of the tracts of land held by Dar Al-Hikmah. The court concluded that the financial transactions of Dar Al-Hikmah were so intertwined with those of the taxpayers and the nominees of the taxpayers, without observance of proper corporate formalities, as to render it unjust to consider the corporation a separate entity. 31 The court's subsidiary fact findings as to the extensive relationship and unity between the taxpayers and the corporations have abundant support in the record and are not clearly erroneous. We determine, however, that these findings alone cannot establish an alter ego relationship under Texas law, because the Haeris are not direct shareholders of Dar Al-Hikmah or Mudin. The Haeri Trust, of which Fadhlalla Haeri was the sole beneficiary, held the shares of both Dar Al-Hikmah and Mudin. The Haeri Trust was funded by Mr. Jafar, who established the trust for Fadhlalla Haeri after Haeri turned over his 47% interest in PDC to Mr. Jafar. 6 32 Our research yielded a few Texas cases that have refused to disregard the corporate fiction under the alter ego doctrine and to treat an individual and corporation as one and the same where the individual did not own any of the corporation's outstanding stock. E.g. George v. Houston Boxing Club, Inc., 423 S.W.2d 128, 132 (Tex.Civ.App.--Houston [14th Dist.] 1967, writ ref'd n.r.e.). In George, a boxing promoter brought a contract claim against a corporation and Adams, an individual who had loaned the corporation money. Noting that the corporation's stock was held in trust for Adams' children, the court refused to apply the alter ego theory, stating: 33 Additionally, we find no Texas cases applying the alter ego doctrine to a situation where the individual owned none of the outstanding stock, which is the situation in the case at bar. 34 Id. at 132; see also Lane v. Dickinson State Bank, 605 S.W.2d 650, 653 (Tex.Civ.App.--Houston [1st Dist.] 1980, no writ) (in suit by employee against employer, bank, and bank president, court refused to find that bank and bank president were alter egos of corporate employer); Patterson v. Wizowaty, 505 S.W.2d 425, 428 (Tex.Civ.App.--Houston [14th Dist.] 1974, no writ) (no Texas authority for the proposition that an individual can be held personally liable under the alter ego doctrine when he owns none of the outstanding stock of the corporation). These cases suggest, and no cases that we uncovered dispute, that the Texas courts will not treat a corporation and an individual as one and the same unless the individual has some ownership interest in the corporation. 35 The Government attempts to avoid this issue by arguing that the taxpayers had an ownership interest in the trust and, as such, were owners of the corporations. 7 The district court, however, did not address the questions whether, under Texas trust law, the taxpayers had a present ownership interest in the Haeri Trust and whether such an ownership interest was sufficient to conclude that the Haeris were shareholders of Mudin and Dar Al-Hikmah. The parties seem to have raised the issue of the taxpayers' interest in the Haeri Trust in the court below, but they have not thoroughly briefed these questions under Texas law in the present appeal. Although the district court furnished some findings that assist in the resolution of these issues, it is not clear that the court's attention was focused on the relationship between the taxpayers and the Haeri Trust. 36 Accordingly, we must vacate the judgment of the district court on the issue whether the taxpayers are alter egos of the corporations. On remand, the district court should determine from the record whether, under Texas law, the taxpayers had an ownership interest in the Haeri Trust and if such an ownership interest exists, whether that interest is sufficient to equate them with shareholders for purposes of disregarding the corporate fictions of Dar Al-Hikmah and Mudin according to the strict alter ego theory.