Opinion ID: 537185
Heading Depth: 4
Heading Rank: 2

Heading: Piercing analysis

Text: 107 We believe that a Utah court would not reverse pierce the entity veils of Rex Montis, Interphase, Telegraph Limited and Gnolaum Unitrust for a variety of reasons. 108 First, corporate veils exist for a reason and should be pierced only reluctantly and cautiously. The law permits the incorporation of businesses for the very purpose of isolating liabilities among separate entities. See generally Dockstader v. Walker, 510 P.2d 526, 528 (Utah 1973) (Ordinarily a corporation is regarded as a legal entity, separate and apart from its stockholders); McCulloch Gas Transmission Co. v. Kansas-Nebraska Natural Gas Co., 768 F.2d 1199, 1200 (10th Cir.1985) (The standards for the application of alter ego principles are high, and the imposition of liability notwithstanding the corporate shield is to be exercised reluctantly and cautiously.) (quoting 1 Fletcher Cyc. Corp. Sec. 41.10 (Rev. Vol.1974), emphasis added); G. Henn & J. Alexander, Laws of Corporations Sec. 146 at 347 (1983) (limited liability is one of the principal objectives of incorporation). 109 Second, this case largely involves reverse piercing, and it is far from clear that Utah has adopted the doctrine of reverse piercing, much less this particular variant of reverse piercing. Messick v. PHD Trucking Service, 678 P.2d 791, 793 (Utah 1984) does discuss the reverse pierce concept, calling it little-recognized theory, but the Utah court ultimately declined to pierce the corporate veil there because of the failure to prove the traditional piercing the corporate veil elements of 1) non-observance of corporate formalities, 2) resulting in fraud, injustice or inequity. Thus, the court did not decide whether it would have pierced the corporate veil in the reverse context had those elements been present. The reverse-pierce theory presents many problems. It bypasses normal judgment-collection procedures, whereby judgment creditors attach the judgment debtor's shares in the corporation and not the corporation's assets. Moreover, to the extent that the corporation has other non-culpable shareholders, they obviously will be prejudiced if the corporation's assets can be attached directly. In contrast, in ordinary piercing cases, only the assets of the particular shareholder who is determined to be the corporation's alter ego are subject to attachment. See 1 Fletcher Cyc. Corp. Sec. 41.20 at 413 (1988 Supp.) ([A] necessary element of the [alter ego] theory is that the fraud or inequity sought to be eliminated must be that of the party against whom the doctrine is invoked, and such party must have been an actor in the course of conduct constituting the abuse of corporate privilege--the doctrine cannot be applied to prejudice the rights of an innocent third party.). Absent a clear statement by the Supreme Court of Utah that it has adopted the variant reverse piercing theory urged upon us here, we are inclined to conclude that more traditional theories of conversion, fraudulent conveyance of assets, respondeat superior and agency law are adequate to deal with situations where one seeks to recover from a corporation for the wrongful conduct committed by a controlling stockholder without the necessity to invent a new theory of liability. 110 Third, the analysis of corporate veil issues is different in a consensual transaction, such as a breach of contract case, than in a nonconsensual transaction, such as many tort cases: 111 The issues of public policy raised by tort claims bear little relationship to the issues raised by a contract claim. It is astonishing to find that this fundamental distinction is only dimly perceived by many courts, which indiscriminately cite and purport to apply tort precedents in contract cases and vice versa. 112 Hamilton, The Corporate Entity, 49 Tex.L.Rev. 979, 984-85 (1971). The obvious difference between consensual and nonconsensual transactions is that the claimants in consensual transactions generally have chosen the parties with whom they have dealt and have some ability, through personal guarantees, security agreements, or similar mechanisms, to protect themselves from loss. For example, the fact that a company is undercapitalized can be overcome in many contractual settings, because the parties can allocate the risk of financial failure as they see fit. But in nonconsensual cases, there is no element of voluntary dealing, and the question is whether it is reasonable for businessmen to transfer a risk of loss or injury to members of the general public through the device of conducting business in the name of a corporation that may be marginally financed. Id. 113 Although breaches of fiduciary duty can be analyzed using tort principles (see Restatement (Second) of Torts Sec. 874 at 300 (1977)), the relationships among the parties in this case were basically voluntary and contractual. Cascade undertook the contractual obligation to manage the affairs of the Joint Venture and of the Associates, and consequently assumed the fiduciary duty of loyalty and duty of care inherent in any principal-agent relationship. See Restatement (Second) of Agency Secs. 1, 379, 387 (1958). The upshot is that Utah courts, like courts generally, appear less likely to pierce a corporate veil when a consensual, contract-like transaction is involved than when a nonconsensual, tort-like transaction is involved. See, e.g., Centurian Corp. v. Fiberchem, Inc., 562 P.2d 1252, 1253 (Utah 1977) (piercing not allowed in sales contract dispute); Dockstader v. Walker, 510 P.2d 526, 528 (Utah 1973) (piercing not allowed in employment contract dispute). 19 114 Fourth, although Weston obviously used his entities to further his personal objectives, just as corporate parents often use their subsidiaries to achieve corporate goals, Weston held the entities out to the world as separate organizations. No one disputes that Weston's entities were validly organized and that de jure formation requirements were met. Indeed, Rex Montis was a publicly held company with over 850 shareholders. (Accounting Tr. 362.) The entities filed separate tax returns. E.g., Accounting Tr. 364-65. The entities held separate shareholder and director meetings. E.g., Exh. 381, Notice of Rex Montis Shareholders Meeting; Accounting Tr. 362-63. In sum, besides Weston's transfers of funds among his entities, the district court made no finding that the entities did not maintain the external incidents of separateness. 115 Fifth, even if Weston's entities failed to comply with all of the formalities that they should have and even if Weston did freely transfer funds among the entities, the claimants here have not shown how their injury was connected with the entities' commingling or lack of formalities or how the claimants relied on the entities' separateness or the lack thereof. As the Utah corporate-veil test demonstrates, it is not enough to declare that two corporations or a corporation and its prime shareholder are not really separate. The claimant must show that recognition of the corporate form would sanction a fraud, promote injustice, or [produce] an inequitable result. Norman v. Murray First Thrift & Loan Co., 596 P.2d 1028, 1030 (Utah 1979). 116 But the injustice or inequity on which a piercing claim is based cannot stem from the mere existence of limited liability, which is a legitimate characteristic of the corporate form. Rather, the injustice or inequity to the claimant must be connected with the lack of separateness between the corporation and its controlling stockholder and the failure to observe corporate formalities. Here, the defendants' losses generally had little to do with the Weston entities' lack of corporate formalities. Although there was comingling of funds among the various Weston entities, all the parties knew that they were separate entities and Weston maintained the corporate formalities of each entity separate from the others. The acts of comingling may have been acts of conversion, breach of fiduciary duty or the like, but there was no misrepresentation of the corporate stature of the entities with whom the various investors dealt. For example, the evidence showed that Cascade misappropriated roughly $300,000 from the Joint Venture and that Rex Montis misappropriated about $10,000. See Part I.C above. Cascade plainly is obligated to return the $300,000 and Rex Montis must return the $10,000. But there is no reason to make Rex Montis responsible for repaying the $300,000 taken by Cascade. That result would be a windfall to the Joint Venture. 20 117 We note that to the extent Weston or Cascade have an ownership interest in the entities, that interest may be susceptible to attachment by creditors. Thus, Cascade's 50 percent interest in Telegraph Limited may be subject to levy. Likewise, Weston's 22 percent interest in his trust, Gnolaum Unitrust, may be reachable by his creditors.