Court Opinion

ID: 9843798
Source: CourtListenerOpinion
Date Created: 2023-09-24 02:43:25.507955+00
Date Added: 2024-06-11T09:16:55.643234
License: Public Domain

CROTHERS, Justice,
concurring in part and dissenting in part.
[¶ 27] I concur with that part of the majority opinion reversing the district court’s judgment imposing successor liability on Mainland, Inc., because based on the law unchallenged by the parties and used by the district court, and based on the factual record before the district court, the listing contracts were not the property of Main Realty, Inc.1 I respectfully dissent from that part of the majority opinion affirming the district court’s piercing Main Realty, Inc.’s corporate veil. This dissent is based on my conclusion the district court .erred in its application of controlling law, and out of concern this case makes piercing a corporate veil the rule, rather than the exception. As such, this case could provide dangerous precedent susceptible of stifling start-up ventures and exposing small business owners to personal liability well beyond the Legislature’s intention.2
*848[¶ 28] Black letter law provides that corporations are independent, legal entities that generally insulate their owners from personal liability. See Mann v. Mann, 57 N.D. 550, 223 N.W. 186, 189 (1929) (citation omitted). The key precept in a properly formed and ordinarily maintained corporation is that a shareholder’s liability is limited to the investment in the enterprise. Hanewald v. Bryan’s Inc., 429 N.W.2d 414, 416 (N.D.1988) (citing 1 F. O’Neal and R. Thompson, O’Neal’s Close Corporations § 1.09 (3rd ed. 1987)). The North Dakota Legislature’s most recent codification of this principle provides:
A holder of or subscriber for shares of a corporation is under no obligation to the corporation or its creditors with respect to such shares other than the obligation to pay to the corporation the full consideration of which such shares were issued or to be issued. As such, a shareholder is not personally liable for the acts or debts of the corporation.
N.D.C.C. § 10-19.1-69.
[¶ 29] A corporation’s separateness can be avoided under limited circumstances, as has been explained in a major treatise:
The doctrine of piercing the corporate veil is the rare exception, applied in the case of fraud or certain other exceptional circumstances, and is usually determined on a case-by-case basis. It is equitable in nature. The corporate veil may be pierced and the shareholder held liable for the corporation’s conduct when, inter alia, the corporate form would otherwise be misused to accomplish certain wrongful purposes, most notably fraud, on the shareholder’s behalf. It is a limitation on the accepted principles that a corporation exists independently of its owners, as a separate legal entity, and that the liability of the owners for the debts of the corporation is limited....
The corporate veil may not be pierced absent a showing of improper conduct. The principle of piercing the fiction of the corporate entity is to be applied with great caution, and not precipitately, because there is a presumption of corporate regularity.
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The general rule limiting shareholder liability will be abrogated only if applying the corporate fiction would accomplish some fraudulent purpose, operate as a constructive fraud, or defeat some strong equitable claim. Although corporate entities may be disregarded where they are made the implement for avoiding a clear legislative purpose, they will not be disregarded where those in control have deliberately adopted the corporate form in order to secure its advantages and where no violence to the legislative purpose is done by treating the corporate entity as a separate legal person.
A corporate entity may not be disregarded simply because it stands as a bar to a litigant’s recovery of property; however, the corporate entity has been disregarded to permit the maintenance of an action.
18 Am.Jur.2d Corporations § 47 (2004) (footnotes omitted).
[¶ 30] This Court has long embraced these general rules, with narrow exceptions, succinctly stated as follows:
There is no doubt of the general rule of authority that a corporation is a legal entity and will be considered as such until there is sufficient cause to consider it otherwise. Corporations, however, cannot be used as a cover under which wrongs may be committed and fraud perpetrated. If corporations are sought to be used as a cover for fraud and wrong, the court will look through the form of the corporation to ascertain its *849actual purpose and intent. Cook on Corporations, § 664, contains the following:
The disabilities of the corporation are not disabilities of the stockholders, nor the disabilities of the stockholders the disabilities of the corporation. Hence it is that a corporation is often organized as a cloak for fraud. Such cases as these are becoming common, and the courts are inclined to ignore the corporate existence when necessary in order to circumvent fraud.
No corporation can become so securely organized and protected- as a legal entity as to become amover for wrong and fraud and thereby defeat the rights of innocent parties. A corporation cannot be greater than law and equity, nor, by reason of its legal entity, be immune from answering for fraud and wrong. In such case the protecting hands of equity will brush aside the outward forms of the corporate entity, and analyze the foundation purpose and intent of the corporation, and if the purpose and intent of the corporation are not imbedded in good faith, and are but a cover for wrong and fraud against the innocent, the corporate entity will afford no protection for such wrong and fraud in a court of equity.
Macfadden v. Jenkins, 40 N.D. 422, 459-60, 169 N.W. 151, 163 (1918).
[¶ 31] A legal test for avoiding separateness between the shareholder and the corporation has evolved:
It has also been held that factors considered significant in determining whether or not to disregard the corporate entity include: insufficient capitalization for the purposes of the corporate undertaking, failure to observe corporate formalities, nonpayment of dividends, insolvency of the debtor corporation at the time of the transaction in question, siphoning of funds by the dominant shareholder, nonfunctioning of other officers and directors, absence of corporate records, and the existence of the corporation as merely a facade for individual dealings.
Hilzendager v. Skwarok, 335 N.W.2d 768, 774 (N.D.1983) (citing Victoria Elevator Co. v. Meriden Grain Co., 283 N.W.2d 509, 512 (Minn.1979)).
[¶ 32] This Court subsequently decided Jablonsky v. Klemm, 377 N.W.2d 560 (N.D.1985), where it clarified its discussion about when corporate legal separateness can be ignored. There, the Court stated:
On several occasions, this court has mentioned some type of inequitable conduct or an inequitable result as a relevant factor in determining whether to pierce the corporate veil. E.g., Federal Sav. and Loan Ins. Corp. v. Morque, 372 N.W.2d 872, 876 (N.D.1985) [(]corporate entity “may be disregarded to avoid injustice.”[)]; Danks v. Holland, [246 N.W.2d 86, 90 (N.D.1976)], [(]no showing of “flagrant wrongdoing” sufficient to pierce corporate veil[)]; Fire Ass’n of Philadelphia v. Vantine Paint & Glass Co., 133 N.W.2d 426, 432 (N.D.1965) [Qnothing “unfair or fraudulent” in the conduct of corporations or individuals, nor was it shown that corporations were “used as a cover for the others for any ulterior purpose.”!)] Our adoption of the Victoria Elevator Co. factors in Hil-zendager, without specific mention of the element of injustice or unfairness, was not intended to delete that element, which has long been recognized by this court and others as the fundamental basis for disregarding the corporate entity. See, e.g., Schriock [v. Schriock, 128 N.W.2d 852, 866 (N.D.1964)]. We believe that an element of injustice, inequity or fundamental unfairness must be
*850present before a court may properly pierce the corporate veil.
While we have concluded that an element of unfairness must exist in addition to a number of the factors adopted in Hilzendager, we do not imply that the facts upon which the unfairness is found to exist must be mutually exclusive of the facts supporting findings on the Hil-zendager factors. The factors enunciated in Hilzendager were adopted from the Minnesota Supreme Court’s decision in Victoria Elevator Co., which in turn adopted those factors from the Fourth Circuit Court of Appeal’s decision in DeWitt Truck Brokers[, Inc. v. W. Ray Flemming Fruit Co.], 540 F.2d [681,] 685-686 [(4th Cir.1976)]. The Fourth Circuit Court of Appeals indicated that the element of unfairness may be established under appropriate circumstances by the showing of a number of these factors, which, “all fitting into a picture of basic unfairness, has been regarded fairly uniformly to constitute a basis for an imposition of individual liability under the doctrine.” DeWitt Truck Brokers, supra, 540 F.2d at 687 (footnote omitted). See also Labadie Coal Co. v. Black, 672 F.2d 92, 99 (D.C.Cir.1982) [Qfailure to adequately capitalize the corporation for the reasonable risks of the corporate undertaking may provide the required “injustice”[)]; Eagle Air v. Corroon and Black/Dawson and Co., 648 P.2d 1000, 1004-1005 (Alaska 1982) [Qdraining of corporate assets sufficient to satisfy element of “wrongdoing”[).]
Jablonsky, 377 N.W.2d at 564.
[¶ 33] Justice Meschke specially concurred in Jablonsky to highlight “the closely balanced nature of the evidence on the underlying factual issues in disregarding the corporate form in this case.” 377 N.W.2d at 570. Notably, the corporation in Jablonsky was capitalized with $19,000 for a project involving six years of residential condominium development and some $1.3 million in sales. Id. at 562. The district court “found that although the minimum corporate formalities were observed, DID [the corporation] was insufficiently capitalized; DID became technically insolvent within a year of its incorporation; there was ‘some siphoning of funds’ by Klemm; the other officers and directors of DID were nonfunctioning; and ‘the existence of DID was merely a facade for Klemm’s individual dealings.’ ” Id. at 563.
[¶ 34] Justice Meschke agreed with the majority the corporation was inadequately capitalized, stating:
The initial capital was no doubt inadequate for the scope of the project undertaken. Where profits from the corporate venture are insufficient to further fuel the capital needs of the venture, it is difficult to view an initial capitalization this meag[er] in relation to the size of the project as anything but insufficient where substantial liabilities are left. However, the finder of -fact might also have viewed the largely uncompensated services of Klemm, the principal officer and stockholder, as additional contribution to capital, rather than as simply another liability contributing to the insolvency of the corporation.
Jablonsky, 377 N.W.2d at 570.
[¶ 35] Justice Meschke then addressed the district court’s finding of insolvency and warned that the finding in Jablonsky should be cautiously followed in other eases:
As to insolvency, the record indicates that, besides these claims, the remaining indebtedness of this corporation was substantially all owed to Klemm alone. In my view, debts to the sole stockholder should not count in piercing the corporate veil. It is the claims pursued in *851this action alone which sustain the finding of insolvency here. In another case, a single claim or class of claims would not necessarily, as a matter of fact, sustain a finding of insolvency when the insolvency arises near the end of corporate activity over a period of years.

Id.

.[¶ 36] Finally, Justice Meschke addressed the extent to which a corporation and its sole shareholder must be, or perceived to be, separate:
It is only in the ■ context of clearly inadequate capitalization that the accompanying findings of “siphoning” and “facade” can be considered sufficient. In another case, the finder of fact might well conclude that a fair profit on several transactions with the corporation would not lead to the inference of diversion of corporate funds by a sole stockholder, particularly where, as here, he drew no salary as an officer and rent owed to him went unpaid. The Chief Justice notes that the fact that Klemm “siphoned” any funds at all is more significant than the amount involved. That may well be true in some instances, but here the finding of “siphoning” seems sustainable only because the amounts exceed initial capital contributed.
Our sustaining the factual finding of “facade” in this case should not be understood as a rule that a sole stockholder cannot do business with his own corporation. That is not the law, nor should it be. Where services are furnished at cost, without gouging, and also are carefully documented, as they apparently were documented in this case, such circumstances alone would not support a finding of “facade” or “pass-through” corporation. I view the evidence in this case as barely sufficient on this point. In a similar case, with better capitalization, I believe such evidence would be insufficient.
Jablonsky, 377 N.W.2d at 570-71. Justice Meschke’s warnings in Jablonsky appear to have become empty noise. See McCullough v. Swanson, 245 N.W.2d 262, 265 (N.D.1976) (ignored attorney disciplinary admonitions had become “empty noise”).
[¶ 37] Here, Axtmanns sought to pierce the corporation’s veil because “Chillemi failed to adequately capitalize Main Realty, Inc. so that it could pay debts as they became due” and because “Chillemi used Main Realty, Inc. as her alter-ego, usfed the corporation as a facade for personal dealings, and failed to follow corporate formalities.”
[¶ 38] The district court concluded “[t]he Corporate Veil of Main and Company [Main Reality, Inc.’s trade name] is pierced and Chillemi and Natwick are personally liable for the judgment against Main and Company.” The conclusion was based on the finding that “Main and Company was a shell corporation, which was underfunded and insolvent at the time of the transfer.” In turn, the district court’s, memorandum opinion explained that Main and Company was a “pass through” corporation that justified holding “Chillemi and Natwick, the sole shareholder and the officers/directors of Main and Company individually liable for the judgment.”3
*852[¶ 89] The notion of a pass-through corporation being either per se bad or determinative of inequity is misplaced. The corporate entity is used for any number of reasons but is usually related to limited liability of the owner. Such is a recognized and legitimate reason for creating and maintaining a corporation. Hanewald, 429 N.W.2d at 415-16. Furthermore, Main Realty, Inc., was a Subchapter S corporation under the Internal Revenue Code. Subchapter S treatment allows closely held corporations meeting certain criteria to pass their income through to the individual shareholders similar to a partnership. 26 U.S.C. § 1361. Thus, shareholders in S corporations pay individual income tax on their pro rata share of corporate income, and the corporation as a separate entity pays no tax. Id. As a result, under both corporate law and tax law, S corporations such as Main Realty, Inc., are designed to pass income through the corporation to the owner-shareholder. Moreover, a shareholder who lets cash accumulate in an S corporation will have a tax liability on income received but will not have cash to pay the tax liability.4 I therefore believe the district court clearly erred when it pierced the corporate veil based on its conclusions Main. Realty, Inc., was a “pass through” or “shell” corporation.
[¶ 40] To the extent it was a separate consideration, I also believe the district court’s finding that Main Realty, Inc., was undercapitalized is based on an incorrect application of the law. The district court stated in its memorandum opinion that “Main and Company was undercapitalized and could obviously not pay its debts.” This view of the law would hold shareholders of any failing corporation liable for the company’s debts.
[¶ 41] A correct application of the law requires examination of the corporations’ capitalization at the time of formation. J-*853R Grain Co. v. FAC, Inc., 627 F.2d 129, 135 (8th Cir.1980) (capitalization measured at formation; losses suffered during operation do not make corporation undercapital-ized) and Kansas Gas & Elec. Co. v. Ross, 521 N.W.2d 107, 115 (S.D.1994) (same). To the extent it ever might be appropriate to examine capitalization of a going concern, we should look to Justice Meschke’s words in Jablonsky that “[w]here profits from the corporate venture are insufficient to further fuel the capital needs of the venture, it is difficult to view an initial capitalization this meag[er] in relation to the size of the project as anything but insufficient where substantial liabilities are left.” 377 N.W.2d at 570.
[¶ 42] Here, the unchallenged finding is that Main Realty, Inc., was capitalized with $20,000 and owned office furniture, fixtures and equipment that appeared appropriate for six to eight independent contractors who — by express contract — were responsible for the majority of their own selling expenses. . In exchange for a monthly fee of $600 and then $650, the corporation provided the independent contractor-selling agents with offices, desks, chairs, a shared secretary, a copy and fax machine, telephones, a trust account, Supra locks, and business liability insurance. Given the limited nature of the corporation’s enterprise, and recognizing an annual cash flow in excess of $72,000, I cannot agree that the district court correctly concluded Main Realty, Inc., was undercapi-talized at formation. Nor can I agree that, in Justice Meschke’s words, Main Realty, Inc., was without profits sufficient to feed the venture’s capital needs.
[¶ 43] Justice Meschke’s concurrence in Jablonsky also recognized that courts should put little or no weight on corporate debt owed to shareholders. When dealing with close corporations such as Main Realty, Inc., I agree with that conclusion. Here, the only corporate debt owed was to the sole shareholder for office supplies and equipment obtained by her and charged to her credit card. The district court was clearly concerned about the corporation’s debt owed to Chillemi and stated, “it could not pay its normal debts and. relied upon Chillemi’s personal credit to operate.” When that credit card obligation is excluded, the only remaining debt is that owed to Axtmanns — which is substantial — but which was not incurred in the ordinary course of business and which should not have been used to determine whether the corporation is sufficiently capitalized.
[¶ 44] For twenty years, income from operations was sufficient to meet Main Realty, Inc.’s capital needs. To conclude otherwise and pierce the corporate veil in this case is to hold that a corporation must ignore all realities of organization, finance, and taxation and have sufficient money in reserve to be able to pay a substantial judgment arising out of the commission of an intentional tort and an award of punitive damages. Such a result is simply too hostile to small businesses, and too far from that which reasonably could have been intended by the Legislature when it enacted N.D.C.C. § 10-19.1-69. I therefore would reverse the district court’s judgment.
[¶ 45] Daniel J. Crothers

. I share Justice Sandstrom’s concern that the agent's “ownership” of the listing contracts may be contrary to law. However, that issue was not addressed by the district court, was not raised on appeal by either party, and we do not have helpful input by Amicus Curie to analyze the issue. Therefore, that issue is not ripe for consideration and should be left for another day.

. The holding in this case reaches beyond the North Dakota Business Corporation Act. N.D.C.C. ch. 10-19.1. Personal liability of a member, governor, manager or other agent of a limited liability company is determined by "[t]he case law that states the conditions and circumstances under which the corporate veil of a corporation may be pierced under North Dakota law...." N.D.C.C. § 10-32-29(3). So too, the shield of a limited liability partnership may be pierced under "the case law that states the conditions and circumstances under which the corporate veil or limited liability shield of a corporation may be pierced under North Dakota law....” N.D.C.C. § 45-22-09(1).

. The district court imposed personal liability on Chillemi and Natwick as officers and directors of Main Realty, Inc., and on Chillemi as the sole shareholder. Axtmanns' complaint sought to pierce the corporate veil and impose liability only on. the shareholder-Chil-lemi. Appellants have not raised any issues relating to whether officers and directors can properly be subjected to personal liability in a piercing action, or whether the district court granted relief not requested by the plaintiffs in this action. Given the facts of this case, I can anticipate a number of strategic, legal and practical reasons why appellants did not *852raise these issues on appeal, and. only mention them here so that this opinion is not read to suggest I have implicitly agreed officer and ' director liability to a third party can or should be accomplished by an action directly based on officer or director activity. See Wills v. Schroeder Aviation, Inc., 390 N.W.2d 544, 547 (N.D.1986) ("An individual is personally responsible 'for an injury occasioned to another by his want of ordinary care or skill in the management of his property or person.’ Section 9-10-06, N.D.C.C. It is well settled that ‘[a] corporate agent cannot shield himself from personal liability for a tort he personally commits or participates in by hiding behind the corporate entity; if he is shown to have been acting for the corporation, the corporation also may be liable, but the individual is not thereby relieved of his own responsibility. Oxmans’ Erwin Meat Co. v. Blacketer, 86 Wis.2d 683, 273 N.W.2d 285, 289 (1979). Accord § 3-04-02(3), N.D.C.C.; Reule v. Bismarck Public School Dist., 376 N.W.2d 32, 33 (N.D.1985); Schlosser v. Great Northern Ry. Co., 20 N.D. 406, 127 N.W. 502, 504 (1910). See also 3A Fletcher, Cyclopedia of the Law of Private Corporations § 1135 (1986); 18B Am. Jur.2d Corporations ... (1985); Bagge v. Dardis, 389 N.W.2d 606 (N.D.1986).”). Officer and director liability may also be established through a shareholder derivative action. N.D.C.C. §§ 10-19.1-85.1 and 10-19.1-86. However, I question whether officer or director liability can be established by piercing the corporate veil. See, e.g., Huffman v. Poore, 6 Neb.App. 43, 569 N.W.2d 549, 557 (1997) (officer and director liability established on proof of tort and no requirement the corporate veil be pierced). Cf. Hilzendager v. Skwarok, 335 N.W.2d 768, 775 (N.D.1983) (veil pierced to hold former officers and directors personally liable for corporate debt).

. Another factor for piercing a corporate veil is whether the corporation has failed to pay dividends. The court in Trustees of Graphic Commc’n Int’l Union v. Bjorkedal, No. 04-3371, 2006 WL 3511767, at *14 (D.Minn. Dec. 6, 2006) noted that “it is rare for small closely-held corporations to pay dividends because such payments would in effect be double-taxed .... The fact that [the corporation] did not pay dividends shows only that its officers were smart, not that [the corporation] was a facade.”