Liability, derivative suits, piercing the corporate veil

To prevent the corporate veil from being pierced...

- keep the corporation's business separate, separate bank accounts, separate property, separate records - keep corporate funds and transactions separate from shareholders' personal funds and transactions - hold meetings of the BOD and of the Shareholders at least once a year - Keep minutes of those meetings - Elect board members - Issue stock - Make sure the corporation is adequately capitalized - Make sure the corporation carries the minimum amount of required insurance

Demand futility must be alleged with particularity that...

1. majority of the board has material financial or familial interests, 2. majority of the board is unable to act independently, 3. underlying business transaction is not a valid exercise of business judgment

UPLA §404(a): General Partner's Liability

All general partners are liable jointly and severally for all debts, obligations and other liabilities of the limited partnership unless otherwise agreed by the claimant

Model Business Corporation Act §8.52: Mandatory Indemnification

A corporation shall indemnify a director who was wholly successful, on the merits, in defense of any proceeding to which the director was a party because they were a director of the corporation against expenses incurred by the director in connection with the proceeding.

UPLA §303(a): No liability as limited partner for limited partnership organization

A debt, obligation or other liability of a limited partnership is not the liability of a limited partner. A limited partner is not personally liable by way of contribution or otherwise solely by reason of being or acting as a limited partner

Model Business Corporation Act §7.45: Discontinuance or Settlement

A derivative proceeding may not be discontinued or settled without the court's approval. If the court determines that a proposed discontinuation or settlement will substantially affect the interests of the corporation's shareholders, the court shall direct that notice be given to the shareholders affected.

Special Litigation Committees

Corporations can appoint a SLC to investigate whether pursuing a demand is in the corporation's best interest. The SLC will usually be made up of disinterested directors

Grimes footnote 8:

Demand is not excused simply because plaintiff has chosen to sue all directors, and a plaintiff cannot necessarily disqualify all directors simply by attacking a transaction in which all participated

SLC Demand test (CA/NY)

If the procedural process used by the SLC is deemed appropriate by the court, the substantive decision reached by the committee is guarded by the BJR. Disinterested directors are better situated than courts to make decisions about what's in the best interests of the corporation

Security for Expense Statutes

If the shareholder holds less than a certain amount of stock (typically 5% of the company), he will be required to post security, and if he loses, that security goes to defendant's expenses.

Model Business Corporation Act §7.42: Demand

No shareholder may commence a derivative proceeding until: - A written demand has been made upon the corporation to take action - 90 days have expired from the delivery date of the demand, unless the shareholder was notified earlier than 90 days that the demand was rejected, or irreparable injury to the corporation would result by waiting the 90-day period.

May a shareholder asserting derivative claims, whose demand letter has been refused by the board, assert that the need for a demand letter is excused for additional causes of action arising out of the same set of facts? (Grimes)

No. A stockholder filing a derivative suit must allege either that the board rejected his pre-suit demand that the board assert the corporation's claim, or allege with particularity why the demand should be excused because it would be futile.

Is a stockholder's suit to remedy an injury to the stockholder's individual rights, and the individual rights of other stockholders, properly classified as a derivative suit? (Eisenberg)

No. A stockholder's action is classified as a derivative suit if it is brought by the stockholder on behalf of the corporation, seeking the corporation's favor. A representative class action is a suit to remedy individual injury to a shareholder, or other similarly positioned shareholders.

Can a court pierce the corporate veil and hold a corporation's owners personally liable for a debt based solely on a creditor's inability to collect that debt? (Sea-Land Services)

No. The corporate veil can only be pierced to avoid sanctioning a fraud or promoting an injustice, which requires a wrong beyond the inability to collect a debt.

Can a party maintain a cause of action to pierce the corporate veil without alleging that a shareholder used the corporate form to conduct business in an individual capacity? (Walkovsky)

No. To pierce the corporate veil, the Plaintiff must allege that a shareholder used the corporate form to conduct the shareholder's own personal business

In a limited partnership, can limited partners be held liable as general partners when they take part in control of the general partner's business (are officers, directors, or shareholders of the corporate general partner) (frigidaire sales)

No. When the shareholders of a corporation, who are also the corporation's officers and directors, conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon third persons who deal with the corporation, the corporation's separate entity should be respected.

Model Business Corporation Act §7.46: Payment of Expenses

On termination of the derivative proceeding, the court may - Order the corporation to pay the plaintiff's expenses incurred if it finds that the proceeding resulted in benefit to the corporation - Order the plaintiff to pay any defendant's expenses incurred in defending the proceeding if it finds that the proceeding was commenced without reasonable cause or improper purpose - Order a party to pay an opposing party's expenses incurred because of the filing or a pleading, motion or other paper if it was not grounded in fact or warranted by existing law or good faith argument, was interposed for an improper purpose, such as to harass or cause unnecessary delay

Can the court pierce the corporate veil to hold the parent corporation liable for a subsidiary's actions?

Piercing the corporate veil to hold a parent corporation liable, allows a Plaintiff to disregard the protections of the corporate form and go after the assets of the parent corporation, if the subsidiary is found to be the mere instrumentality of the parent corporation. To do this, a court must find a showing of substantial domination.

Would adherence to the fiction of separate corporate existence sanction fraud or promote injustice?

The mere fact that the plaintiff will not be paid is not sufficient to justify piercing (assumption of risk type beat for contracting parties) Was the purpose of the undercapitalization to avoid liability? Was there an intentional misrepresentation, deception or other fraud-like conduct?

SLC Demand test (Delaware)

Two step approach: the trial court must first inquire into the good faith of the committee and the basis of the committee's conclusions, and then it must apply its own independent business judgement to determine whether the suit should be dismissed

Is there such unity of interest and ownership that the separate personalities of the corporation and the shareholder no longer exists?

Was there a failure to follow the corporate formalities? Was there a failure to maintain separate accounts? Was there a failure to adequately capitalize the corporation?

Can the court pierce the corporate veil to hold a parent corporation liable for its subsidiary's conduct when the parent corporation controls the subsidiary? (In Re Silicon Gel Breast Implants)

Yes. A court may pierce the corporate veil to hold a parent corporation liable for its subsidiary where there's no real distinction between them, however, courts won't pierce the corporate veil, unless failing to do so would result in a fraud or injustice.

Does the business judgment rule permit an independent committee formed by a tainted board of directors to cause a shareholder derivative action to be dismissed? (Zapata)

Yes. An independent committee acting in good faith, after a reasonable investigation, with a reasonable basis may dismiss a shareholder derivative suit if, in the court's independent business judgment, dismissal is appropriate.

Must federal courts follow state statutes requiring that a bond be posted prior to the initiation of a shareholder-derivative suit? (Cohen)

Yes. Federal courts must follow state statutes requiring that a bond be posted prior to the initiation of a shareholder-derivative suit

Should a shareholder derivative action be dismissed based on an independent special litigation committee's determination that the suit isn't in the corporation's best interests? (Auerbach)

Yes. Under the business judgment rule, disinterested directors are better situated than courts to make decisions about what's in the best interests of the company.

Delaware General Corp Law §145(b), (c): Indemnification of officers, directors, employees and agents; insurance

b. A corporation shall have power to indemnify any person who was or is a party to an action or suit by or in the right of the corporation by reason of the fact that the person is or was a director, officer, employee, or agent of the corporation against expenses (including attorney's fees) incurred in defense or settlement of such action if the person acted in good faith and in a manner the person reasonably believed to be in the best interest of the corporation o However, no indemnification shall be made in respect to any claim or issue as to which such person was judged liable to the corporation unless the court in which such action was brought determines that such person is fairly and reasonably entitled to indemnity for such expenses. c. To the extent that a present or former director or officer has been successful on the merits, or in defense of any claim, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred

How can a limited partner become a general partner

by taking control of or attempting to manage the limited partnerships business

Is the claim at issue a breach of contract? If so, did the other party assume the risk?

did the other party do their due diligence? were they a sophisticated party? Once contract has been entered into, there is no longer a burden to continue monitoring the corporation Courts are less sympathetic to contract claims than tort claims, because contracts are mutual agreements that had to be assented to by both parties. The contracting plaintiff could have walked away, or asked for a personal guarantee from the shareholder after doing due diligence.

Does the parent corporation have substantial domination over the subsidiary?

do the parent and the subsidiary have common directors or officers? Do the parent and the subsidiary file consolidated financial statements and tax returns? Does the parent corporation finance the subsidiary? Is the subsidiary operating with grossly inadequate capital? Does the parent company pay the salaries and expenses of the subsidiary? does the subsidiary receive no business except that given to it by the parent? Does the parent use the subsidiary's property as its own? Are the daily operations of the two corporations kept separate? Does the subsidiary not observe the basic corporate formalities?

Shareholder derivative actions are...

equitable actions brought by a shareholder on behalf of the corporation to recover for injury to the corporation.

The demand requirement...

most states require that the shareholder approach the BOD and demand that the Board pursue litigation before the shareholder is allowed to bring a derivative suit in the name of the corporation.

Limited Partnership is one where

one or more general partners with unlimited liability manage the business, while one or more limited partners with limited liability contribute only capital to the business

Can the court pierce the corporate veil?

piercing the corporate veil allows a Plaintiff to disregard the protections of the corporate form and pursue the personal assets of the shareholders. Courts can pierce the corporate veil if there is such unity of interest and ownership that the separate personalities of the corporation and the shareholder no longer exist, and adherence to the fiction of separate corporate existence would sanction or promote injustice

If a demand is made and rejected...

the board rejecting the demand is entitled to the presumption of the business judgment rule unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefits of the presumption.

Shareholder lack of personal liability

the shareholders of a corporation are not personally liable for the debts and obligations of the corporation

Enterprise liability

under the theory of enterprise liability, when seemingly independent entities are operated as one, plaintiff can go after the combined assets of all the legal entities. This is called horizontal piercing of the corporate veil.