In the recent decision William R. Lee Irrevocable Trust v. Lee (In re Lee), the Seventh Circuit Court of Appeals affirmed a bankruptcy court’s decision (also affirmed by the district court) piercing a non-debtor’s corporate veil and allowing a creditor of the non-debtor to participate in the bankruptcy of the corporation’s individual shareholder.
While courts are often hesitant to pierce the corporate veil, this case provides a short, but instructive reminder: that hesitation ends where the facts make abundantly clear that a shareholder is abusing the corporate veil to hide individual bad acts. Furthermore, if the shareholder cannot even bother to dispute an egregious set of allegations, then courts may pierce the veil on summary judgment.
The debtor was an individual in chapter 7 who, by the time of his bankruptcy filing, was the sole shareholder of the successor entity to Lees Inns of America, Inc. (“LIA”), an Indiana corporation. But the debtor did not always own 100% of the business.
Initially, the debtor and his brother incorporated LIA as a public company in 1974, and then took the company private in 1994. At that point, the debtor owned a slight majority of LIA’s shares, while his brother transferred his shares to a trust (the “Trust”) created for his two sons (the debtor’s nephews). LIA itself owned a number of subsidiary companies that provided related business services to LIA.
Around the same time, the debtor was also starting a new business, Maxim, which faced substantial financial difficulties. Around 1995, the debtor proposed merging Maxim with LIA, but was unable to move forward with such a transaction due to pushback from his brother. The dispute apparently caused great strife between the debtor and his brother (and nephews).
In the ensuing years, the debtor made clear his feelings for his brother and nephews, as well as his intention to take over LIA for himself. Importantly, the following facts were undisputed:
- At a shareholders meeting in 1998, the debtor told his nephews, “I will screw you at every opportunity . . . I will do everything I can to make sure you never receive one dime from this company . . . I’ll guarantee you one thing, I’ll nail your ass to the wall.”
- In 2000, the debtor forced a merger between LIA and LLL Acquisition Corporation—an entity wholly owned by the debtor—which “merged out” the Trust’s shares in LIA.
- The Trust, which opposed the merger, asserted its rights under the Indiana Dissenters’ Rights Statute, which entitled the Trust to payment of the fair value of its shares in LIA immediately prior to the merger, and gave rise to an appraisal proceeding.
- Post-merger and pre-appraisal, the debtor bought 41 acres of real property from LIA for $1.3 million. The debtor then sold a portion of the property (25.5 acres) two years later to a third party for $1.7 million. The transfer was never disclosed to the Trust.
- Post-merger and pre-appraisal, the debtor caused LIA to transfer its interests in its subsidiary businesses to another entity controlled by the debtor for little to no consideration. The transfers were never disclosed to the Trust.
- Post-merger and pre-appraisal, the debtor caused certain entities to file a state court action against LIA, and caused each entity to enter into an agreed judgment whereby LIA’s remaining assets would be transferred to the debtor or to companies he controlled. The action and judgment were never disclosed to the Trust 1.
- The appraisal proceeding was held during September 2008 and October 2008, and resulted in a $7.5 million judgment (the “Judgment”) in favor of the Trust against LIA.
The Bankruptcy and Veil-Piercing Action
The debtor filed for chapter 7 in January 2012, and the Trust filed an adversary proceeding in August 2013 seeking to pierce the corporate veil of LIA and hold the debtor personally liable for the Judgment. Interestingly, the debtor conceded the Trust’s version of the facts, as described above, by failing to file a statement of material facts in dispute or to designate any of the Trust’s evidence as creating a genuine issue of material fact.
The debtor’s primary defense, rather, was that under the Indiana Dissenters’ Rights Statute, a shareholder’s sole remedy to a non-consensual merger is to recover fair value through an appraisal proceeding; in other words, the debtor argued that the statute precludes veil piercing as a shareholder remedy. Both the district court and the Seventh Circuit Court of Appeals disposed of that argument by making a sensible distinction between pre-merger and post-merger conduct.
As to pre-merger conduct, each court read the statute to limit shareholders’ recourse to appraisal proceedings, consistent with the statute’s purpose: to prevent battles over the validity of merger transactions. The courts held that the same logic, though, does not extend to post-merger conduct because challenges to post-merger conduct do not impede the consummation of merger transactions. A contrary reading of the statute, on the other hand, would violate public policy and encourage post-merger misconduct. Namely, majority shareholders would be incentivized to misbehave in precisely the manner that the debtor did—by using mergers to force minority shareholders out of a company and then raiding the company to ensure minority shareholders would be left holding the bag.
Veil Piercing on Summary Judgment
With the statutory argument out of the way, the only remaining question was whether the undisputed facts were a sufficient basis upon which to grant summary judgment. Given the high burden and fact-intensive analysis required in veil-piercing cases,2 such actions can be difficult to prove and even more so on summary judgment. But here, where the facts were undisputed and demonstrative of flagrant behavior, both the district court and the Seventh Circuit Court of Appeals determined that summary judgment was appropriate.
In re Lee provides an interesting data point in interpreting state statutes governing dissenters’ rights, distinguishing between pre-merger and post-merger conduct. The decision also serves as a reminder (hopefully a needless one for readers of the blog) that an entity’s corporate status is not a tool for shareholders to use to act on a personal vendetta. Particularly where uncontested facts and statements paint a clear picture of a shareholder’s motives, courts are willing to pierce the corporate veil.
The debtor later admitted that he caused the action to be filed to ensure the Trust would not recover anything from the appraisal proceeding.
For example, under Indiana law, a party must demonstrate that “the corporation was so ignored, controlled or manipulated that it was merely the instrumentality of another, and that the misuse of the corporate form would constitute a fraud or promote injustice.” Meridian N. Investments LP v. Sondhi, 26 N.E.3d 1000, 1005 (Ind. Ct. App. 2015)