All Is Not Lost Simply Because A Target Defendant Has No Assets - - Pull Out The Magnifier And Investigate The Corporate Connections Of Your Target For Alternative Deep Pockets!
March, 2004
by Michael S. Errera and Dean S. Rauchwerger
All viable recovery actions require the presence of three critical elements: (1) liability, (2) provable damages and (3) a target defendant with recoverable assets. This article addresses elements one and three in situations where other entities or persons may be liable, based on their corporate relationships, for the conduct of the targeted defendant that has no recoverable assets due to an improper asset transfer, dissolution, insolvency or failed business.
Connecting the Dots of the Corporate Relationships
There are two primary theories allowing a party to seek recovery from alternative entities/persons for the actions of a primarily culpable party that, for all practical purposes, has no recoverable assets: (a) successor liability and (b) piercing the corporate veil. Both of these concepts have evolved significantly over the years and have been analyzed under different tests. A thorough analysis must be performed in the proper jurisdiction at the onset of a recovery investigation.
A. Successor Liability
The most common scenario where “successor liability” comes into play is when an entity sells or transfers its assets to a successor entity and essentially ceases to exist. When an action is brought against such an entity, the most effective recovery strategy may be to pursue its successor. Traditionally, a successor company that purchased the assets of a previous company would not be liable for the debts or liabilities of its predecessor, with some critical exceptions. That rule has evolved into one, or a combination, of the following tests to determine if a successor entity is liable for its predecessor’s acts: (a) mere continuation, (b) continuity of the enterprise, and (c) product line.
• Mere Continuation: Focusing on the continuity of the directors, officers and shareholders from the predecessor corporation to the successor entity.
• Continuity of the Enterprise: Expanding the mere continuation theory by focusing not only on the continuity of the directors, officers and shareholders, but also on the continuation of the enterprise as a whole.
• Product Line: Considering whether the successor entity continues the production, manufacture or sale of the predecessor’s product so as to show a continuation of the prior business.
There are many factors considered under these theories, such as: (1) the amount of assets purchased or sold, (2) whether the predecessor company is dissolved, (3) how the successor entity is holding itself out to the public, (4) use of the same name, clients or product base, (5) continuity of directors, officers and shareholders, and (6) similarity of the products/services being offered or sold.
B. Piercing the Corporate Veil
One of the most attractive aspects of a corporation is the limited liability afforded to the corporation’s shareholders, directors and officers. Yet such protection may be lost where the court finds that an equitable remedy, like piercing the corporate veil, is appropriate. This liability trigger generally arises in situations where a parent company dominates or controls its subsidiary to the point where there is not separation, where a company is formed merely to avoid liability, or where the shareholders of a corporation ignore all corporate formalities. There are five inter-mingled general theories where the corporate veil may be pierced: (a) alter ego, (b) instrumentality, (c) equity or totality of the circumstances, (d) sham, and (e) violation of public policy.
• Alter Ego: There is no real distinction between the corporation and its owners, and the corporate enterprise is essentially disregarded by shareholders.
• Instrumentality: Focusing on the amount of control or domination that a parent corporation has over its subsidiary.
• Equity or Totality of Circumstances: Considering the equitable circumstances.
• Sham: Applied where the corporate entity was formed to effectuate a fraud.
• Violation of Public Policy: Applied where the entity uses a corporate form to evade a statute.
The factors common to each of these liability theories include the nature of the claim, corporate status of the defendant, undercapitalization and the following “laundry” list:
• commingling of funds;
• failure to maintain corporate records or to maintain them separately;
• undercapitalization;
• appointment of identical directors and officers;
• use of the same office, business location and employees;
• disregard of legal and corporate formalities; and
• formation to avoid a statute or perpetrate a fraud.
Practical Tips and Strategies
In situations where successor liability or piercing the corporate veil may be an alternative liability avenue, obtaining corporate and business records and conducting a thorough fact investigation are crucial. Below are some helpful hints:
• Never assume that the recovery opportunity is lost merely because the particular entity most responsible no longer exists or has no apparent assets.
• Conduct thorough research of the history of all potential defendants, including information on subsidiaries and parent and sister companies, ownership, dividends and finances.
• Seek to place all potentially liable parties or their related entities on notice of the loss so as to avoid spoliation or notice issues.
• Analyze choice of law issues, as each jurisdiction takes a slightly different view of alternative corporate liability, and consult counsel for a proper legal analysis
Practical Reference Guide
Please contact the authors to share your experiences on seeking alternative corporate liability or any inquiries you may have on these issues. If you are interested in a copy of a practical reference guide on the various ways and strategies to seek alternative corporate liability or are interested in an in-house seminar on this topic, please contact CM partner Dean S. Rauchwerger (drauchwerger@clausen.com). ¨
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