By Shirley Palumbo, Greenspoon Marder
The whole purpose of corporate formation is to shield oneself from personal liability. Bankruptcy courts firmly respect this shield where a trustee or a judgment creditor attempts veil piercing in bankruptcy pursuant to state law.
Piercing the corporate veil (“PCV”) is not to be pled as an independent cause of action; rather, it is a judicial doctrine[i] that is brought to the court’s attention in order to disregard the limited liability shield afforded to corporations and impose liability on the owner(s) of the company themselves, upon showing proof that the company is a ‘mere instrumentality’ (alter ego) of the shareholder and that it was formed or used by the shareholders for a fraudulent or misleading purpose.[ii] Under Florida Statute § 605.0503(7)(c), a member of a limited liability company may be subject to an alter ego liability on application to the court by a judgment creditor. [iii]
Florida has adapted a three-prong test in order for the bankruptcy courts to find an alter ego theory that allows PCV: (1) that the shareholder dominated and controlled the corporation to such an extent that its separate existence was in fact non-existent but only an alter ego of the shareholder; (2) that the corporate form was used fraudulently or for an improper purpose; and (3) that the fraudulent or improper use of the corporate form caused injury to the claimant.[iv]
While the burden of proof is under a preponderance of the evidence standard[v], the probabilistic reasoning employed by the bankruptcy courts, in practice, seems to have raised the burden to that of a more stringent “clear and convincing” standard. Whilst a preponderance standard would appear to favor a judgment creditor or trustee, it is, in fact, an arduous act to be able to produce at least some useful evidence to prove PCV in bankruptcy, as evidenced in In Rivera v. Larsen, (“In re Paul Larsen, P.A.”)[vi].
In In re Paul Larsen, P.A., Judge Delano found that the trustee failed to meet the burden for PCV.[vii] In that case, Mr. Larsen, president, shareholder, and an insider of the Debtor within the meaning of 11 U.S.C. § 101(31), owned the Larsen, P.A. along with his wife. He also owned two other entities. Pre-petition, a judgment in Colorado was entered against the other two entities. The judgment was not against Mr. Larsen personally, but he became part of the post judgment garnishment proceedings. Larsen, P.A. had financially covered the out of state court litigation against the other two entities, and, as such, the Colorado judgment creditors were listed in the Larsen, P.A. bankruptcy as creditors.
The judgment creditors filed an adversary proceeding, which was ultimately taken over by the Chapter 7 trustee under his strong arm powers pursuant to 11 U.S.C. § 544(b). The trustee alleged that Mr. Larsen used the Debtor, as well as his other 2 entities, as alter egos by obtaining monies from investors through the entities, and then transferring the funds for his own personal use and benefit, to the detriment of the investors who, ultimately, lost their investment funds. Consequently, the trustee postulated a PCV claim that would hold Mr. Larsen individually liable for the debts of Debtor.
To prove alter ego, the trustee showed the court the Debtor’s lack corporate formalities: no corporate minutes, no stock book, no directors or officers elections; no corporate record keeping. Moreover, the company had been under capitalized throughout its years of existence; and the business records showed an increase in liabilities but no increase in assets. The evidence also showed loans made by Mr. Larsen to the corporation and payments from the Debtor Company to the owner’s rented residence. It also presented payments from the Debtor Company to two other entities owned by Mr. Larsen for the out of state court litigation against the other 2 entities. As a closed corporation, he and his wife fully control the Debtor Company. In particular, the trustee asserted that the fraud had occurred on investments made in Mozambique and in Colorado that did not come to fruition.[viii]
However, the Court found no fraud or improper purpose of the Debtor Company that would allow the trustee to lift the veil of protection. Following Florida’s three-prong test for PCV, Judge Delano found that Mr. Larsen “controlled, but did not dominate the P.A.”; she also considered the longevity of the business, its filing of annual reports and a separate corporate bank account. The fact that the trustee had not presented evidence of the investments being fictitious ones, and zeroing on the fact that the District Judge in the Colorado lawsuit had found Mr. Larsen had been upfront and that he did not breach any fiduciary duty, was taken also into consideration and must have been pivotal in her decision to conclude Mr. Larsen did not use the entities for an improper purpose.
The evidence was devoid of false statements or misrepresentations, or an actual deceiving act. Moreover, there was never any link made between the loss of the investors (now judgment creditors) and any form of misstatement or misappropriation of funds by Mr. Larsen. Significantly, no evidence was presented with regards to the allegation that the investments in Mozambique or Colorado were fabricated investments. The failure of the trustee to prove fraud was the demise of the trustee’s PCV attempt.
Indeed, there were few, if any, badges of fraud presented. For example, Judge Delano mentioned two payments from Debtor’s accounts had been presented to show a perpetuation of a fraud scheme: a check dated January 17, 2008, to Direct TV in the amount of $53.24 for internet service at the home office, and a check dated December 31, 2016, to a third party in the amount of $2,800.00. But, the judge found the bank records were incomplete and therefore did not present a complete representations of the transactions between the companies and Mr. Larsen to prove the companies were being used for a fraud scheme or for an improper purpose.
The proof of causation was also missing from the evidence. Nothing was presented to show that the judgment creditors had lost their investments because of Mr. Larsen’s improper use of the companies. Recall that the judgment creditors were direct creditors of the non-bankruptcy entities and truly had no real dealings with the Debtor Company. Thus, causation was a missing link.
This decision illustrates the court’s reluctance to pierce the corporate veil when doing so would require a leap far beyond the trend in Florida case law and federal common law. Bankruptcy courts will not PCV unless the Debtor Company also was formed for an improper purpose, or created to commit a fraud, mislead creditors, or evade the payment of a debt. Judge Delano correctly determined that the trustee failed to prove the debtor had committed any form of fraud. Nothing on the record specifically showed Mr. Larsen had been up to no good or had transfer assets from the debtor to himself in order to avoid or hinder collection efforts.
The opinion is significant in that it is reflective of the scrutiny the bankruptcy courts impose to the transaction between the parties for PCV. The burden of proof imposed does not seem clear. The interest in protecting the shield against the owner that is afforded by law is probably the reason the court fosters careful use of PCV as a remedy. Certainly, PCV is known to be allowed only in “extraordinary circumstance”, where there is proof of fraud.[ix] However, if a PCV allegation truly requires the Plaintiff to present a high degree of probability that there was fraud or intent to use the companies improperly, then the standard of proof is not really by preponderance. To allege the PCV doctrine, a “mere failure to observe corporate formalities alone is not enough… absent proof of fraud or ulterior motive by the shareholder, the corporate veil shall not be pierced.”[x] Consequently, in order to prevail on a PCV theory, the Plaintiff must prepare the case with a combination of the badges of fraud to meet more than a high probability analysis. This, in effect, raises the standard of proof to “clear and convincing” based on an analogy between fraudulent transfers and common law fraud.
[i] See, Bippen v. 331 5th Avenue, Inc., 2020 WL 5217054, at * 4 (M.D. Fla. 2020) (citing to: Peacock v. Thomas, 516 U.S. 349, 354 (1996).
[ii] Dania Jai–Alai Palace, Inc. v. Sykes, 450 So.2d 1114, 1120-1121 (Fla. 1984); See also, Venn v. Grizzle, 2019 WL 1440905 *5((Bankr. M.D. Fla. 2019) (March 31, 2019)(citing to In re Gherman, 103 B.R. 326, 330-31 (Bankr. S.D. Fla. 1989); and Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114, 1121 (Fla. 1984).
[iii] Fla. Stat. § 605.0503(7)(c) (2021).
[iv] Venn v. Grizzle at *5-6. (See also, Nuvasive v. Absolute Medical LLC, 2019 WL 1468522 (Bankr. M.D. Fla. 2019) (February 11, 2019) and Zurich American Insurance Company v. Hardin, 2020 WL 3272636, *2, March 11, 2020 (Slip Copy) (M.D. Fla. 2020).
[v] See Nuvasive v. Absolute Medical LLC, 2019 WL 1468522 (Bankr. M.D. Fla. 2019) (February 11, 2019).
[vi] (In re Paul C. Larsen, P.A.), 610 B.R. 684, 688 (Bankr. M.D. Fla. 2019), aff’d, 626 B.R. 446 (M.D. Fla. 2021).
[vii] Id. At 688.
[viii] Id. at 689.
[ix] Johnson v. New Destiny Christian Ctr. Church, Inc., 303 F. Supp. 3d 1282, 1286–87 (M.D. Fla. 2018) (quoting In re Hillsborough Holdings Corp., 166 B.R. 461, 468 (Bankr. M.D. Fla. 1994)).
[x] Zurich American Insurance Company v. Hardin, 2020 WL 3272636, *2, March 11, 2020 (Slip Copy) (M.D. Fla. 2020).