Corporate Disregard: A Case Overview

It is not uncommon to have a client who has a strong claim against a closely held corporation or LLC, whether based in contract or tort, only to find out that the target defendant company is insolvent or otherwise unable to satisfy the obligation. Initial investigation may reveal that the owner/officer has misappropriated or misapplied company funds or otherwise failed to respect the “corporate form”. Under these circumstances, lawyers will normally look to see if there are any bases to pursue the owners/officers of the company and hold them personally liable.

There are a number of exceptions to the personal liability shield that a corporation or LLC normally offers its owners and officers. These materials are intended as an overview of some of the most significant Washington cases concerning the doctrine of corporate disregard, also known as piercing the corporate veil, which may permit a plaintiff to seek recovery from the assets of the owners/officers of the company.

1. Knowing participation

Johnson v. Harrigan Peach, 79 Wn. 2d 745, 489 P2d 923 (1971). Misrepresentations and breaches of warranties regarding a residential real estate development lead to personal liability for the owner/officer of company. An officer who takes no part in a tort committed by a corporation, is not liable, unless he “knowingly participated in, cooperated in the doing of, or directed that the acts be done.” Johnson, at 753. “Close control” over the direction and management of the company, can be a basis for inferring that the officer had knowledge of fraudulent conduct: “if they exercise such close control, direction and management of the corporation that the law as a matter of elemental justice ought to charge them with the knowledge of such fraud.” Johnson, at 754.

See also, State of Washington v. Ralph Williams NW Chrysler, 87 Wn. 2d 298, 553 P.2d 423 (1976); and Grayson v. Nordic Construction, 92 Wn. 2d 548, 599 P.2d 1271 (1979).

2. Intentional use to violate or evade a duty

Norhawk Investments, Inc. v. Subway Sandwich Shops, Inc., 61 Wn. App. 395, 811 P.2d 221 (1991). Two-part analysis to determine whether to disregard corporate entity: (1) the corporate form was “intentionally used to violate or evade a duty,” and (2) disregard is “necessary and required to prevent unjustified loss to the injured party.” Id., at 398-399.

Meisel v. M&N Modern Hydraulic Press Company, 97 Wn. 2d 403, 410, 645 P.2d 689 (1982). The first step typically involves “fraud, misrepresentation, or some form of manipulation of the corporation to the stockholder’s benefit and creditor’s detriment.” Id., at 410. The second step requires the establishment of a causal link between the intentional misconduct and the harm which the disregard seeks to relieve. Id. In other words, the “wrongful corporate activities must actually harm the party seeking relief so that disregard [of the corporate form] is necessary.” Id., at 410.

See also, Morgan v. Burks, 93 Wn. 2d 580, 611 P.2d 751 (1980) for a discussion of what constitutes an “unjustified loss” warranting piercing the corporate veil.

3. Commingling assets

McCombs Constr. v. Barnes, 32 Wn. App. 70, 645 P.2d 1131 (1982). Corporate officer used company funds to pay for a personal residence, then defaulted on amounts owing to a contractor. When there is such commingling between the principals and the corporation that separateness ceases to exist, courts have pierced the corporate veil and imposed personal liability on the commingling shareholder. Id., at 76.

Norhawk Investments v. Subway Sandwiches, 61 Wn. App. 395, 811 P.2d 221 (1991). Commingling of assets in and of itself does not form a basis for disregarding the corporate form unless:

[T]here must be such a commingling of property rights or interests as to render it apparent that they are intended to function as one, and, further, to regard them as separate would aid the consummation of a fraud or wrong upon others.

Id., at 401 (citations omitted).

4. Alter ego

Burns v. Norwesco Marine, Inc., 13 Wn. App. 414, 535 P 2d (1975). Owners of company (father – son, where father was an attorney) held assets of corporation in their own name and “conducted the affairs as a personal enterprise.” Where corporate entity has been disregarded by principals “so that there is such unity of ownership and interest that the separateness of the corporation has ceased to exist” the court found a basis for imposing personal liability. Id., at 418 (citations omitted).

See also, Truckweld-Equipment Co., Inc. v. Olson, 26 Wn. App. 638, 618 P.2d 1017 (1980) for a discussion on the requirement of a causal relationship between lack of corporate formalities and harm to the plaintiff.

5. Inadequate capitalization

Truckweld-Equipment Co., Inc. v. Olson, 26 Wn. App. 638, 618 P.2d 1017 (1980). In and of itself, inadequate capitalization is not generally sufficient cause to pierce the corporate veil: “we know of no rule of law requiring a corporate stockholder to commit additional private funds to an already faltering corporation.” Id., at 645 (citation omitted).

Conclusion

What these cases establish is that, when courts are reviewing a situation to see whether it warrants piercing the corporate veil, equitable issues play a significant role in the analysis. When the conduct of the officer/owner is egregious and the resulting harm would not have occurred absent the abuse of the corporate form, the courts will often stretch to find a way to hold the owners/officers liable.

Tip to practitioners: whenever there is the possibility of a claim for piercing the corporate veil, poor bookkeeping and failure to appropriately account for personal vs. business expenses are often revealed in the company’s own financial records and bank account statements. These can form the foundation for making an argument that the corporation should be disregarded, especially if the circumstances otherwise favor finding a way to obtain relief for the aggrieved party.