Minnesota courts will “pierce the corporate veil” of an LLC where the LLC is an alter ego of the individual member and there is an element of injustice or fundamental unfairness. In Guava LLC v. Merkel, A15-0254 (Minn. Ct. App. Aug. 17, 2015) (“Guava II“), the Minnesota Court of Appeals affirmed a Hennepin County District Court decision, holding that the district court did not abuse its discretion by piercing the LLC’s corporate veil and holding its sole member personally liable as a judgment debtor, as both prongs of the Victoria Elevator Co. alter ego test were satisfied.
In October 2012, Guava, LLC (“Guava”) filed a complaint against Spencer Merkel (“Merkel”), alleging violations of Minn. Stat. § 626A.02 and a civil conspiracy. Michael Dugas (“Dugas”) signed for Alpha Law Firm, LLC (“Alpha”) on behalf of Guava, and Attorney Paul Hansmeier (“Hansmeier”), the sole member of Alpha, noticed his appearance as “of counsel” for Guava. No representative of Guava ever appeared before the district court, despite a court order to do so. In an earlier decision, the court noted that it was unclear whether Guava even existed. Guava LLC v. Merkel, No. A13-2064, 2014 WL 3800492, at *1 (Minn. Ct. App. Aug. 4, 2014) (“Guava I“).
Shortly after filing its complaint, Guava moved for an order permitting it to subpoena more than 300 internet service providers for disclosure of customer names and addresses. The district court denied the motion, finding that there was no indication that the information sought was relevant and material to the action and that the request was broad and excessive. Guava filed a renewed subpoena motion on 17 internet service providers, which the court granted on the condition that the recipients could move to quash the subpoenas. Several of the internet service providers and their customers (“John Does”) moved: (1) to quash Guava’s subpoenas, (2) for a protective order, and (3) for dismissal of Guava’s action. Before the district court had an opportunity to rule on the motions, Guava and Merkel filed a stipulation in which Guava agreed to dismiss all claims with prejudice. The district court concluded that the lawsuit was merely an attempt to harass and burden non-parties through obtaining IP addresses to pursue settlement rather than proceed with potentially embarrassing litigation regarding downloading pornographic movies.
On August 7, 2013, the district court issued an order concluding that Guava and Dugas acted in bad faith and without a basis in law and fact to initiate the action. The court sanctioned Guava, Dugas, and Alpha, jointly and severally, by awarding attorney fees to the John Does and internet service providers. The sanction award was reduced to judgment on September 20, 2013.
During the above proceedings, Hansmeier took steps to defund and dissolve Alpha. Less than two weeks after the hearing on motions to quash, Hansmeier transferred $65,970 from Alpha to Class Action Justice Institute, LLC, another LLC of which Hansmeier was the sole member. One week after an order to show cause why the court should not award attorney fees and costs to the non-party John Does, Hansmeier transferred $80,000 from Alpha to his personal account. Two weeks after the order granting sanctions against Alpha, Hansmeier dissolved Alpha. As part of the dissolution, Hansmeier certified that Alpha did not have any known debts, liabilities, or pending proceedings against it.
On January 8, 2014, one of the John Does moved to add Hansmeier as a judgment debtor, alleging Hansmeier dissolved Alpha to avoid paying the ordered sanctions. The district court declined to add Hansmeier as a judgment debtor at that time, noting that to do so would alter the factual findings in the order, which were matters intertwined with a pending appeal. The district court, however, ordered an examination of debtors on June 16 and July 2, 2014, at the request of one of the judgment creditors.
On August 4, 2014, the Minnesota Court of Appeals issued a decision substantially affirming the district court’s judgment. Afterwards, a judgment creditor again moved to add Hansmeier as a judgment debtor. This time, the district court granted the motion, concluding that it was proper to pierce the corporate veil and hold Hansmeier jointly and severably liable, noting: (1) Hansmeier had intentionally defunded Alpha and disregarded the corporate form; (2) Hansmeier’s testimony to the court was inconsistent; and (3) Hansmeier failed to provide responsive information throughout the proceedings.
Hansmeier appealed the district court’s judgment, arguing, among other things, the district court: (1) did not have subject-matter jurisdiction to consider whether to pierce Alpha’s corporate veil, and (2) could not pierce the corporate veil on the merits.
District Court had Subject-Matter Jurisdiction to Pierce Veil
Hansmeier argued that the district court did not have subject-matter jurisdiction to consider whether to pierce Alpha’s corporate veil, because veil piercing is not part of a district court’s post-judgment enforcement jurisdiction and must be brought in a separate action and complaint.
Courts generally have broad discretion in applying equitable remedies. See Gabler v. Fedoruk, 756 N.W.2d 725, 730 (Minn. 2008). The court may grant “any equitable relief it considers just and reasonable in the circumstances” in an action by a creditor of an LLC when the creditor’s claim has been reduced to judgment and execution has been returned unsatisfied. Minn. Stat. § 322B.833, subd. 1(3)(i). Veil piercing is an equitable remedy. Equity Trust Co. Custodian ex rel. Eisenmenger IRA v. Cole, 766 N.W.2d 334, 339 (Minn. App. 2009). As an equitable remedy, veil piercing falls within the category of relief authorized in Minn. Stat. § 322B.833, subd. 1(3)(i). As such, the Guava II court determined the district court had subject matter jurisdiction to pierce the corporate veil as a remedy in the post judgment proceedings against Alpha.
Proper to Pierce the Corporate Veil on Merits
Next, Hansmeier argued that piercing the corporate veil was improper on its merits.
Veil piercing applies to LLCs as it does to corporations. Minn. Stat. § 322B.303, subd. 2. A court may pierce a corporate veil when there is fraud or when the shareholder is the “alter ego” of the corporation. Gunderson v. Harrington, 632 N.W.2d 695, 705 (Minn. 2001). Under the alter ego theory of piercing the corporate veil, Minnesota courts consider two prongs: (1) the relationship of the individual to the corporation, and (2) the relationship of the veil-piercer to the corporation. Victoria Elevator Co. v. Meriden Grain Co., 283 N.W.2d 509, 512 (Minn. 1979).
Alpha was Alter Ego to Hansmeier
In determining whether a corporation is an alter ego of an individual, Minnesota courts evaluate the reality of how the corporation operated. Id. Factors relevant to that determination include: (1) insufficient capitalization for purposes of corporate undertakings, (2) failure to observe corporate formalities, (3) nonpayment of dividends, (4) insolvency of debtor corporation at time of transaction in question, (5) siphoning of funds by dominant shareholder, (6) nonfunctioning of other officers and directors, (7) absence of corporate records, and (8) existence of corporation as a façade for individual dealings. Id. A number of the above factors must be present for the court to find the corporation an alter ego of the individual. Id.
In Guava II, the court affirmed the district court’s findings that nearly all of the above factors were present: (1) Alpha was primarily used for Hansmeier’s personal purposes; (2) Hansmeier’s completely disregarded corporate formalities and the separation of personal and business transactions in his dealings with Alpha; and (3) Alpha was insufficiently capitalized and deliberately undercapitalized. To support findings of these factors, the district court relied on the following facts: (1) Hansmeier failed to produce corporate or any other records for Alpha, other than bank statements; (2) Hansmeier testified that Alpha was never insured, never had a client trust account, never had any fee agreement or contract, and was “hardly, if at all, used as a law firm”; (3) Hansmeier transferred $80,000 from Alpha’s account for a down payment on his home and transferred $300,000 from Alpha’s account to a limited liability company that oversaw a trust for the benefit of his family; and (4) nearly all of Alpha’s funds came from entities controlled by Hansmeier. Further, the district court found that Hansmeier was using Alpha as a façade to perpetrate fraud on the court.
Fundamentally Unfair to Deny Veil Piercing to John Doe
The second prong of the alter ego theory test requires the veil-piercer to demonstrate an “element of injustice or fundamental unfairness” that would result from not piercing the corporate veil. Victoria Elevator, 282 N.W.2d at 512. Injustice or unfairness is present if the individual has used the corporate form to gain “an advantage he does not deserve.” Id. The veil-piercer does not need to prove strict common law fraud, but instead, must show that the corporate entity operated as a constructive fraud or in an unjust manner. Cole, 766 N.W.2d at 340.
Hansmeier argued that he must have used Alpha’s liability shield in dealings with John Doe and that there was no fundamental unfairness to John Doe to support veil piercing. The court held that the second prong of the alter ego theory test does not require a finding of a particular type of relationship between the veil-piercer and the company or its owner. The court further held that it would be fundamentally unfair if it did not pierce the corporate veil because: (1) Hansmeier’s actions prevented the judgment creditors from collecting their judgment against Alpha; (2) Hansmeier knew of the possibility of sanctions in the action, transferred money away, and terminated Alpha to avoid paying the judgments; and (3) Hansmeier abused the corporate liability shield to avoid paying sanctions in a bad-faith lawsuit for which he was responsible. As such, the Guava II court found that the district court did not abuse its discretion by piercing Alpha’s corporate veil and holding Hansmeier liable as a judgment debtor.
The Guava II court found that under the facts of the case, piercing the corporate veil was proper and the sole member of a professional LLC was personally liable for the debts of the company. In reaching its conclusion, the Guava II court considered Hansmeier’s misconduct toward the court. Even more important was that the alter ego theory test was met to demonstrate that Alpha was in fact the alter ego of Hansmeier.
To preserve the corporate liability shield, businesses must ensure that they are properly capitalized for the purposes of their undertakings, observing corporate formalities, paying dividends, not entering into transactions if they are insolvent, not siphoning corporate funds to the owners, requiring all officers and directors to perform duties, maintaining corporate records, and not maintaining the company as a façade for individual dealings.
For advice on member and shareholder personal liability or rights, contact Jim MacGillis or one of the Minnesota business attorneys of Trepanier MacGillis Battina P.A.
About the Author:
Minnesota business attorney James C. MacGillis advises clients on corporate and business law matters such as business entity formation, business transactions, and corporate governance. Jim may be reached at 612.455.0503 or email@example.com. Trepanier MacGillis Battina P.A. is a Minnesota business law firm located in Minneapolis, Minnesota.