Ohio Court Pierces Corporate Veil and Holds Transfers to Shareholder Were Fraudulent

A recent decision by the Ohio Court of Appeals (Second District) held that the City of Springfield, Ohio was entitled to “pierce the corporate veil” of the defendant corporation in order to reach the shareholder’s assets.  The court further held that transfers totaling about $900,000 to its shareholder (proceeds from the corporation’s sale of real property) were fraudulent conveyances pursuant to §1336 of the Ohio Revised Code.

This case was decided in June of 2013, but only recently published in the September 16, 2013 edition of the Ohio State Bar Association Report.

Forming a corporation, trust or other entity in and of itself does not automatically protect assets.  How the entity is operated (and how and when various transfers are made) also needs detailed attention.  The trial court in this case paid particular attention to the timing of the transfers in finding that they were fraudulent.

At a minimum, this new Ohio decision is another reminder that simply forming a corporation, trust or other entity is not enough for asset protection.  You need to pay close attention to how that entity is operated (and how and when various asset transfers are made).

 

Ohio Court of Appeals Provides Guidance About "Piercing the Corporate Veil"

The Ohio Court of Appeals (10th District, Franklin County) recently provided some very specific guidance about "piercing the corproate veil" in Ohio.  The case is Lind Stoneworks, Ltd. v. Top Surface, Inc., 194 Ohio App.3d 98 (10th District 2011).

The trial court held a corporation and its sole owner liable for a corporate debt.  The trial court "pierced the corporate veil" and found the owner to be personally liable.  The owner admitted that the corporation had no officers, no directors, and had apparently failed to follow some other corporate formalities.

The Court of Appeals held that in this case, these facts alone were not sufficient to impose personal liability on the owner.  The appeals court basically found that there was insufficient evidence to pierce the corporate veil.  The decision of the trial court was reversed and the case was remanded for further consideration.

Many factors can influence whether or not personal liability will be imposed on a corporation owners.  The Court of Appeals noted that in general, shareholders, officers and directors are not liable for a corporation's debts.

A limited liability company does not have as many required formalities as a corporation.  Nevertheless, it should still have a separate bank account and otherwise be treated as a separate entity.

The message from this recent Ohio court decision is clear:  make sure that you follow basic formalities with your corporation, limited liability company, or other business entity.  This is relatively easy to do; and failing to do it can completely defeat the purpose of forming the entity in the first place.

Piercing the Corporate Veil

Corporations and limited liability companies (LLCs) provide significant liability protection to their owners.  Shareholders of corporations and members of limited liability companies generally are not responsible for debts of the corporation or LLC.  A recent Ohio case, however, serves as a reminder that creditors may attempt to "pierce the corporate veil" and hold an owner individually liable for debts of the entity. 

In RCO International Corporation v. Clevenger, 180 Ohio App.3d  211 (2008) the Plaintiff brought a breach of contract action against an LLC and its two members.  While the lower court granted summary judgment in favor of the owners, an Ohio appeals court held that the creditor may have made sufficient allegations against the owners, to sue them personally.  While the Plaintiff did not allege fraud, it did allege an illegal act (the company's sending a false invoice).  On the surface, the facts of this case did not seem to present a strong case for "piercing the corporate veil".  The decision, however, may have rested on certain procedural issues.  In any event, this recent case is a good reminder that simply forming a corporation or LLC does not in and of itself automatically give the owner limited liability in all circumstances. 

What can be done to prevent a creditor from "piercing the corporate veil" and holding an owner personally liable?

  • Make sure your corporation or LLC is properly set up.  If you are setting up an entity without the help of an attorney, you may not be taking all the necessary steps to make sure that the entity is properly formed.
  • Observe formalities once the entity is formed.  Corporations should hold annual meetings of shareholders.  There should be meetings of the Board of Directors.  An LLC should have an Operating Agreement, and the terms of that Operating Agreement should be followed.  Your entity should have a separate bank account and be treated as a separate entity.
  • Your corporation or LLC should have usual and customary insurance for whatever business it is conducting.  A court is far more likely to try and "pierce the corporate veil" if the owner has intentionally failed to provide customary insurance for the entity's activities.
  • Follow good business practices.  Forming an entity will not shield an individual owner from fraud or illegal acts.

The leading court decision in Ohio, Belvedere Condominium Unit Owners Association v. R.E. Roark Companies, 67 Ohio St. 3d 274 (1993), as well as decisions in many other states, make clear that if usual and customary practices are followed, a corporation or an LLC should provide limited liability protection for its owners.