Category Archives: Investigative Techniques

Reaching Behind the Curtain

Not too long ago a close friend of one of our Chapter members paid a substantial sum of money to a relative, the owner of a closely held corporation, in exchange for a piece of the relative’s real estate to which, it turns out,  the relative/owner did not have clear title.  The relative apparently used a substantial portion of the funds to immediately clear debts of his corporation of which he and his wife are the sole officers and shareholders.  He now claims that, since he used the sale proceeds for corporate purposes, the refund of the purchase price he owes our Chapter member’s friend is a debt of the corporation and not of his personally.   Our Chapter’s friend has engaged an attorney at the suggestion of our certified Chapter member.

Our legal system recognizes that corporations have a separate existence from their shareholders/owners and are treated as ‘individuals’ under the law. There are two ways for a wrong-doer to use the existence of a corporation to avoid efforts to recover a money damage judgment from him or her:

–As in this case, the scammer argues that the corporation and not the shareholder/owner committed the offense, and therefore the shareholder’s personal assets and property should not be used to satisfy any judgment for the offense.

–Argues that the wrongdoer/shareholder’s property is held in the name of the corporation, and therefore s/he has no personal assets that can be used to satisfy a judgment against him  or her.

The first reflects the classic doctrine that shareholder/owners are not liable for the debts or liabilities of the corporation. Of course, if the shareholder/owner also controls the corporation and personally acted wrongfully, s/he may still be liable for her misconduct, and the corporation may simply be jointly and severally liable together with her. Whether the wrongful conduct was that of the corporation or that of an individual shareholder usually is a question of fact to be decided by the jury.

The second reflects the corporation’s ability, as a separate legal entity, to own its own property. If the corporation owns the property, then the individual shareholder does not.  Since both pre-judgement attachment writs and writs of execution can only reach a defendant’s interest in leviable assets, a wrongdoer can appear without assets and judgment proof – and your client can be unable to satisfy a money judgment against her- if the wrongdoer/shareholder has transferred title in her personal assets to the corporation. This does not apply to a non-money judgment to recover specific money or property which can reach proceeds or property in the hands of the wrongdoer or of third persons. Of course, if the wrongdoer’s transfer of assets to the corporation was to defraud creditors, the injured party can seek to have the transfers set aside.

However, even where a corporation apparently shields the defendant or his or her property, the wrongdoer and her leviable property can still be reached if the court can be convinced to disregard the corporation or to regard it merely as her alter ego. The court may do so if it can be proved that the corporation is merely a sham whose sole purpose is to help the wrongdoer fraudulently avoid liability for her conduct. This is sometimes called piercing the corporate veil.

If the corporation is found to be the alter ego of the shareholder, then either or both of the following consequences apply, depending on the goal in piercing the corporate veil:

–The wrongdoer is no longer shielded from liability for the corporation’s misconduct because the wrongdoer and the corporation are viewed by the court as one and the same.

–Corporate property can be reached to satisfy a judgment against the wrongdoer because the property is now regarded, properly, as the wrongdoer/shareholder’s property.

One of the factors to consider in attempting to pierce the corporate veil is whether the corporation is closely held; i.e. owned or directed by one or by a small or limited number of shareholders, officers, and directors (often all the members of the same family). Obviously, the larger the number of shareholders, and the more broadly the corporation’s directing positions are distributed, the less likely it is to be a sham or alter ego for one person. However, given the lawful goals and purposes of incorporation, even a small, closely held corporation may be legitimate. Conversely, the existence of other shareholders or other directors and officers may not mean that the corporation is not a sham.

The ACFE tells us that there is no hard and fast test to determine whether a corporation is a sham. Instead, courts will look at a variety of factors to determine whether to pierce the corporate veil. These factors include:

–As in this case, does the wrongdoer exercise sole or ultimate control over the activities of the corporation?

–Does the corporation’s charter describe the approved activities of the corporation with some specificity, or is it left largely to the discretion of the wrongdoer?

–Does the corporation fail to hold director’s and shareholder’s meetings, record minutes of those meetings, and otherwise observe the formalities of corporate existence?

–Is the corporation so undercapitalized as to raise questions about its viability as a separate entity?

–Are the corporation’s finances so intertwined or identifiable with those of the wrongdoer as to raise questions about its separate existence?

–Does the corporation own property which does not seem to reasonably relate to its activities, particularly as described in its charter?

–Does the wrongdoer use the corporation’s property as if they were her own, personal assets, including but not limited to whether she uses them for purposes not within the corporation’s approved activities?

These and similar or related facts can indicate that the corporation is a sham and has no true, separate existence from the wrongdoer/shareholder. In that case, the court would be justified in ruling that the corporation should be regarded as an alter ego of the wrongdoer and that the corporation and the wrongdoer be considered as one and the same ‘person’ for purposes of determining liability or levying on assets to satisfy a money judgment.

Many thanks to our member for bringing this case to our attention!