Posted In: Business Transactions & Corporate Counseling
By Louis P. Alexander Jr. on June 3, 2020
In a recent case, Denny v. Breawick, L.L.C., 2019-Ohio-2066, the Court of Appeals for Ohio’s Third District (Hancock County) permitted the plaintiff to pierce the veil of a single-member limited liability company. The court’s analysis in Denny v. Breawick has underscored the importance of observing corporate formality, even for single-member limited liability companies.
Facts of the case
In Denny v. Breawick, defendant Timothy Hunsaker, a building contractor, was the sole member of two Ohio limited liability companies – Breawick, L.L.C. and Buren Trace Development, L.L.C. Hunsaker performed construction work in the Buren Trace Development through Breawick.
Hunsaker met with Plaintiff, Cheryl Denny, nine times before the parties entered into a contract for construction of a house in the Buren Trace Development, which Hunsaker signed on behalf of Breawick.
Disagreements arose during construction regarding the work. Hunsaker made unauthorized changes, insisted upon expensive “extras” and threatened to quit work on the project if Denny did not pay for them. Several suppliers placed liens on the property and another named Denny in a related lawsuit, for which Denny incurred costs and legal fees to resolve.
Hunsaker ultimately quit work on the house, claiming he was not getting paid and filed a mechanic’s lien on the property. Denny was forced to hire a new contractor to repair Hunsaker’s deficient work and continue work to make the house habitable, but significant work and expense were still required to complete the project to contract specifications.
Lawsuit and Trial
Denny sued defendants Breawick, Buren Trace, and Hunsaker for violation of the Ohio Consumer Sales Practices Act (CSPA), breach of contract, converted funds, fraud, unjust enrichment, violation of the Ohio Home Construction Service Law (HCSL), and sought to pierce the corporate veil to hold Hunsaker personally liable for her damages.
The trial court denied Denny’s claims for fraud, unjust enrichment, conversion, and violation of the CSPA. However, the trial court found that the defendants were in breach of the contract and violated the HCSL, by charging excess costs without owner approval and knowingly failing to perform in a workmanlike manner. The trial court also sanctioned the defendants for HSCL violations and awarded Denny attorney’s fees.
More importantly, the trial court found that Breawick and Buren Trace were merely the alter egos of Hunsaker, and determined that their violations of the HCSL were illegal acts that justified piercing Breawick’s corporate veil; thereby holding Hunsaker personally liable for Denny’s damages.
On appeal, the defendant-appellants argued that the trial court erred by applying the standards and operating requirements of a corporation to impose personal liability on the owner for the limited liability company’s activities. Appellants further argued that Buren Trace and Breawick were not Hunsaker’s alter egos and that the violations of the HCSL were not the types of “illegal acts” that justify piercing.
Applicable Law for Piercing the Corporate Veil
Ohio Revised Code Section 1705.48(B) provides that no member of a limited liability company shall be personally liable for the obligations of the company solely by reason of being a member. However, a member of a limited liability company may be held personally liable if the plaintiff demonstrates that the behavior of the members merits disregarding or piercing, the entity’s limited liability structure. Huttenbauer Land Co., L.L.C. v. Harley Riley, Ltd., 1st Dist. Hamilton No. C-110842, 2012-Ohio-4585, ¶ 15. Further, a trial court may apply the doctrine of piercing the corporate veil to limited liability companies. Huttenbauer, supra; Acquisition Servs., Inc. v. Zeller, 2d Dist. Montgomery No. 25486, 2013-Ohio-3455, ¶ 45 [citations omitted].
The analysis for piercing the veil under Ohio law is known as the “Belvedere test,” as the same is clarified by the Ohio Supreme Court’s holding in Dombrowski (below). In Belvedere Condominium Unit Owners’ Assn. v. R.E. Roark Cos. Inc., 67 Ohio St.3d 274, 275, 617 N.E.2d 1075 (1993), the Ohio Supreme Court established the elements for piercing: (1) control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own, (2) control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and (3) injury or unjust loss resulted to the plaintiff from such control and wrong. Belvedere.
In Dombroski v. WellPoint, Inc., 119 Ohio St.3d 506, 2008-Ohio-4827, 895 N.E.2d 538, the Ohio Supreme Court clarified the requirements of the second prong of the Belvedere test. Dombroski at ¶ 1, see, also Binsara, L.L.C. v. Bolog, 2019-Ohio-4040. Under Dombroski, “the plaintiff must demonstrate that the defendant shareholder exercised control over the corporation in such a manner as to commit fraud, an illegal act, or a similarly unlawful act.” Id. at ¶ 29. [Emphasis added]. The Dombrowski Court added the phrase “…or a similarly unlawful act” in order to address shareholders that abuse the corporate form to commit acts that are as objectionable as fraud or illegality. Binsara, supra.
“This test focuses on the extent of the shareholder’s control of the corporation and whether the shareholder misused the control so as to commit specific egregious acts that injured the plaintiff.” Dombroski at ¶ 18.
“All three prongs of the test must be met for the court to pierce the corporate veil.” My Father’s House No. 1, v. McCardle, 2013-Ohio-420, 986 N.E.2d 1081, ¶ 28 (3d Dist.) at ¶ 27.
“[L]imited shareholder liability is the rule * * *, and piercing the corporate veil in this manner remains a ‘rare exception,’ to be applied only ‘in the case of fraud or certain other exceptional circumstances.’” Dombroski at¶ 17, quoting Dole Food Co. v. Patrickson, 123 S.Ct. 1655, 538 U.S. 468, 475, 155 L.Ed.2d 643 (2003). Courts are to pierce the corporate veil when “it would be unjust to allow the shareholders to hide behind the fiction of the corporate entity.” Belvedere at 287.
The Appellate Court’s Analysis
The Denny v. Breawick court analyzed the first prong of the Belvedere test, which is known as the “alter ego doctrine.” The court explained that a corporation is an individual’s alter ego when “the individual and the corporation are fundamentally indistinguishable.” Denny v. Breawick, quoting Belvedere at 288. “Some of the factors used to determine if this standard has been met include (1) whether corporate formalities were observed, (2) whether corporate records were kept, (3) whether corporate funds were commingled with personal funds, and (4) whether corporate property was used for a personal purpose.’ Pottschmidt v. Klosterman, 169 Ohio App.3d 824, 2006-Ohio-6964, 865 N.E.2d 111, ¶ 37 (9th Dist.). [Emphasis added].
With respect to the first prong, the court found that there was evidence to support that the limited liability companies were alter egos of Hunsaker with no separate mind, will, or existence of their own. In support of this finding, the court noted the following: (a) Hunsaker drew funds from Breawick’s bank account to pay for his personal expenses; (b) Buren Trace did not have a separate bank account; and (c) defendants did not observe corporate formalities, as neither company kept corporate records, and the defendants could not identify when or if any meetings took place.
As to the second prong of the Belvedere test, the court found that the defendants violated two provisions of the HCSL: (1) Failed to perform home construction services in a workmanlike manner (failure to complete project; construction deficiencies; did not work regularly and made unapproved changes to specifications); and (2) Charged for excess costs without approval of the owner (demanded payment for “extras” and threatened to stop working if plaintiff did not pay for them). The court reasoned that while Defendants were not found to have committed fraud, the two violations of the HCSL were “illegal acts” so egregious as to satisfy the Dombrowski standard.
Finally, for the third prong, the court found that Denny showed that Hunsaker’s illegal acts were the cause of the damages, as Denny was forced to spend large sums of money to make the house habitable and even greater sums to complete construction to the original contract specifications, and Denny had to pay to remove liens to continue work and for extras as a result of Hunsaker’s actions.
The Court of Appeals found that competent, credible evidence existed for each prong of the Belvedere test, and affirmed the judgment of the trial court.
Some of the logic from Denny v. Breawick was echoed (and cited) by another recent case, the aforementioned Binsara, L.L.C. v. Bolog, 2019-Ohio-4040. In Binsara, the Court of Appeals for Ohio’s Fifth District (Stark County) affirmed a trial court judgment allowing a plaintiff to pierce the corporate veil. Among its findings of fact, the trial court in Binsara found that defendants – including six different entities – did not keep meeting minutes, corporate appointments, board appointments, board records, or corporate records, and that bank records showed transfers of money between all business entities owned by the shareholders/members.
As demonstrated by these recent holdings, the observance of corporate formality is critical for the preservation of the limited liability structure and the protection of the member.
The attorneys at Brouse McDowell are skilled in the area of corporate law and can assist your business with its preparation and maintenance of corporate records. Please contact our Business Transactions & Corporate Counseling Group for more information.
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