A primary reason for creating a corporation to conduct business is to shield corporate shareholders from personal liability for the corporation’s acts and debts. This corporate shield is of obvious benefit to shareholders, allowing them to freely invest in an enterprise while limiting their risk. The corporate shield, however, is a great frustration to creditors of a corporation when the corporation does not have sufficient assets to pay its debts. In certain circumstances, corporate creditors can “pierce the corporate veil” to reach the assets of corporate shareholders or the assets of other corporations in which those shareholders also participate.
The Indiana Court of Appeals recently handed down an opinion involving these issues in the case of Konrad Motor and Welder Service, Inc. v. Magnetech Industrial Services, Inc. In that case, Magnetech sued Konrad Electric for failure to pay for repair work on two large electric motors. During the course of the lawsuit, Konrad Electric ceased operation. The husband of the sole shareholder of Konrad Electric then started a new corporation named Konrad MWS. By the time Magnetech finally won its case against Konrad Electric, there were no assets left to pay the judgment. Magnetech then attempted to pierce Konrad Electric’s corporate veil by suing Konrad MWS for payment of the debt.
In ruling that Konrad MWS owed the debt, the Court of Appeals noted that the corporate veil may be pierced “where one corporation is so organized and controlled and its affairs so conducted that it is a mere instrumentality or adjunct of another corporation.” Further, corporations will not be recognized as separate entities “where evidence shows that several corporations are acting as one.” Factors to be considered when determining whether one corporation may be held liable for the debt of another corporation include “the intermingling of business transactions, functions, property, employees, funds, records, and corporate names in dealing with the public.”
In the Magnetech case, the Court of Appeals ruled that Konrad MWS owed the debt of Konrad Electric because both corporations had similar names, had the same employee, were in the same line of business, had the same customers, and conducted business at the same location.
The Magnetech case highlights the importance for small business owners to closely adhere to corporate formalities and to keep their personal affairs separate from their business affairs, as well as to keep separate the affairs of multiple corporations in which they may be involved. The Magnetech case also demonstrates that creditors who find themselves unable to collect from corporate debtors may have additional legal tools with which to recover their losses.
For more information regarding corporate liability, piercing the corporate veil, or collection law in general, contact Steve Hoar, or a member of KDDK’s Bankruptcy, Collection and Creditors’ Rights Practice Team.