Piercing the Corporate Veil: Fraudulent Builder Tries to Hide Behind Business |[OH CT APP]|

In early 2002, a property owner met with a builder to discuss remodeling his home and adding a 6,000 square foot addition. The builder discussed the project in his capacity as the sole shareholder and employee of his construction corporation, Castlebrook Builders, Inc. Claiming to be concerned about the unique nature of the project and uncertainties that might follow, the builder decided to operate on an oral agreement with the owner. Uncertainties notwithstanding, the owner contended that the builder estimated and promised that the project would cost around $500,000 and reach completion within a year.

As the project unfolded, the builder increasingly sent invoices demanding payment that exceeded the original estimation. The owner began requesting an accounting of the work done for payments made once the total charges reached $900,000. No accounting was ever provided. After over a year, the owner testified having paid a total of $1,314,218. The owner then hired a third-party builder to estimate the project value and costs to remedy construction defects. The third-party builder valued the project between $540,000 and $580,000. Because of major discrepancies between the cost promised and the subsequent payments demanded without accounting, the owner accused that the builder of fraud. To the owner and in court, the builder was unable to account for work completed for large portions of the owner’s payments. For example, among other payments discrepancies, the builder admitted to having charged the owner $59,000 for unrelated work, $197,817 of lumber not used for the project, and double charges of $36,000 for foundation work.

Even though the parties to the oral agreement did not include the builder per se, the owner alleged that the corporation was merely an alter ego of the builder and that he should be individually responsible. In 2002, the builder founded the corporation without any legal assistance. No shares had been issued and the builder was sole employee. Before and during the project, the builder used the corporate checking account to pay for his credit cards, personal medical treatment, gasoline, his truck, and his daughter’s apartment. Furthermore, evidence indicated that the builder failed to keep accurate minutes at annual shareholder meetings.

Seeking damages for the overpayments, the owner sued Castlebrook Builders, Inc. for, among other things, fraud. Under the alter ego theory, the owner sought to “pierce the corporate veil” by holding the builder personally liable. At trial, the owner showed that the builder had (1) such complete control over the corporation that it had no separate mind, will, or existence of its own, (2) exercised control over the corporation in such a manner as to commit fraud against the owner seeking to disregard the corporate entity, and (3) caused the owner to incur unjust losses. The jury rendered a verdict for the owner holding the corporation and the builder jointly and severally liable for $332,000. The builder appealed the decision claiming that the trial court erred in putting the veil piercing question to the jury and failing to provide sufficient evidence under the Belvedere veil piercing test.

In SNAPP v. CASTLEBROOK BUILDERS, INC., 2014-Ohio-163, 7 N.E.3d 574 (3d Dist. Jan. 14, 2014), the appellate court upheld the jury verdict, piercing the Castlebrook Builders’ corporate veil to hold the builder personally liable for damages caused to the home owner. The court noted that although shareholders are generally not liable for corporate misdeeds, they are not absolutely immune from liability for the actions of their corporation. The builder claimed that the exceptional nature of veil piercing requires that it is limited only to cases in which the corporation was formed to perpetuate a fraud. The court rejected this notion as cited under the Ohio Supreme Court’s decision in Belvedere which states that veil piercing may be applied when “control of the corporation by those to be held liable [is] exercised in a manner to commit fraud or an illegal act against the person seeking to disregard the corporate entity.” Belvedere Condominium Unit Owners’ Assn. v. R.E. Roark Cos., Inc., 67 Ohio St.3d 274, 617 N.E.2d 1075 (1993). Accordingly, the court held that corporate veil piercing is not limited to instances wherein the corporation was formed under fraudulent pretenses, but rather when a shareholder with complete control uses it to defraud someone.

In response to the builder’s insufficient evidence contention, the court found that the jury’s decision was based on sufficient evidence. Under the first prong of the Belvedere test, requiring a plaintiff to show that the defendant had such complete control over the corporation to the extent that it had no separate mind, will, or existence of its own, the court noted that there are several factors under Ohio jurisprudence that help determine whether this prong has been satisfied. These factors 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. Applying those factors, the court noted the following evidence in the case as sufficient to satisfy the control prong under Belvedere: (a) the builder failed to issue shares for the corporation, (b) the builder failed to carefully evidence his yearly corporate meetings in minutes, and (c) he commingled corporate funds with his personal finances and used the corporation’s money to pay for his credit cards, medical treatment, and his daughter’s apartment.

Additionally, the builder claimed that the second prong, here showing fraud, was not satisfied. The court did emphasize that veil piercing is limited to extreme cases of misconduct such as fraud, and that it should not be applied to mere unjust or inequitable acts. However, it found sufficient evidence of fraud under the following standard in Ohio: fraud can be shown by evidence of (1) a representation or, where there is a duty to disclose, concealment of a fact, (2) which is material to the transaction at hand, (3) made falsely, with knowledge of its falsity, or with such utter disregard and recklessness as to whether it is true or false that knowledge may be inferred, (4) with the intent of misleading another into relying upon it, (5) justifiable reliance upon the representation or concealment, and (6) a resulting injury proximately caused by the reliance. Here, the court held that the owner had sufficiently shown fraudulent acts by the builder to satisfy the test. In particular, the court found the following evidence as sufficient: (a) evidence that the builder made multiple statements regarding the estimated or promised costs of the transaction and evidence that the costs were significantly higher, (b) evidence of billing statement charges not actually owed by the home owner, (c) evidence of the owner’s reliance upon the builder’s misrepresentations of costs, and (d) inferential evidence that the builder’s decision not to use a contract as he normally did indicated his intention to overcharge the owner.

Best Practices:

1. Veil piercing is an exceptional judicial tool for creditors and other plaintiffs to obtain pay/damages – Piercing the veil is a broad equitable doctrine by which courts impose personal liability on investors and managers in a limited liability business enterprise such as a corporation. However, as the court noted, piercing the corporate veil is limited to extreme circumstances that amount to fraud, crime, or similarly unlawful acts and not mere unjust or inequitable acts.
2. The Belvedere standard is the standard – To pierce the corporate veil, a plaintiff must demonstrate all three of the following: (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) defendant shareholder exercised control over the corporation in such a manner as to commit fraud, an illegal act, or a similarly unlawful 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.
3. If incorporated, maintain corporate formalities – As the court noted, corporate formalities such as annual shareholder meetings (sufficiently documented by meeting minutes) and issuance of shares (even if all to oneself) can rebut a claim that the shareholder’s use of the corporate form was only to shield him or her from liability.
4. Close Corporations and LLCs may still be pierced, but corporate formalities are less probative – Because of their more personal and less formal natures, close corporations and LLCs likely need not show the same strict adherence to corporate formalities as public corporations must.
5. Formalize income from corporations as to not commingle corporate and personal expenses – Shareholders can take income from their corporations in the form of standard dividends based on earned surplus or assets in excess of liabilities (if incorporated in Delaware, shareholders must also consider the stock par value when calculating dividends). An individual who is the sole shareholder and employee of the corporation can also take a salary for the work in his or her employee capacity.

– Christian H. Robertson II

All materials have been prepared for general information purposes only to permit you to learn more about construction law. The information presented is not legal advice, is not to be acted on as such, may not be current and is subject to change without notice.