Intermingling and Piercing the Corporate Veil

It has long been the law in Massachusetts that a corporation (or even an individual) can, under certain circumstances, be held liable for the debt of another corporation. This is commonly known as “piercing of the corporate veil.”

In a recent case decided by the Massachusetts Appeals Court involving a landlord seeking to hold the parent company liable for the rental obligations of its subsidiary, the tenant, the Court denied the landlord’s request. The Court found that, even assuming there was confused intermingling between the parent and subsidiary, there was insufficient evidence that the parent used its inter-corporate relations with its subsidiary to defraud the landlord or that the intermingling itself actually caused the landlord injury.

The tenant had entered into two commercial leases (there were two separate suites) with the landlord. Thereafter, another corporation, the parent company, acquired the tenant. At the time of the acquisition the tenant was close to insolvent.

Following the acquisition, the tenant and the parent tried to combine their operations, and some of the parent’s employees began working at the tenant’s leased premises, and in fact the parent occupied one of the two suites. Both entities also combined their websites. The two companies shared officers and employees, and most of the members of the two boards of directors were the same. There was evidence that there was confusion among officers and employees of both companies concerning who worked for whom. There was other evidence of the “intermingling” of the two corporations.

The tenant stopped paying rent and the landlord brought an action against both the tenant/subsidiary and the parent, seeking to hold the parent liable under the lease pursuant to a theory of corporate disregard.

The case was tried to a jury who found for the landlord; but the judge “reversed” the jury’s decision by allowing the parent’s “motion for judgment notwithstanding the verdict.” The landlord appealed.

The Appeals Court found that while the judge properly instructed the jury as to the standard to pierce the corporate veil (prove either active and pervasive control of a related business by the parent, with fraudulent or harmful consequences from the inter-corporate relationship, or that there was a confused intermingling of activity between the entities, and ambiguity as to the manner and capacity in which the two corporations were acting), as well as appropriately outlining the factors from a leading federal case: (“(1) common ownership; (2) pervasive control; (3) confused intermingling of business assets; (4) thin capitalization; (5) nonobservance of corporate formalities; (6) absence of corporate records; (7) no payment of dividends; (8) insolvency at the time of the litigated transaction; (9) siphoning away of corporation’s funds by dominant shareholder; (10) nonfunctioning of officers and directors; (11) use of the corporation for transactions of the dominant shareholders; and (12) use of the corporation in promoting fraud.”), there was no liability of the parent company in this case.

While many lawyers believe it is enough to prove the above factors (not necessarily all, but enough for the fact finder to believe that overall structure and operations were misleading) to pierce the corporate veil and hold a party liable for the debts of another, the Court held that there must be evidence of a causal connection between the corporations’ “confused” relationship and landlord’s damages, that is, the landlord must “causally link” the parent’s pervasive control of its subsidiary to the landlord’s injuries. The Court also noted there was no fraud perpetrated on the landlord, nor was there any evidence the parent “siphoned away” the subsidiary’s funds and used its control to cause the tenant to default.

From a landlord’s perspective, there are provisions that could have been inserted in a lease to protect the landlord, or provide leverage to obtain parent’s guaranty after the merger. Rudolph Friedmann LLP can assist in drafting such provisions.

Jim Singer is a partner in Rudolph Friedmann’s litigation department.