Business Associations - Paul A. Quiros, Lynn S. Scott, and James F. Brumsey

• Jurisdiction: Georgia,United States,Federal
• Publication year: 2003
• Citation: Vol. 55 No. 1

Business Associationsby Paul A. Quiros*

Lynn S. Scott**and

James F. Brumsey***

This Article surveys noteworthy cases in the areas of corporate, securities, partnership, and banking law decided during the survey period¹ by the Georgia Supreme Court, the Georgia Court of Appeals, the United States Court of Appeals for the Eleventh Circuit, and the United States district courts located in Georgia. The Article also summarizes recent enactments of the Georgia General Assembly with respect to the foregoing subject matters.

I. Corporations

A. Piercing the Corporate Veil

Under the typical veil-piercing scenario, a third-party creditor or claimant asks a court to set aside the legal fiction that a corporation is its own entity, separate and distinct from its owners. Under most circumstances the courts honor this legal fiction to preserve the corporate form, which, in turn, generally shields investors in a corpora- tion from liability and encourages investment and growth in business.² However, courts in America have long since recognized that the distinction between the corporation and its owners is not absolute. For example, in 1905, Judge Sanborn, writing for the United States District Court for the Eastern District of Wisconsin, delivered what is often regarded as the classic iteration of the corporate veil-piercing doctrine:

If any general rule can be laid down, in the present state of authority, it is that a corporation will be looked upon as a legal entity as a general rule, and until sufficient reason to the contrary appears; but, when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons.³

Though the language used by the Georgia courts to describe the doctrine varies to some degree from that of Judge Sanborn, the concept is the same—if the separate personalities of the corporation and its owner no longer exist, such that the corporation serves as the alter ego or business conduit of its owner, then equitable principles of the law will intervene and hold the owner liable for the debts of the corporation.⁴

The most interesting veil-piercing case decided by the Georgia courts during the survey period did not concern a creditor seeking to pierce the corporate veil in order to hold the owner liable for corporate debts; but rather, a third-party creditor sought to pierce the corporate veil in order to hold the corporation liable for the debts of a shareholder.⁵ This concept is commonly referred to as "reverse piercing of the corporate veil."⁶ The reverse piercing concept is not nearly as weathered or heralded⁷ as the more common version of the doctrine described above. But the reverse piercing concept has begun to gather momentum in certain jurisdictions,⁸ and, during the survey period, Georgia was no exception.

1. Court of Appeals Upholds Jury Charge Allowing Reverse Piercing of the Corporate Veil; Supreme Court Reverses. In Acree v. McMahan,⁹ the court of appeals affirmed a jury verdict in favor of reverse piercing of the corporate veil to hold a corporation liable for the debts of its shareholder.¹⁰ Dr. Russell Acree was the principal shareholder of Memorial Health Services, Inc. ("MHS"), a corporation formed for the purpose of managing and purchasing hospitals in south Georgia. In 1990 Acree recruited Dr. Howard McMahan and Dr. Gene Jackson to relocate to Ocilla, Georgia, where Acree was finalizing plans to manage the Irwin County Hospital. Acree, McMahan, and Jackson formed a corporation, AJM, Inc., to organize the structure of their practice, whereby Jackson and McMahan would be on the hospital's staff and generally assist in working to turn around the hospital's finances. Each principal was a one-third owner of AJM, Inc. They agreed that, if the hospital was sold to AJM, Inc., McMahan and Jackson could participate in the equity ownership of the hospital. After disagreements arose between Acree, on one hand, and Jackson and McMahan on the other hand, Acree agreed (in his individual capacity) to buy out the other two for $750,000 each, to be paid in installments. For over a year, Acree caused both MHS and the hospital to make the required payments owed by Acree to McMahan and Jackson. Subsequently, Jackson moved away and Acree ceased making payments to McMahan, citing unhappiness with McMahan's continued performance under the terms of the buyout agreement. McMahan brought suit against Acree and MHS to recover damages for breach of contract. Following the trial, the judge instructed the jury that even though the agreement was between McMahan and Acree in his individual capacity, it could find MHS liable if it found sufficient evidence to pierce the corporate veil.¹¹

The jury returned a verdict in favor of McMahan. Acree and MHS appealed. On appeal Acree and MHS contended that the trial court erred in its charge to the jury because reverse veil-piercing (which would allow MHS to be liable for Acree's debts) is not available under Georgia law.¹² Finding that McMahan presented sufficient evidence of abuse of the corporate form to submit the veil-piercing issue to the jury,¹³ the court of appeals turned to the issue of whether the concept of reverse piercing is available under Georgia law.¹⁴ The court rejected as inconclusive two cases on which MHS relied in support of its contention that reverse veil-piercing is unavailable in Georgia.¹⁵ The court declared, "[so] long as it is properly pierced under applicable law, we see no reason why the corporate 'veil' should not be a membrane permeable from either direction, permitting liability to move either into or out of the corporate form, to serve the interests of justice and prevent fraud."¹⁶ The Georgia Supreme Court granted certiorari in February 2003 to review the issue ofwhether reverse piercing ofthe corporate veil is available under Georgia law.¹⁷

In a case of first impression, the supreme court reversed the court of appeals,¹⁸ stating, "We reject reverse piercing, at least to the extent that it would allow an 'outsider,' such as a third-party creditor, to pierce the veil in order to reach a corporation's assets to satisfy claims against an individual corporate insider."¹⁹ Relying on the decisions and reasoning of a number of foreign jurisdictions,²⁰ the court stated, " 'Reverse alter ego is an equitable doctrine; it stretches the imagination, not to mention the equities, to conceive of how someone wholly outside the corporation may be used to pierce the corporate veil from within.'"²¹ The court continued:

"The [outsider] reverse-pierce theory presents many problems. It bypasses normal judgment-collection procedures, whereby judgment creditors attach the judgment debtor's shares in the corporation and not the corporation's assets. Moreover, to the extent that the corporation has other non-culpable shareholders, they obviously will be prejudiced if the corporation's assets can be attached directly. In contrast, in ordinary piercing cases, only the assets of the particular shareholder who is determined to be the corporation's alter ego are subject to attachment."²²

The court further reasoned that the possibility of losing out to an individual shareholder's creditors would unsettle the expectations of the corporation's creditors who understand their loans to be secured by corporate assets.²³ Because the concept of disregarding the corporate form is based on equitable principles, the court continued, "'it is appropriately granted only in the absence of adequate remedies at law.'"²⁴ Finally, the court cited a case on which Acree unsuccessfully relied at the appellate level by stating, "[a]llowing outsider reverse piercing claims would constitute a radical change to the concept of piercing the corporate veil in this state and, thus, should be created by the General Assembly and not by this Court."²⁵ Because McMahan prevailed against Acree individually, it was not necessary to disregard the corporate entity for McMahan to enforce his rights under the contract.²⁶

2. Court of Appeals Upholds Jury Verdict Piercing the Corporate Veil. In a textbook piercing of the corporate veil under Georgia law, the court of appeals affirmed a jury verdict holding an owner personally liable for the debts of three corporations in Scott Brothers v. Warren.²⁷ In Scott Brothers, Danny Warren entered into an agreement with Scott Brothers, Inc., a corporation owned by Robert and Glenn Scott. Pursuant to the agreement, Warren would supply video cassette and gaming machines to be rented to customers of a chain of video rental stores owned by Scott Brothers. Unbeknownst to Warren, a number of the machines were also in video stores owned by Scott Development, Inc. and Scott Entertainment, Inc., both of which Glenn Scott owned exclusively. Revenues from the rentals and any replacement costs for lost or stolen machines were to be shared equally between Warren and Scott Brothers. After three years of regular payments, Scott Brothers refused to make further payments. When Warren attempted to retrieve his 544 machines, he discovered that 311 of the machines were missing. Scott Brothers then refused to pay Warren his share of the past due rentals and replacement costs. Warren sued Robert and Glenn Scott and each of their companies for breach of contract. Following a denial of defendants' motion for a directed verdict, the jury pierced the corporate veil, finding Glenn Scott and the three companies liable for breach of contract.²⁸

On appeal the court reiterated the oft-cited language from Derbyshire v. United Builders Supplies, Inc.,²⁹ stating that to prevail on a veil-piercing claim

"[i]t must be shown that the stockholders' disregard of the corporate entity made it a mere instrumentality for the transaction of their own affairs; that there is such unity of interest and ownership that the separate personalities of the corporation and the owners no longer exist; and to...