Business Associations - Paul A. Quiros, Lynn S. Scott, and George Ward Hendon, Jr.

• Publication year: 1999

Business Associationsby Paul A. Quiros^*

Lynn S. Scott^** and

George Ward Hendon, Jr.^***

This Article surveys recent developments in Georgia's corporate, securities, partnership, and banking law. It covers noteworthy cases decided during the survey period¹ by the Georgia appellate courts, United States district courts located in Georgia, and the Eleventh Circuit Court of Appeals. Also included in this Article are highlights of recent revisions to the Official Code of Georgia Annotated ("O.C.G.A.").

I. Corporations

A. Piercing the Corporate Veil

Georgia courts may permit "piercing the corporate veil" to hold individual shareholders, officers, or agents liable for corporate debts when those individuals have so disregarded the corporate structure that allowing the corporate veil to shield them from liability would create an injustice or perpetuate a fraud. A corporation is a legal entity separate from its shareholders, officers, and agents, which effectively shields the assets of these individuals from the liabilities of the corporation. In essence, the owners and managers of a corporation act as mere agents on behalf of the corporation. However, the courts have been increasingly willing to look beyond form and at substance in determining whether the corporate entity and attendant liability shield for its owners has been so abused that the only way to avoid injustice is to hold the agents of the corporation liable for its debts.² For example, Georgia courts have pierced the corporate veil in cases in which the corporation's agents have commingled corporate funds with personal funds or among related corporate entities and accounts.³

In spite of a wealth of case law addressing veil-piercing claims, the Georgia courts have not woven a consistent thread of cases applying the various veil-piercing theories to disparate factual situations. The courts have used a variety of theories to justify piercing the corporate veil, including alter ego, apparent or ostensible agency, fraud, abuse, and joint venturer.⁴ As a result, appellate review appears confused, and consequently, the parties involved in such cases do not have a consistent guide in the case law to reasonably predict the outcome of these claims.⁵

Courts generally frame the issue of piercing the corporate veil as whether the corporation is the alter ego or business conduit of the shareholders.⁶ The main inquiry is not the composition of corporate ownership or control because, under Georgia law, a corporation and its shareholders or officers are separate entities even if wholly-owned and controlled by a sole shareholder.⁷ To state a claim to pierce the corporate veil in Georgia, the plaintiff must show the following: (1) that the shareholder's disregard of the corporate entity made it a mere instrumentality for the transaction of the shareholder's own affairs; (2) that there is such unity of interest and ownership that the separate personalities of the corporate form and the shareholder or officer cease to exist; and (3) that to adhere to the doctrine of a separate corporate entity would promote injustice or protect fraud.⁸ To submit the issue to a jury, courts require evidence that the corporate arrangement is a sham used '"to defeat justice, to perpetrate a fraud, or to evade statutory, contractual or tort responsibility.'"⁹

1. Georgia Court of Appeals Pierces the Corporate Veil of Closely-Held Corporations to Hold Officers Liable for Corporate Debts When Closely-Held Corporations Were Stripped of Assets to Avoid Liability. In Speir v. Krieger,¹⁰ plaintiff filed suit against McFrugal Auto Rental, Inc. ("McFrugal") after a car rented from McFrugal ran into plaintiff's vehicle, causing injuries to plaintiff. Plaintiff subsequently discovered that, contrary to state law, McFrugal did not carry third-party liability insurance on its rental vehicles even though McFrugal sold such insurance to its customers. On December 18, 1995, the trial court awarded plaintiff $7248 in compensatory damages and $250,000 in punitive damages on a fraud claim. Prior to the verdict, McFrugal's Chief Executive Officer and one of its two shareholders, Roveto, sold the assets of McFrugal and another related closely-held entity, McFrugal Holding Company ("McFrugal Holding"), to a new corporation, McRent-A-Car, Inc. ("McRent"). McRent was formed for the purpose of acquiring the assets of the two closely-held corporations (together, "McFrugal Companies"). This transaction left the McFrugal Companies insolvent.¹¹

After receiving the verdict, plaintiff filed suit in equity against the McFrugal Companies seeking to pierce the corporate veil between the entities and to hold their shareholders liable on the ground that Roveto commingled the assets between the entities to avoid payment of the judgment. On January 22, 1997, the trial court entered a judgment holding the McFrugal Companies liable for the earlier verdict. Plaintiff then filed another suit in equity against the two corporate officers of the McFrugal Companies, Speir and Roveto, to hold them personally liable for the outstanding judgment. The parties filed cross-motions for summary judgment, and the trial court, finding no issues of material fact, granted plaintiff's motion. Only Speir appealed.¹²

On appeal Speir contended that the trial court's ruling only pierced the corporate veil between McFrugal and McFrugal Holding and, therefore, created a single entity from which plaintiff must seek recovery.¹³ The court of appeals disagreed, stating that "[t]he improper commingling of two independent corporations so as to render them 'one entity' does not create a separate corporation entirely liable for plaintiff's damages and conveniently shielding the operation officers therefrom."¹⁴ Furthermore, the court noted, "[i]t does not follow that operating two separate corporations illegally creates one legal corporation."¹⁵ To agree with plaintiff's logic would force the court to support the notion that Speir and Roveto could, in effect, illegally commingle the assets of McFrugal and McFrugal Holding to avoid a judgment creditor, then strip the assets out of those corporations and shield those assets by organizing a new corporation.¹⁶ This provided an example of corporate form taking precedence over substance, and, as a result, the court upheld the judgment against the insolvent corporations' officers.¹⁷

Speir also contended that, even if the McFrugal Companies' corporate officers could be held personally liable, he was not a corporate officer during the time of the alleged misuse of the corporate form. Speir, who held the positions of corporate secretary and registered agent, claimed that he resigned from his official duties with the McFrugal Companies at a board of directors meeting in December 1994 and submitted an affidavit to that effect. Plaintiff countered with certified copies of the corporate registry for the McFrugal Companies.¹⁸ The corporate registry is filed with the Secretary of State and is required to be updated annually;¹⁹ the failure to notify the Secretary of State within sixty days that a corporation's registered agent has resigned subjects the corporation to administrative dissolution.²⁰ The certified documents submitted by plaintiff indicated that, as of September 11, 1996, Speir was still registered as the corporate secretary and registered agent of McFru-gal."

Finally, Speir argued that he was not a party to the previous lawsuits between plaintiff and the McFrugal Companies, and, therefore, the prior judgments could not be enforced against him. Speir asserted that no evidence in the record demonstrated that he directly participated in any of the illegal activities.²² Rejecting this argument, the court distinguished the rule in Cherry v. Ward,²³ which was the principal case that Speir relied upon.²⁴ Cherry stands for the proposition that

"[a]n officer of a corporation who takes part in the commission of a tort by the corporation is personally liable therefor, [and] an officer of a corporation who takes no part in the commission of a tort committed by the corporation is not personally liable unless he specifically directed the particular act to be done or particiated or co-operated therein."²⁵

The court found that Cherry may be relied upon only in cases in which the evidence is insufficient to pierce the corporate veil but that personal liability can still attach if the officer personally committed a tortious act or personally directed that one be committed.²⁶ The court reasoned that Speir's argument ignored the result of the successful veil-piercing claim achieved by plaintiff—that is, by finding that the corporate veil ceased to exist, Speir's privity of interest with McFrugal and his identity as an operating officer and stockholder of McFrugal were exposed.²⁷ To support its analysis, the court quoted the following:

"[T]he trend is becoming more and more pronounced that the jurisdiction of all the states, including Georgia, are breaking down the impregnability of this fiction of the separateness of the corporation and its members. More sympathetically and more frequently are the courts coming to realize the fallacy of this fiction so that the law of corporations is developing along the lines that a corporation cannot be considered without taking into account its life-blood, its activities supplied by, interwoven with, and related to the individuals who constitute its members, shareholders and stockholders."²⁸

The dissent, written by Judge Blackburn, diverged from the majority opinion on the ground that the majority would wrongfully permit a corporate officer to be held liable for actions of a corporation without requiring (1) that the corporate officer be a party to the suit, and (2) evidence that directly ties the officer to the commission of the tort.²⁹ As to the first point, Judge Blackburn suggested that "[n]o matter how egregious the facts, a party must still be afforded notice and the opportunity to...