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THE
APPLICATION OF FORUM LAW
TO "PSEUDO-FOREIGN" CORPORATIONS
Is a State Able to Apply its Own Law Regarding Piercing
an Entity to so-called "Pseudo-Foreign" Corporations?
This research will attempt to answer the question whether
a state can apply its own law regarding piercing an entity to so-called "pseudo-foreign" corporations. This type of entity is one
"incorporated in one state and transacting all or most of their
business in another state [.]" Phillip I. Blumberg, The Law
of Corporate Groups: Tort, Contract, and Other Common Law Problems in
the Substantive Law of Parent and Subsidiary Corporations (Aspen
Law & Business, 1987 and 2001 Supp.), § 26.03 at 624 n. 3.
See also Stephen R. Ginger, "Regulation of Quasi-Foreign Corporations
in California: Reflections on Section 2115 After Wilson v. Louisiana-Pacific
Resources, Inc.," 14 S. W. U. L. Rev. 665, 666 n. 8 (1984).
Thus, in a situation wherein a California resident operates
a business entity exclusively in California, dealing with California
customers, but the entity is formed in Nevada (the only connection with
a state other than California), that entity is "pseudo-foreign,
As will be shown, a great number of states apply their own piercing
law to such entities.
In the pseudo-foreign entity situation described immediately
above , the business owner is domiciled in the forum state. This
is an important point vis-a-vis jurisdiction in the courts inside the
forum state. As recently explained by a California Federal District
Court:
Absent one of the traditional bases for jurisdiction--
in-state presence, domicile, or consent-- the constitution requires
that the defendant have 'certain minimum contacts with [the Forum
State] such that the maintenance of the suit does not offend traditional
notions of fair play and substantial justice.'
Colt Studio, Inc. v. Badpuppy Enter, 75 F. Supp.2d
1104, 1107 (C. D. Cal. 1999)(quoting International Shoe Co. v. Washington,
326 U. S. 310, 316 (1945)).
The court added:
If a defendant is domiciled in the Forum State,
or its activities there are 'substantial, continuous and systematic,'
a. ... court may exercise jurisdiction as to any cause of action,
even if unrelated to the defendant's activities within the state.
See Perkins v. Benguet Consol. _Mining Co., 342 U. S. 437 (1952).
This form of personal jurisdiction is known as general jurisdiction.
See id. However, even if a nonresident defendant's contacts with
the forum state are not sufficiently 'continuous and systematic' for
general jurisdiction, it may still be subject to jurisdiction on claims
related to its activities or contacts there. See Burger King Corp.
v. Rudzewicz, 471 U. S. 462 (1985). This form of personal jurisdiction
is known as limited jurisdiction. See id.
Colt Studio, 75 F. Supp.2d at 1108.
In our theoretical involving a Nevada pseudo-foreign
entity owned by a resident of California and operated there, California
courts have general personal jurisdiction over the owner (based
on domicile) and the entity (based on "substantial, continuous
and systematic" activity). Because of this, it does not offend
due process for California to apply its laws to such a corporation.
As stated by the United States Supreme Court:
[F]or a state's substantive law to be selected in
a constitutionally permissive manner, that state must have a significant
contact or significant aggregation of contacts, creating state interests,
such that choice of its law is neither arbitrary nor fundamentally
unfair.
Allstate Ins. Co. v. Hague, 449 U. S. 302, 312-13
(1981).
Where a pseudo-foreign entity operates in a particular
state, the requisite "significant contacts" are obviously
present. Only when contacts are insignificant does the constitution
bar the use of forum law. See John Hancock Mutual Life Ins. Co. v.
Yates, 299 U. S. 178 (1936); Home Ins. Co. v. Dick, 281 U.S. 397
(1930). Further, when the relevant contact involves residence, the balance
tips in favor of the application of forum law. See Nevada v. Hall,
440 U. S. 410 (1979); Watson v. Employers Liability Assurance Corp.,
348 U. S. 66 (1954). (Both of these cases upheld the "application
of forum law where the relevant contacts consisted of plaintiff's residence
and the place of injury." Hague, supra, 449 U. S. at 313
n. 17. In a lawsuit against our theoretical pseudo-foreign entity, the
plaintiff is likely to be a California resident, and California will
be the place of injury.)
Because of the significant contacts between the forum
state and a pseudo-foreign corporation or other entity it is not surprising
that many courts have applied their own laws concerning piercing to
entities with such contracts.
See, e.g., Lipsig v. Ramlawi, 760 So.2d 170 (Fla. App.
2000)(court applied Florida law to Michigan corporation); Raber v. Osprey
Alaska, Inc., 187 F.R.D. 675 (M. D. Fla. 1999) (court applied Florida
law to Alaska corporation); In re Yarbrow, 150 B. R. 233 (B.A.P. 9th
Cir. 1993)(court applied New Mexico law to California corporation);
Itel Containers Int'1 Corp. v. Atlanttrafik Express Serv., 909 F.2d
698 (2d Cir. 1991)(court applied New York law to European corporation);
Hansen v. Green River Group, 748 P.2d 1102 (Utah App. 1988)(court applied
Utah law to Nevada corporation); Dietel v. Day, 16 Ariz. App. 206, 492
P.2d 455 (1972)(court applied Arizona law to California corporation);
Morris v. New York State Dep't of Tax'n and Fin., 82 N.Y.2d 135, 623
N.E.2d 1157 (1993)(court applied New York law to Delaware corporation).
Courts also apply their own laws in such situations
on matters not involving piercing. See, e.q., Wilson v. Louisiana-Pacific
Resources, Inc., 138 Cal. App.3d 266, 187 Cal. Rptr. 852 (1983) (court
applied California law to Utah corporation on issue of cumulative voting,
pursuant to Cal. Corps. Code § 2115 which subjects pseudo-foreign
corporations to California's corporate law); Western Airlines, Inc.
v. Sobieski, 191 Cal. App.2d 399, 12 Cal. Rptr. 719 (1961)(same issue,
but decided prior to the enactment of § 2115); Goya Foods, Inc.
v. Unanue, 233 F.3d 38 (1st Cir. 2000); Askanase v. Fatjo, 130 F.3d
657 (5th Cir. 1997); Elmer v. Tenneco Resins, Inc., 698 F. Supp. 535
(D. Del. 1988); In re MacGregor Sporting Goods, Inc., 199 B.R. 502 (D.
N. J. 1995); Loveridae v. Dregoux, 678 F.2d 870 (10th Cir. 1982);
Clarkson Co. v. Shaheen, 660 F.2d 506 (2d Cir. 1981).
Other
Courts Look to the Law of the State of Incorporation on the Issue of
Whether to Pierce
To be sure, other courts in such situations look to
the law of the state of incorporation on the issue of whether to pierce,
or other issues. See, e.g., Trans-World Inter., Inc. v. Smith-Hemion
Prods., Inc., 972 F. Supp. 1275 (C. D. Cal. 1997)(piercing; court
applied Delaware law to Delaware corporation); Plaskon Elec. Materials,
Inc. v. Allied-Signal, Inc., 904 F. Supp. 644 (N. D. Ohio 1995)(piercing;
court applied Delaware law to Delaware corporation); In re Moss,
258 B.R. 405 (W. D. Mo. 2001)(piercing; court applied Nevada law to
Nevada corporation); The Government of the Virgin Islands v. Lansdale,
172 F. Supp.2d 636 (D. V.I. 2001)(piercing; court applied California,
Delaware, and Texas law to California, Delaware, and Texas corporations);
Joiner v. Ryder Sys., Inc., 966 F. Supp. 1478 (C. D. I11. 1996)(noting
that law of state of incorporation applies to piercing issue); Autrey
v. 22 Texas Servs., Inc., 79 F. Supp.2d 735 (S. D. Texas 2000)(piercing;
court applied Pennsylvania law to Pennsylvania limited partnership);
Select Creations, Inc. v. Paliafito Am., Inc., 852 F. Supp. 740
(E. D. Wisc. 1994)(reverse piercing; court applied California law to
California corporation); Soviet Pan Am Travel Effort v. Travel Comm.,
Inc., 756 F. Supp. 126 (S. D. N.Y. 1991)(piercing; court applied
Maryland law to Maryland entity); Hynson v. Drummond Coal Co.,
601 A.2d 570 (Del. Ch. 1991)(obligations of shareholders).
As can be seen, there is no uniformity among the courts
on the issue under review. This can lead to inequitable results. In
the cases of Calder v. Jones and Keeton v. Hustler Magazine, Inc.
were discussed. In those cases, the Supreme Court held that merely having
jurisdiction over a business entity is not tantamount to having
jurisdiction over the owners or employees of the entity. Rather, one
must find the requisite "minimum contacts" as to each individual separately. Where one owns a pseudo-foreign corporation and is
domiciled in the Forum State (as in our theoretical example), the courts
there already possess general personal jurisdiction over the owner.
See Colt Studio, supra. Thus, minimum contact analysis is not
needed. However, if one owns a pseudo-foreign corporation but is not
domiciled in the state wherein the entity operates, the forum court
will not necessarily have personal jurisdiction over the owner. Some
courts are not too concerned with this. For example, in Raber v.
Osprey Alaska, Inc., 187 F.R.D. 675 (M. D. Fla. 1999) (cited supra),
the court stated:
When the alter ego doctrine is applied and the corporate
veil is pierced, the corporation and the persons who dominate the
corporation are treated as one person under the law. Under the alter
ego doctrine any acts committed by either [the] corporation or a member
of the corporation are treated as the acts of both and 'if either
is bound, by contract, judgment or otherwise, both are equally bound.'
Id. at 678-79 (citation omitted).
An exception to the rule of Calder and Keeton
holds that jurisdiction over the entity IS akin to jurisdiction over
the owner, IF the owner is the alter ego of the entity.
The "Majority Rule" is that the Law of the
Place of Formation Decides the Issue
In such a situation, the "majority rule" is
that the law of the place of formation decides the issue. In
cases like Raber, however, the court does not perform the piercing
analysis at the jurisdictional stage. Instead, it is performed during
trial, using forum law. By so doing, as the quote from Raber
indicates, a judgment against the entity is equivalent to a judgment
against the owner, even if the court does not have personal specific
jurisdiction (a.k.a. limited jurisdiction) over the owner. To us, this
violates the teachings of Calder and Keeton. Further,
it violates the 14th Amendment, as interpreted by the United States
Supreme Court. See World-Wide Volkswagen Corp. v. Woodson, 444
U. S. 286 (1980):
The Due Process Clause of the Fourteenth Amendment
limits the power of a state court to render a valid personal judgment
against a nonresident defendant. A judgment rendered in violation
of due process is void in the rendering state and is not entitled
to full faith and credit elsewhere. Due process requires that the
defendant be given adequate notice of the suit, and be subject to
the personal jurisdiction of the court [.]
Id. at 291 (citations omitted)(emphasis added).
If jurisdiction over an entity, which is then pierced,
allows a court to render a valid judgment against the owner of the entity,
why did the Supreme Court draw the distinction it did in Calder
and Keeton? A way to reconcile all of the cases is to focus on
the domicile of the owner of the pseudo-foreign entity. If (as in our
theoretical example) he lives in the Forum State, the courts there can
obviously render a valid personal judgment.
If he lives outside the forum (or owns a truly
foreign entity, which does business in the forum state), the courts
should have to perform the piercing analysis at the jurisdictional stage. (Using the law of the state where the entity was formed.) If
a piercing occurs, the court would have personal specific jurisdiction
over the owner and can render a valid personal judgment against him.
(As such a finding of alter ego would be the "law of the case," any judgment against the entity would be a judgment against the owner
personally.) If no piercing is allowed, only the entity would be properly
before the court and any judgment would only be valid against it.
Cf. Goehring v. Superior Court, 62 Cal. App.4th 894, 73
Cal. Rptr.2d 105 (1998).
If such a requirement was mandated, a lot of the confusion
is this area of the law would be obviated. This confusion also extends
to the application of the "internal affairs doctrine" and
the position of the Restatement (Second) of the Conflict of Laws (1971).
Under the internal affairs doctrine, "courts traditionally
looked to the law of the state of incorporation in resolving questions
regarding a corporation's internal affairs [.]" Wilson,
supra, 187 Cal. Rptr. at 858. Internal affairs involve "matters
peculiar to the relationship among or between the corporation and its
current officers, directors, and shareholders [.]" Edgar v.
MITE Corp., 457 U. S. 624, 645 (1982). Examples of this include
the election of directors, and the legality of dividend distribution
or the issuance of stock. See Blumberg, supra, § 26.02 at 619. All 50 states follow the internal affairs rule. See Janet Cooper Alexander, "Unlimited Shareholder Liability Through
A Procedural Lens," 106 Harv. L. Rev. 387, 414 n. 126 (1992). But
cf. Wilson, supra, 187 Cal. Rptr. at 858 (the internal affairs doctrine "has never been followed blindly in California").
Under
the Internal Affairs Doctrine, "Courts Traditionally Looked to
the Law of the State of Incorporation in Resolving Questions Regarding
a Corporation's Internal Affairs [.]"
Many believe that the United States Supreme Court "constitutionalized" the internal affairs doctrine in CTS Corp. v. Dynamics Corp. of America,
481 U. S. 69 (1987). See, e.g., Alexander, supra, at 411
n. 120; Alan R. Palmiter, "The CTS Gambit: Stanching the Federalization
of Corporate Law," 69 Wash. U. L. Q. 445, 501-10 (1991); P. John
Kozyris, "Some Observations on State Regulation of Multistate Takeovers:
Controlling Choice of Law Through the Commerce Clause," 14 Del.
J. Corp. L. 499, 515 (1989); Lea Brilmayer, "Rights, Fairness,
and Choice of Law," 98 Yale L. J. 1277, 1298-99 n. 72 (1989); Alan
E. Garfield, "State Competence to Regulate Corporate Takeovers:
Lessons From State Takevoer Statutes," 17 Hofstra L. Rev. 535,
576 n. 220, 582 (1989). See also McDermott v. Lewis, 531 A.2d
206, 218 (Del. 1987)(relying on CTS Corp., court concluded that
the Commerce Clause required the application of the internal affairs
doctrine "except in the rarest situations").
Others, of course, have a different opinion. See, e.q.,
Mark R. Patterson, "Is Unlimited Liability Really Unattainable?
Of Long Arms and Short Sales," 56 Ohio St. L. J. 815, 862 (1995);
Richard M. Buxbaum, "The Threatened Constitutionalization of the
Internal Affairs Doctrine in Corporation Law," 75 Calif. L. Rev.
29, 34-35 (1987).
Despite this difference of opinion, one thing is absolutely
clear: "The central question in choosing the appropriate law to
govern a corporation asks whether the particular issue involved is an
internal one or one that involves third parties. This question is one
that has not yet been answered in the context of shareholder liability
[.]" Patterson, supra, at 862. In other words, since piercing
causes an owner to be personally liable to a creditor for a corporation's
(or other entity's) debt, piercing might or might not be an internal
affair issue. No court case has yet answered this question. However,
one state, Texas, has addressed the issue by statute.
Texas, has Addressed the Issue by
Statute -Piercing an Internal Affair Issue
Texas has enacted a Business Corporation Act (BCA).
BCA Art. 8.02 reads, in pertinent part:
[0]nly the laws of the jurisdiction of incorporation
of a foreign corporation shall govern (1) the internal affairs of
the foreign corporation, including but not limited to the rights,
powers, and duties of its board of directors and shareholders and
matters relating to its shares, and (2) the liability, if any, of
shareholders of the foreign corporation for the debts, liabilities,
and obligations of the foreign corporation for which they are not
otherwise liable by statute or agreement.
As the Legislative Comment makes clear, Article 8.02 "expressly provide[s] that the question of shareholder liability
for corporate obligations, whether in contract or tort, is a matter
of internal affairs of the corporation and is therefore governed solely
by the law of its jurisdiction of incorporation. If only the other 49
states promulgate such statutes, the issue would be clarified.
The view of the Restatement (Second) of the Conflict
of Laws is similarly confused. The Restatement concerns itself with
choice of law issues. The choice of law rules pertaining to corporations
are generally the same as those pertaining to non-corporate parties,
except for legal questions "peculiar to corporations." See
Blumberg, supra, § 26.02 at 616 (citing Restatement (Second)
§ 301). Those issues "peculiar to corporations" are those
which fall under the internal affairs of the corporation. Id. at 617.
As already stated, the internal affairs of corporations are generally
decided by the law of the state of incorporation. Id. (citing § 302(2)). "The traditional rule also applies with respect
to the imposition of liability on shareholders under the explicit statutory
law of the state of incorporation." Id. at 620 (citing §
307). Restatement (Second) § 307 reads:
The local law of the state of incorporation will be
applied to determine the existence and extent of a shareholder's liability
to the corporation for assessments or contributions and to its creditors
for corporate debts.
"In the Comment, the only exception to which reference
is made relates to actions that are deemed 'penal' or 'contrary to a
strong local public policy' of the forum." Id. at 620 n. 17 (citing
Comment a to § 307).
Despite this clear language, Professor Blumberg reaches
a different conclusion:
The Restatement position, though generally sound,
is overstated. In fact, the Restatement itself cautions that whenever
a conflicting policy of the forum or of another jurisdiction with
a more significant relationship to the parties or the occurrence is
involved, the local law of the other state with such an overriding
interest will be applied rather than the law of the state of incorporation.
Id. at 621.
Other commentators agree with this view. See,
e.q., Patterson, supra, at 863-65; Henry Hansmann &
Reinier Kraakman, "A Procedural Focus on Unlimited Shareholder
Liability," 106 Harv. L. Rev. 446, 450-53 (1992). As might be expected,
others have a different view. See Alexander, supra, at 410-15
(arguing that § 307 requires a court to apply the law of
the state of incorporation on the issue of shareholder liability to
creditors).
Blumberg argues that § 302(2) applies to such situations
instead of § 307, since the former "is of general application."
Blumberg, supra, § 26.03 at 625 n. 7. § 302(2) reads:
The local law of the state of incorporation
will be applied to determine [issues involving the rights and liabilities
of a corporation], except in the unusual case
where, with respect to the particular issue, some other state has
a more significant relationship to the occurrence and the parties,
in which event the local law of the other state will be applied.
As Alexander, supra, points out, it seems odd
that the language of § 302(2), which deals with corporate liabilities, should override § 307, which deals specifically with shareholder liability. See id. at 410-11 n. 119. (It is unusual
for a rule of general applicability to override one of specific applicability.)
Be that as it may, Blumberg states that the Restatement
allows forum law to be applied "wherever a state other than the
state of incorporation has a more significant relationship to the parties
or the occurrence," especially where the "corporation has
little contact with the state of incorporation except for the fact of
incorporation," or the "corporation has a significant relationship
to the other state[.]" (That is, the corporation is a pseudo-foreign
entity.) Blumberg, supra, § 26.03 at 623-24.
Blumberg continues:
Thus, even where a jurisdiction seeks to insulate
shareholders from any liability for the obligations of corporations
incorporated under its own laws, such corporations will also be subject
to the laws of other jurisdictions in which they transact business
and such laws that impose liability on shareholders of foreign corporations
doing business within the jurisdiction may prevail.
Id. at 625 (citing Pinney v. Nelson, 183
U. S. 144 (1901) and Thomas v. Matthiessen, 232 U. S. 221 (1914),
which upheld a California law imposing a pro rata liability upon shareholders
of foreign corporations with respect to contractual and other obligations
incurred within California. In both cases, the shareholders were on
notice that the corporation was organized to conduct business in a state
imposing such liability on shareholders).
Relying on this principle, New York and Wisconsin have
upheld the constitutionality of laws, which provide that shareholders
are liable for the unpaid wage claims of employees. "[S]uch liability
may be asserted against shareholders of a foreign corporation although
the law of the state of incorporation specifies limited liability for
shareholders."
Id. at 626-27 (citing Kane v. Benson,
86 F.R.D. 460 (E. D. N.Y. 1980); Joncas v. Krueger, 61 Wisc.2d
529, 213 N.W.2d 1 (1973)). Significantly, the Kane court held that the
ownership of shares in a corporation constituted "transacting business" for the purposes of New York's long-arm statute. Thus, the state had
personal jurisdiction over the shareholders. This is akin to holding
that jurisdiction over the corporation is synonymous to jurisdiction
over the shareholders. As already stated, this violates the teaching
of Calder v. Jones and Keeton v. Hustler Magazine, Inc.
The
Law of the State of Incorporation, Notwithstanding its General Acceptance,
is a Rule that will Yield in Appropriate Circumstances to the Special
Policies of Other Jurisdictions
Professor Blumberg concludes: "Thus, the law of
the state of incorporation, notwithstanding its general acceptance,
is a rule that will yield in appropriate circumstances to the special
policies of other jurisdictions." Blumberg, supra, §
26.03 at 627. He then adds a footnote, containing a rather significant
understatement: "Statutory intervention by a state other than the
state of incorporation to require application of its own law may raise
serious constitutional questions under the commerce and full faith and
credit clauses of the federal Constitution." Id. at 627 n. 17.
As is obvious, I agree. (See my previous paper, "The Approach
of California in Applying Its Law to Foreign Corporations . . ").
There
are Several Reasons Why One Would Want to Form a Nevada Entity!
As all of the above reveals, the law in this area is
a quagmire, at best. Courts in various jurisdictions go both ways on
the issue, and neither the internal affairs doctrine nor the Restatement
(Second) of the Conflict of Laws provides clear answers. Despite this,
there are still several reasons why one would want to form a Nevada
entity, which is a pseudo-foreign corporation in California.
First, if the Supreme Court finally decides that piercing
is an internal affair of a corporation, and that the internal affairs
rule is required under the commerce clause, one would be protected by
Nevada law in all jurisdictions of this country without having to re-form
the entity.
Second, if our theoretical pseudo-foreign entity owner
moves out of California (but his business remains there), and a suit
arises there, the court would not necessarily have personal jurisdiction
over the owner. Instead, as California applies the "majority rule" (see my last paper), it would use Nevada piercing law
to determine if it could obtain personal jurisdiction over the owner.
Third, if the pseudo-foreign entity has business dealings
with vendors or suppliers outside of California, and is sued in one
of those states, even if that state has jurisdiction over the entity,
it would not necessarily have jurisdiction over the owner. Again, if
the state at issue followed the "majority rule," the court
would apply Nevada piercing law to determine if it had personal jurisdiction
over the owner.
Fourth, if the pseudo-foreign corporation expands beyond
the borders of California, it may face litigation in another state.
Even though that state would have personal jurisdiction over the entity
(since it has purposefully availed itself of the protection of the laws
of that state), it would not necessarily have personal jurisdiction
over the owner. Once again, if the particular state follows the "majority
rule," it would apply Nevada piercing law to determine if it had
jurisdiction over the owner.
For all of these reasons, there still exists a benefit
to forming entities in Nevada, even if all of the business activity
will occur in another state.
- This research
attempts to answer the question of whether or not a state
can apply its own law regarding piercing an entity to so-called "pseudo-foreign" corporations.
Which State to Incorporate In?