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Why Nevada?

The Current State of "Piercing the Corporate Veil" in Nevada

SUBSTANTIVE LAW IN NEVADA

As a general rule, "corporations are recognized as legal entities separate from their shareholders, officers, and directors. ... 'Piercing the corporate veil' refers to the judicially imposed exception to this principle by which courts disregard the separateness of the corporation and hold a shareholder responsible for the corporation's action as if it were the shareholder's own." Robert B. Thompson, "Piercing The Corporate Veil: An Empirical Study," 76 Cornell L. Rev. 1036, 1036 (1991). In the absence of the judicial exception, corporate liability is limited to the assets of the corporation. This is a longstanding rule. "The concept of limited liability through corporate organization and investment has been legally recognized in Nevada since before the granting of its statehood." In re Twin Lakes Village, Inc., 2 B.R. 532, 545 (D. Nev. 1980).

NEVADA CASE LAW

ADOPTION OF THE DOCTRINE

"Piercing the corporate veil" exists in Nevada. Its adoption by the state supreme court came "well into this century." Bishop, supra, § 6.17[B] at 6-39. The fairly late adoption of the doctrine may be attributed to the fact that Nevada courts traditionally hesitate to engage in "judicial legislation." Bishop, supra, § 6.17[B] at 6-39 (citing In re Twin Lakes Village, Inc., 2 B.R. 532, 540 (D. Nev. 1980)). The fact that "piercing the corporate veil" exists indicates that the reluctance to judicially legislate can be overcome to the detriment of principles.

The doctrine first appeared as dictum in a 1957 case, Nevada Tax Comm'n v. Hicks, 73 Nev. 115, 310 P.2d 852 (1957). See In re Twin Lakes Village, Inc., supra, 2 B.R. at 538. Later the same year, the Nevada Supreme Court adopted the doctrine in McCleary Cattle Co. v. Sewell, 73 Nev. 317 P.2d 957 (1957). See Bishop, supra, § 6.17[B] at 6-40; In re Twin Lakes Village, Inc., supra, 2 B.R. at 538.

In adopting the doctrine in McCleary, the court for the first time "pierced the corporate veil." The facts indicated that Frank McCleary and Catherine McCleary owned the Henry McCleary Timber Company The Sewells brought suit against the timber company and obtained a judgment which was affirmed on appeal. The suit arose out of an agreement between the Sewells and the timber company. Approximately one year after this agreement, the McClearys incorporated a cattle company. About four years later, the charter of the timber company was revoked by official state action both in Washington, the state of its domicil, and in Nevada. Prior to the revocation's completion, all of the assets of the timber company were transferred to the cattle company. The assets amounted to several million dollars, and the transfer was done for tax purposes. All of the stock in both corporations was owned by Frank and Catherine McCleary, and each held the same number of shares in the cattle company as each held in the timber company Frank McCleary was also the president of both corporations.

On these facts, the trial court found that the cattle company was the alter ego of the timber company, "pierced the corporate veil," and held the cattle company liable for the Sewell's judgment against the timber company. In affirming this ruling, the Nevada Supreme Court adopted a three-part test for applying the doctrine of "piercing the corporate veil":

(1) The corporation must be influenced and governed by the person asserted to be its alter ego; (2) there must be such unity of interest and ownership that one is inseparable from the other; and (3) the facts must be such that adherence to the fiction of separate entity would, under the circumstances, sanction a fraud or promote injustice.

McCleary, 73 Nev. at 282, 317 P.2d at 959. These requirements were borrowed from a California decision, Minifie v. Rowley, 187 Cal. 481, 202 P. 673 (1921). The court added, "it is not necessary that the plaintiff prove actual fraud. It is enough if the recognition of the two entities would result in an injustice." McCleary, 73 Nev. at 282, 317 P. at 959 (quoting Gordon v. Aztec Brewing Co., 33 Cal.2d 514, 522, 203 P.2d 522, 527 (1949).

The Nevada Supreme Court's analysis of the facts to the three-part test was conclusory: "There can be no question but that, under these circumstances, the trial court was justified in disregarding the corporate fiction and in holding the cattle company to be the alter ego of the timber company." McCleary, 73 Nev. at 282, 317 P.2d at 959. As recognized by Chief Judge George, "[o]ne major difficulty which has developed with this test . . . is that it lends itself over to descriptive, rather than causational, analysis," In re Twin Lakes Village, Inc., supra, 2 B.R. at 539, which "often leaves the court to make a determination in largely an ad hoc manner." Id. at 540. Ultimately, the basis for such a test is the concept of equity, under which courts refuse to sanction the use of statutory limitations for the purpose of perpetrating fraud or an otherwise illegal act. Id. at 541-542. Subsequent decisions of the Nevada Supreme Court leave little doubt that Judge George's analysis is absolutely correct.

APPLICATION OF THE DOCTRINE

Through the intervening years, the court has issued more than a dozen published opinions on the issue of '"piercing the corporate veil." While the McCleary three-part test nominally remains intact, subtle shifts in emphasis indicate that it is becoming less likely as time goes on that the court will "pierce the corporate veil," as the court has done this only once in the last twenty years.

Significantly, the court. in North Arlington Medical Building, Inc. v. Sanchez Constr. Co., 86 Nev. 515, 471 P.2d 240 (1970), rejected the argument that undercapitalization, by itself, is a valid reason for "piercing the corporate veil ":

Undercapitalization, where it is clearly shown, is an important factor in determining whether the doctrine of alter ego should be applied. However, in the absence of fraud or injustice to the aggrieved party, it is not an absolute ground for disregarding a corporate entity. In any event it is incumbent upon the one seeking to pierce the corporate veil, to show by a preponderance of the evidence, that the financial setup of the corporation is only a sham and caused an injustice.

In Lipshie v. Tracy Investment Co., 93 Nev. 370, 2d 819 (1977), again, the court refused to "pierce the corporate veil." The facts indicated that Bonanza No. 2, a corporation, had a financial obligation to Norman Lipshie, upon which it defaulted After Bonanza No. 2 went through a bankruptcy proceeding, the Tracy Investment Co. assumed management and control of Bonanza's assets. The officers of Tracy were essentially the same officers of Bonanza; the officers of Tracy were the directors of Bonanza; the sole stockholder of Tracy, Kirk Kekorian, was the chairman of the board and director of both Tracy and Bonanza; and the principle place of business and registered agent for Tracy and Bonanza were the same. Yet, despite these facts, Tracy was deemed not to be Bonanza's alter ego.

The court stated that there was no evidence presented that Tracy and Bonanza were other than valid, separate, and independent corporate entities. The fact that Tracy owned all of the shares of Bonanza and that the officers of Tracy and Bonanza were identical was not sufficient cause to overcome the separateness of the two corporations. Furthermore, there was a lack of evidence of fraud or injustice, as the facts revealed that it was always Tracy's intent to have the obligation owed by Bonanza to continue as Bonanza's indebtedness. The fact that Bonanza defaulted did not represent an injustice on the part of Tracy. The court concluded that Lipshie received exactly he had bargained for.

In Deal v. 999 Lakeshore Assoc., 94 Nev. 301 579 P.2d 775 (1978), the court "pierced the corporate veil." Like previous cases where this was done, the facts are rather egregious. I.C. was the owner-developer of a condominium development, which was constructed by the Kindred Construction Co. Suit was brought by various condominium owners for negligent construction, defective manufacture and breach of warranty. The suit was brought against Deal individually, since his corporation, Incline Properties, Inc., dissolved immediately after construction was completed. The condominium owners obtained a judgment against Deal, and the supreme court affirmed.

The facts revealed that Deal controlled all corporate activities of Incline Properties; mixed his business activity with that of the corporation; never held a board of directors meeting; capitalized the multimillion dollar corporation with $1,000; and took all of the corporate assets after liquidation. It would have been highly unjust to allow the person controlling the corporation to take all of the assets of the corporation as his own, while leaving innocent creditors holding the bag.

A very similar set of facts led the court to once again pierce the corporate veil" in Mosa v. Wilson-Bates Furniture Co., 94 Nev. 521, 583 P.2d 453 (1978). Ralph Mosa was the sole contributing stockholder of Mobel, Inc. Once Mosa took control of the corporation, no corporate formalities were observed; the corporate bank account was disregarded and all receipts and expenditures were made from an account in Mosa's name; and the corporation's liquor license was changed from the corporate name and placed in Mosa's name. The court held Mosa personally liable for the debts of Mobel, Inc.

ABANDONMENT OF THE DOCTRINE

As can be seen from these cases to this point in which the "corporate veil" was "pierced," the corporation was a mere "sham" of the individual controlling it. When this was combined with the unjustness of a creditor not recovering their debt, the court would not allow the corporate entity to shield the controlling party from liability. Mosa was decided 23 years ago. Since that time, the Nevada Supreme Court has "pierced the corporate veil" two times.

The first case decided was Bonanza Hotel Gift Shop, Inc. v. Bonanza No. 2, 95 Nev. 463 596 P.2d 227 (1979). Here, the court held that the alter ego doctrine was not applicable to hold a corporation liable for the obligations of its subsidiary. The court focused on the separate nature of the corporations Citing Lipshie, the court stated that a mere showing that one corporation is owned by another, or that the two share interlocking officers or directors, is insufficient to support a finding of alter ego. What needs also to be shown is that the subsidiary is a "mere instrumentality" of another corporation. Furthermore, mere mutuality of interest does not prove the subsidiary is a "mere instrumentality" of the parent corporation without evidence of a commingling of funds or property interests of the two corporations, or of prejudice to creditors.

Since the facts showed that separate corporate books and accounts were kept; separate directors meetings were held with full corporate formalities observed; and the corporations had independent headquarters, business responsibilities and operations, it was clear that the subsidiary was not a "mere instrumentality" of the parent, and thus the alter ego doctrine was not applicable.

The next case decided was Rowland v. LePire, 99 Nev. 308, 662 P.2d 1332 (1983). Here, the Rowland Corporation contracted to build a house for Eugene and Judy Lepire. Following problems on the project, the Lepires filed a breach of contract suit against the Rowland Corporation, which also counter claimed for breach of contract. The Lepires won at trial, and the trial court awarded them $65,000. Further, the court found that the Rowland Corporation was the alter ego of Glen Rowland and Martin Rowland and entered a personal judgment against them. The supreme court reversed this personal judgment.

Initially, the court noted that a "legitimate business dispute" arose between the parties. This fact takes on importance given the rest of the facts. The total capitalization of the corporation was $1,100. No formal directors or shareholders meetings were ever held, no dividends were ever paid, and neither the officers nor directors were paid. Also, the corporation had no minute book. However, it did have a contractor's license and a corporate checking account. It also obtained workers' compensation insurance and transacted business with the state Employment Security Division.

The court concluded that the corporation was, indeed, undercapitalized and that there was little existence separate and apart from Martin and Glen Rowland. Yet, the court failed to "pierce the corporate veil." Why? Although unstated, the fact of a "legitimate business dispute" is the key. A finding of a "legitimate" dispute precludes a finding of fraud or unjustness. Thus, with this case, the court has downplayed the significance of factors such as corporate formalities, personal influence, unity of interest, and undercapitalization. Instead, fraud seems to be the linchpin. In egregious situations, the "corporate veil" will be "pierced," but in normal business disputes, it will not.

The next case supports this view, and also added some new wrinkles. It also represents the only case in the last 20 years where the "corporate veil" was "pierced." This case was Polaris Indus. Corp. v. Kaplan,103 Nev. 598 747 P.2d 884 (1987). Here, Polaris advanced goods to a corporation National Marketing Services, in excess of $50,000. National Marketing issued a promissory note to Polaris for this amount. The note was assumed by Commercial Resources, Inc., the successor of National Marketing. Both National Marketing and Commercial Resources were formed and owned by Bob Davis and Michael Kaplan. They were the sole shareholders and officers of corporations. Both corporations did business at the same location and used the same bank..

Evidence at trial indicated that Kaplan and Davis did not always follow corporate procedures, and that they often used corporate money for personal expenses. After Commercial Resources defaulted on the note, Polaris brought suit, alleging that Davis, Michael Kaplan, and Jerome Kaplan, Michael's brother and a salesman for Commercial Resources, were the alter ego of the corporation and were personally responsible for the debt. The trial court entered judgment for Polaris against the corporation for the amount of the note, but declined to hold either Michael Kaplan or Jerome Kaplan personally liable. (Bob Davis had defaulted prior to trial, and was not a party to the appeal.) The supreme court affirmed as to Jerome Kaplan and reversed as to Michael Kaplan.

One commentator, Stephen Presser, stated that "the Polaris court seems to read this test to require that the party to be charged 'wholly owned and controlled’ the corporation whose veil is sought to be pierced." Stephen Presser, Piercing the Corporate Veil (1993), § 2.29 at 2-256 quoted in Bishop, supra, § 6.17[B][1] at 6-41 n. 168.) If Presser's view is correct, Polaris further reduces the likelihood of the "corporate veil" being "pierced" against a certain group on individuals, such as Jerome Kaplan.

As regards Michael Kaplan, the court explicitly stated, for the first time, that there is no litmus test for determining when the corporate fiction should be disregarded. Rather, the result depends on the circumstances of each case. The various factors were listed, as usual, but none is conclusive. The court then pointed to the facts which indicated a lack of formal corporate formalities and the use by Michael Kaplan of corporate funds for his personal use. While these facts pointed to a unity of interest between Michael Kaplan and the corporation, this itself was not enough to "pierce the corporate veil." Such actions must also be the cause of the plaintiff's injury, and must sanction a fraud or promote an injustice before the "corporate veil" can be "pierced." The court held that the failure to observe proper corporate formalities and the corporation's payment of Michael Kaplan's personal debts did not sanction a fraud or promote an injustice to Polaris.

The causal connection was met, however, by the fact of Kaplan's numerous withdrawals of corporate funds for his personal benefit. The evidence indicated that the corporation could have paid its debt to Polaris if these withdrawals had not been made Thus, Michael Kaplan's actions were the direct cause of Polaris' injury and it would have been unjust to allow Kaplan's actions to go unpunished.

The court indicated that the essence of the alter ego doctrine is to do justice. Thus, equitable considerations now appear to be at the heart of decisions involving the alter ego doctrine. Although equity is an amorphous concept, the facts of recent cases indicate that the "corporate veil" will not be "pierced" absent a significant amount of fraud or injustice being shown.

As pointed out by Keith Paul Bishop, the Nevada Supreme Court has been wise in not making under capitalization a determinative factor in imposing alter ego liability. Since the state legislature has not imposed a minimum required level for corporations, the court should not act on its behalf. Bishop, supra, § 6.17[B][3 at 6-45 to 6-46.

SUMMARY

The run of cases indicates that the court will not "pierce the corporate veil" in the absence of a great deal of fraud. The court in recent cases has downplayed the other factors and focused on fraud and injustice, and now even places a duty on those dealing with corporations to obtain personal guarantees from the corporation's owners. Further, if there is a legitimate business reason for undercapitalizing a corporation, this is proof that the corporation is not a "sham." If this is so, "piercing" becomes quite difficult in this state.

"PIERCING" IN OTHER STATES

As stated by Robert B. Thompson:

Resolution of a piercing question is almost always left to a judge's determination of corporate illegitimacy. Almost all state corporation statutes simply ignore the whole idea of piercing the corporate veil. Thompson, supra, 76 Cornell L..Rev. at 1041.

Do all of these facts mean that there is no advantage to incorporating in Nevada? Not at all. Thompson's conclusion shows that while courts "do not appear" to be allowing "piercing" in more situations, they certainly are not ''piercing" in less cases, either. In fact, the percentage of cases where "piercing" is allowed has remained constant for several decades. Id. at 1049. If Barber's conclusion is correct, courts nationwide are increasingly "piercing the corporate veil." However, as Part I clearly indicates, the Nevada Supreme court is reducing the instances wherein the "corporate veil" is "pierced," and has done this only once in the last 20 years. Thus, if Nevada law is applied, there is a lesser likelihood of the "corporate veil" being "pierced" than if the law of the "average" state is applied. Fortunately, if a corporation is formed under Nevada law, the great weight of legal authority indicates that Nevada law will be applied to it, no matter the state in which it operates.

CONCLUSION

Furthermore, if traditional choice of law principles* are followed, Nevada law will follow a Nevada corporation wherever it conducts business. Thus, incorporating in Nevada makes a lot of sense.

*choice of law principles will be covered in another section.

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