Michigan Court of Appeals Decision Suggests that Breach of Contract May Be Enough of a “Wrong or Fraud” to Pierce Corporate Veil

The Michigan Court of Appeals issued an unpublished decision on October 24, 2013 in the case of Woodridge Hills Association v. Douglas Walter Williams and D.W. Williams, LLC that tells the classic oldco / newco tale with a twist: a creditor may be able to satisfy the “fraud or wrong” prong of Michigan’s corporate veil piercing test merely by showing that oldco breached its contract with the creditor.  This line of reasoning could significantly lower the bar for creditors to pierce the corporate veil of a debtor corporate entity to reach its owner’s personal assets.

In this case, a roofing company (oldco) allegedly did shoddy work for a condominium development, which sued the roofing company, obtaining a judgment.  The owner put the roofing company in Chapter 7 bankruptcy, and opened a new business under a new name (newco).  Newco had the same owner and the same general business.  The owner attempted to distance newco from oldco, by purchasing some oldco assets from the bankruptcy estate of oldco, and by holding itself out not as a roofing company but as a “general contractor.”  With oldco now in bankruptcy and “judgment proof,” the creditor sough to apply the judgment to  both newco and the owner through the theories of “piercing the corporate veil” (vis a vis the owner) and “successor liability” (vis a vis newco) (the “successor liability” portion of the opinion is not discussed in this posting.)

The prevailing case law in Michigan holds that a creditor may pierce the corporate veil of a closely-held debtor when the individual owner (1) uses the company as a “mere instrumentality” (i.e. the “personal piggy bank” argument) and (2) uses the corporate structure to “commit a wrong or fraud” in an attempt to avoid legal obligations, thereby (3) creating an “unjust loss” for the creditor. 

The first and third prongs in this case were straightforward.  The owner of the roofing company routinely used corporate funds to pay his personal expenses, disregarding the separation between his company and himself.  And, the condominium development creditor clearly experienced a loss, because it was unable to collect from the roofing company.  However, to find the “wrong or fraud,” the Court of Appeals did not focus on the owner’s orchestrated bankruptcy of old and creation of newco.  Rather, it focused on the fact that oldco breached its contract with the condominium development.  The Court then went on to curiously mention that the owner used oldco as a vehicle not only to “circumvent plaintiff’s collection efforts” but also to “shield himself from personal liability.” 

This last observation of the court is emblematic of the problems with this opinion as it related to veil piercing.  One of the core purposes of the corporate form is to protect individual owners from liability created by their business.  This owner’s missteps were (1) using oldco as his private piggy bank, and (2) forming newco to attempt to avoid the judgment against oldco.  Rather than basing its opinion on these facts, the Court focused on two other arguably irrelevant facts: that oldco breached its contract with the creditor; and that the owner sought refuge behind oldco’s corporate status.   

A copy of the opinion is available at: (http://statecasefiles.justia.com/documents/michigan/court-of-appeals-unpublished/310940.pdf?ts=1382702968)