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Opinions 2/21/13: Maryland Court of Special Appeals

Opinions 2/21/13: Maryland Court of Special Appeals

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Corporations and Partnerships

Piercing the corporate veil 

BOTTOM LINE: The circuit court erred by finding defendant personally liable for the debts of the limited liability company solely owned by defendant, absent a finding of fraud.

CASE: Serio v. Baystate Properties, LLC, No. 1441, Sept. Term, 2009 (filed Jan. 25, 2013) (Judges Matricciani, Graeff & KENNEY (retired, specially assigned)). RecordFax No. 13-0125-00, 28 pages.

FACTS: Timothy Wenzel, Managing Member of Baystate Properties, LLC (Baystate), entered into a contract (the Agreement) with Vincent Serio, as Managing Member of Serio Investments, LLC to build houses to certain specifications on two lots identified as 1901 and 1903 Hillside Drive (the Hillside Drive Lots), which were owned by Serio individually.

As work progressed, Wenzel drafted multiple addenda to the Agreement representing changes to the work requested that, in aggregate, obligated Serio Investments to pay Baystate an additional $43,638. Each addendum, when first presented by Wenzel, referenced Serio personally, but Serio revised those references and both parties signed the addenda, with Serio signing as the Managing Member of Serio Investments. In June of 2007, Serio presented Wenzel with a handwritten waiver by Baystate and Serio Investments of any claims for personal liability under the Agreement. Wenzel typed that document and both Wenzel and Serio, on behalf of Baystate and Serio Investments respectively, executed the document.

Shortly thereafter payments to Baystate began to slow. When Wenzel contacted Serio regarding the payments, he was assured that the properties would soon be sold. In fact, the 1901 Hillside Drive Lot had sold on June 29, 2007 for $380,000. The 1903 Hillside Drive Lot was sold on October 11, 2007, but, because the buyers subsequently defaulted on a mortgage, Serio received only approximately $20,000 on the sale. According to Baystate, none of the proceeds from the sale of the Hillside Drive Lots were deposited into the Serio Investments account.

Baystate filed a complaint against Serio and Serio Investments in the circuit court (the Finished Houses case) for money owed on the Hillside Drive Lots, and an action in the district court (the Empty Lot case) to recover for work done on an unimproved lot adjacent to the Hillside Drive Lots.

Serio engaged Shanell Harleston and the Harleston Law Firm, LLC, to represent both Serio and Serio Investments in the litigation. On May 12, 2009, Harleston contacted Serio by letter to inform him that her recent employment with the federal government necessitated the closing of her private practice, and of her intent to withdraw as his attorney in the Baystate litigation. Subsequently, Harleston filed, under Rule 2-132, a motion to withdraw appearance as counsel in the circuit court. Because the clerk’s office did not correctly docket that motion, it was not ruled on until the day of the trial.

Prior to the beginning of the trial, the circuit court granted Harleston’s request to withdraw as counsel. Serio then asked the court for a brief continuance, but the court, finding that Serio was long aware of his need to secure substitute counsel, denied the request.

At the conclusion of the bench trial, the court did not find fraud but, to enforce a paramount equity, held Serio personally liable for the obligations of Serio Investments. The court entered judgment in favor of Baystate and against Serio individually in the amounts of $131,438 for the Finished Houses case and $10,380 for the Empty Lot cases.

The Court of Special Appeals affirmed in part and reversed in part.

LAW: Section 4A-301 of the Md. Corporations and Associations Article provides that no member shall be personally liable for the obligations of the limited liability company solely by reason of being a member of the limited liability company. Case law has recognized the availability of an action to disregard a limited liability entity congruent with the equitable remedy of piercing the corporate veil. See McCleary v. McCleary, 150 Md. App. 448, 458 (2002).

“[A]lthough the courts will, in a proper case, disregard the corporate entity and deal with substance rather than form, as though a corporation did not exist, shareholders generally are not held individually liable for debts or obligations of a corporation except where it is necessary to prevent fraud or enforce a paramount equity.” Bart Arconti & Sons, Inc. v. Ames-Ennis, Inc., 275 Md. 295, 310 (1975).

“Despite the proclamation that a court may pierce the corporate veil to enforce a paramount equity, arguments that have urged a piercing of the veil “for reasons other than fraud” have failed in Maryland courts.” Residential Warranty v. Bancroft Homes Greenspring Valley, Inc., 126 Md. App. 294, 307 (1999).

In Hildreth v. Tidewater, 378 Md. 724, 735 (2006), the trial court found Hildreth, who was the sole shareholder, director and officer of HCE, Inc. (HCE), a New Jersey corporation, personally liable for contracts entered into by HCE. HCE was formed in November 1996 and began to do business in Maryland, without registering as a foreign corporation as required by Maryland law. The trial court based its decision on the notion of enforcing a paramount equity and the Court of Special Appeals affirmed. Id. at 733-34.

The Court of Appeals reversed, stating: “[I]t is abundantly clear from our actual holdings in cases where attempts were made to pierce a corporate veil — to hold stockholders personally liable for corporate obligations — that those circumstances, individually or in combination, do not suffice.” Id. at 734.

The Hildreth Court, in its opinion, acknowledged prior “favorable references” to the “synthesis” of “when a corporate entity will be disregarded” in the 1953 edition of Brune, MARYLAND CORPORATION LAW AND PRACTICE, which, in §371, provides:

“First. Where the corporation is used as a mere shield for the perpetration of a fraud, the courts will disregard the fiction of separate corporate entity. Second. The courts may consider a corporation as unencumbered by the fiction of corporate entity and deal with substance rather than form as though the corporation did not exist, in order to prevent evasion of legal obligations. Third. Where the stockholders themselves, or a parent corporation owning the stock of a subsidiary corporation, fail to observe the corporate entity, operating the business or dealing with the corporation’s property as if it were their own, the courts will also disregard the corporate entity for the protection of third persons.” Id. While the first ground addresses fraud, the second and third grounds are “subsumed [] in the doctrine of paramount equity.” Id. at 739.

The Hildreth Court found no support in the record to justify holding the shareholder personally liable for the corporate obligation, stating: “What the record does show is that [Hildreth’s corporation] was a valid, subsisting corporation which, until it suffered a reversal of fortunes, had substantial assets and business prospects. [T]here is no evidence that [Hildreth’s] conduct in any way influenced Tidewater to enter into the contractual arrangement from which this debt arose. Tidewater knew that it was dealing with a corporation, and it had satisfied itself that the corporation had substantial contracts and assets, that it had two business locations in the State, that it had numerous employees and that it was not a ‘one man show.’” Id. at 737.

As to whether Hildreth’s conduct was for the purpose of evading a legal obligation, the Hildreth court reflected on its refusal in Bart Arconti to pierce the corporate veil in a situation where the stockholders’ conduct was “clearly designed to cause the corporation to evade a legal obligation” and rendered the corporation “all but insolvent.” Id. at 738-39 (citing Bart Arconti, 275 Md. at 305). The Court concluded that if the conduct found in Bart Arconti did not warrant holding the shareholder personally liable, the conduct in Hildreth did not do so either. Id. at 739.

Moreover, the corporate veil will not be pierced to redress the breach of a contractual obligation in the absence of fraud when the party seeking to pierce the corporate shield has dealt with that corporation in the course of its business on a corporate basis. Turner v. Turner, 147 Md. App. 350 (2002).

In this case, the circuit court found that, while there was no evidence to support fraud, the circumstances warranted the enforcement of a paramount equity. In reaching that conclusion, the circumstances the court relied upon were that Serio personally owned and sold the two lots individually. Regarding financial solvency, the circuit court found that Serio Investments possessed no assets and very little cash. It noted that Serio Investments had significant debt and no income or deposits besides Serio’s own personal checks. The court found that Serio had misled Baystate regarding the sale of the homes on the Hillside Drive Lots and that Serio Investments had agreed to establish an escrow account. In the circuit court’s view, Serio’s failure to deposit the funds from the sale of the Hillside Drive lots into Serio Investments, and the fact that Serio Investments later filed for Chapter 7 bankruptcy, evidenced an intent to evade the company’s legal obligations to Baystate.

The evidence relied upon by the circuit court, at most, approaches the conduct at issue in Bart Arconti, where the Court refused to pierce the corporate veil and hold a shareholder personally liable for conduct that rendered its corporation all but insolvent and was “clearly designed to cause the corporation to evade a legal obligation.” See Bart Arconti, 275 Md. at 305. See also Residential Warranty, 126 Md. App. at 307.

Baystate, also a limited liability company, contracted with Serio Investments, a valid, subsisting limited liability company at the time of the transaction. While Serio Investments might have been inadequately capitalized, there was no evidence that Baystate entered into the Agreement depending on Serio to fund its contracts from his personal account or that Baystate took reasonable steps to assure the availability of adequate funding. Baystate was aware that the lots were in Serio’s name prior to entering the Agreement. Even though an escrow account that was provided for in the Agreement was not established, there was no evidence that Baystate ever challenged or questioned the failure to establish a funded escrow account.

Serio made it clear in the beginning that Serio Investments was Baystate’s contractual partner for funding the project. The Agreement and each addendum continued to identify “Serio Investments” as Baystate’s contractual partner and were signed by Serio as the “Managing Member.” During their course of business, the parties also executed a document stating that Wenzel and Serio were not to be held liable for any obligations of their respective limited liability companies. Serio Investments made payments to Baystate consistent with its obligations under the contract for six months. All payments made to Baystate under the contract were either with checks issued from Serio Investments’ corporate account, signed by Serio as the “Managing Member,” or with cashier checks funded by Serio Investments.

Under these circumstances, the circuit court abused its discretion in finding Serio personally liable for the obligations of Serio Investments.

COMMENTARY: To effectuate a withdrawal as counsel, an attorney must mail notice to the client, “informing the client of the attorney’s intention to move for withdrawal and advising the client to have another attorney enter an appearance[.]” Furthermore, “the motion shall be accompanied by the client’s written consent to the withdrawal or the moving attorney’s certificate that notice has been mailed to the client at least five days prior to the filing of the motion.” Rule 2-132(b).

Rule 2-132(c) requires the clerk, after an attorney’s appearance is stricken, to notify a litigant for whom there is no attorney of record that, if no counsel’s appearance has been entered in 15 days, the absence of counsel will not be grounds for a continuance.

In Das v. Das, 133 Md. App. 1 (2000), a wife initiated an action for absolute divorce against her husband. The attorney, engaged by the husband, later notified the husband of “her impending withdrawal by letter” and “advis[ed] him to `immediately obtain alternative counsel and have them enter their appearance.’“ Id. at 24. The husband did not respond to the attorney’s letter, and after waiting “considerably more than five days,” the attorney filed her motion to withdraw as counsel. Id. The circuit court granted the motion on June 3 and the trial commenced on August 11. When the husband later moved to vacate the entry of default in the divorce action, the Court of Special Appeals said the husband’s argument, “that he lacked the notice he needed to retain new counsel[,] strains credibility,” and the need to employ new counsel came as “no surprise” because of the attorney’s letter and the court’s notice to employ new counsel. Id. at 26.

Serio was notified on February 5, 2009, that the trial date was set for July 22, 2009. On May 1, 2009, Harleston issued an announcement to her clients, including Serio, that she was closing her office. She followed up the announcement with a Rule 2-132 letter to Serio on May 12, 2009, in which she stated her need to withdraw because her employment with the federal government prevented her from seeing the litigation to its conclusion, and her health issues undermined her ability to effectively carry out the representation. By Serio’s own admissions, he was aware of the trial date and fully understood Harleston’s intent to withdraw. Yet, Serio did not seek to engage counsel until shortly before trial.

Harleston met the requirements imposed by Rule 2-132(b) and Serio had adequate time to secure a substitute attorney but he failed to do so. The circuit court did not abuse its discretion in granting Harleston’s motion to withdraw and denying Serio’s request for a continuance.

PRACTICE TIPS: As to the third ground cited in Brune for piercing the corporate veil, sometimes referred to as the “alter ego” doctrine, the Court of Appeals in Hildreth indicated that “with great caution” and only “in exceptional circumstances” could a corporate entity be disregarded if the plaintiff shows: (1) ‘[C]omplete domination, not only of the finances, but of policy and business practice in respect to the transaction so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own,’ (2) that ‘such control [was] used by the defendant to commit fraud or wrong, to perpetrate the violation of the statutory or other positive legal duty, or dishonest and unjust act in contravention of the plaintiff’s legal rights’ and (3) that such ‘control and breach of duty proximately caused injury or unjust loss.’” Hildreth, 378 Md. at 735 (quoting 1 Fletcher, FLETCHER CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS, § 41.10 at 583-86 (1999 Rev. Vol.)).

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