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Thursday, July 12, 2018

IDAHO SUPREME COURT ALLOWS PLAINTIFF TO PIERCE THE CORPORATE VEIL AND HOLD A NON-SHAREHOLDER LIABLE FOR CORPORATE DEBTS

One of the most important reasons for businesses to incorporate is to shield individual shareholders from being held liable for the business’s debts. However, the importance for small businesses to keep the business’s “life” separate from the personal lives of the owners was driven home in a recent Idaho employment case that allowed the veil to be pierced not only to reach a shareholder but a non-shareholder spouse of the owner as well.

In Lunneborg v. My Fun Life, No. 45200, 2018 Ida. LEXIS 129 (June 28, 2018), the Idaho Supreme Court allowed, among other things, a former employee to pierce the corporate veil and hold a non-shareholder liable for corporate debts, which in this case included damages and attorney fees plaintiff was awarded in his lawsuit against his former employer.

My Fun Life (“MFL”) was a multi-level marketing company that sold memberships for access to discount travel accommodations. Dan Edwards was the sole shareholder and director of MFL and his wife Carrie was not a shareholder of MFL, but she had previously served as COO of the corporation, and thereafter as its Executive Vice President. In early 2014, Edwards wanted to hire someone to take over the day-to-day operations at MFL and also wanted to hire someone who could develop nutritional products that MFL members could purchase in addition to travel accommodations. Thomas Lunneborg worked at OxyFresh,  a multi-level marketing company that sold nutritional products, among other goods,  in sales and product development for over 20 years, had experience in marketing, distributing, and bringing nutritional products to market and, in early 2014, was OxyFresh’s Vice President of Logistics and Product Development. OxyFresh’s naturopath knew Edwards was looking for an executive level employee to run MFL, and introduced Edwards and Lunneborg to one another.

Edwards offered Lunneborg a position at MFL as its COO via a letter dated April 8, 2014, which the court later determined to be an employment contract. While the letter stated that his employment would be at-will, it also provided that Lunneborg would be paid six months’ salary if he was terminated without cause. Only three months later, Edwards terminated Lunneborg for what he claimed was cause, based on information that the trial court later determined to be erroneous. Because Edwards felt he terminated Lunneborg for cause, he refused to pay Lunneborg any severance.

Lunneborg filed a complaint against MFL alleging, among other things, that MFL breached its employment contract with him by terminating him without cause and not paying him the severance and that MFL’s actions violated the Idaho Wage Claims Act, entitling him to treble damages. Lunneborg eventually filed an amended complaint to add Edwards and Carrie as defendants, asserting that he could pierce MFL’s corporate veil and reach the personal assets of both Edwards and Carrie to satisfy any potential judgment against MFL.

The case was eventually tried to the bench, which determined that Lunneborg was terminated without cause and was entitled to his $60,000 severance pay under agreement, trebled to $180,000 under the Idaho Wage Claims Act. The trial court also pierced MFL’s corporate veil and found Edwards and Carrie were jointly and severally liable to Lunneborg. After the judgment, the defendants moved to alter or amend the judgment, arguing that the court erred when it found Carrie’s separate property (as a non-shareholder in MFL) could be subject to Lunneborg’s judgment. The court denied that motion and issued an amended final judgment, granting Lunneborg costs and attorney fees of over $160,000.00 in addition to the previous damages award, which defendants appealed.

Among the issues on appeal to the Idaho Supreme Court was whether the trial court erred when it pierced MFL’s corporate veil and also whether it erred when it allowed that piercing to reach Carrie Edwards’s personal assets?

In determining to pierce the corporate veil, the trial court found that MFL did not observe any corporate formalities and that the evidence showed that the Edwards’ financial activities created a unity of interest among their closely held businesses and their personal accounts. Among other things, the trial court found that MFL did not issue any stock certificates and it did not conduct regular corporate meetings. Furthermore, Carrie testified that her family, including the Edwards’ children, received over $100,000.00 in commissions and shares of membership fees, and that Edwards and Carrie also received approximately $360,000.00 in shareholder distributions to pay their family’s personal expenses. The court also found substantial evidence that corporate credit cards were routinely used to purchase personal items and to pay for personal expenses; commingling of funds without proper accounting and reconciliation; and transfers, characterized as “loans,” without any documentation, often made between their many businesses. In short, the trial court noted that “the lines between [the Edwards’] personal assets and the assets of all their businesses, including MFL, were heavily blurred” and found a unity of interest existed between the Edwards and MFL, thus permitting the court to pierce the corporate veil.

The supreme court began its analysis by noting that to pierce the corporate veil in Idaho, a claimant must demonstrate (1) a unity of interest and ownership to a degree that the separate personalities of the [company] and individual no longer exist and (2) if the acts are treated as acts of the [company] an inequitable result would follow. The supreme court noted that the trial court followed this standard, holding that Lunneborg only needed prove one factor in order to pierce the corporate veil and hold the Edwards personally liable. The supreme court noted that it had never expressly adopted a list of factors for consideration in these cases, and declined to do so in this case but stated that when determining whether to pierce the corporate veil, trial courts are free to consider many factors, including principles of fairness and justice, “without resorting to a formulaic recitation of elements that must be proven as if the exercise were akin to a criminal case wherein the ‘elements’ must be proven by the state beyond a reasonable doubt.” It determined that the trial court had not abused its discretion in weighing these factors and affirmed that court’s ruling.

As to Carrie’s personal liability, the trial court found that she once served as both Executive Vice President and COO of MFL; that she was also intimately involved in the day-to-day financial operations of MFL and the Edwards’ other four business entities; and that she was the one who took direct action in managing these businesses’ affairs. It also found that she also played a role in Lunneborg’s initial hiring, including attending meetings during his recruiting period and directly communicating with him in the days prior to his termination. The trial court ultimately concluded that Carrie exercised ample control over MFL to warrant piercing the corporate veil to reach her separate property despite her not being a shareholder. Specifically, the court found that Carrie’s actions in moving the money around were “the most important and most significant disregard of MFL’s corporate entity.”

In reviewing the trial court’s ruling regarding Carrie, the supreme court first noted that whether a non-shareholder can be liable for the debts of a corporation was a matter of first impression in Idaho and held that it was adopting the majority view in the United States that a non-shareholder can be held liable and stated “in these circumstances, when a claimant seeks to hold a non-shareholder liable for corporate debts, the court may look to a range of evidence to consider whether fairness dictates allowing recovery against a non-shareholder-officer, with the primary consideration being the element of control or influence exercised by that person in the affairs of the corporation.” It stated that the trial court had determined that despite the fact that Carrie was a non-shareholder, she had extensive financial control of MFL, and was an integral part of the corporation. It found that the trial court’s findings were supported by substantial evidence and its holding was consistent with other jurisdictions that have permitted piercing the corporate veil when an individual exercises sufficient control over the corporation, despite their status as a non-shareholder. As such, it determined that the trial court did not abuse its discretion in piercing the corporate veil to reach Carrie’s separate property and affirmed that court’s decision.

This ruling should be a cautionary tale to all small, closely-held businesses, especially family-owned ones, not just in Idaho but everywhere, to keep the lives of the business and the family separated to avoid potentially catastrophic consequences.