Wednesday, August 8, 2012

Serio v. Baystate Properties, LLC (Ct. of Special Appeals)

Filed: March 8, 2012
Opinion by Retired Judge James A. Kenney, III

Held: Absent a finding of fraud, the circuit court erred by finding defendant personally liable for the debts of the limited liability company solely owned by him.

Facts: The plaintiff, a home builder, entered into a contract with defendant, as managing member of an LLC, to build houses to certain specifications on two lots lots which were owned by the defendant individually. As work progressed, the plaintiff drafted multiple addenda to the Agreement reflecting changes to the work. Each addendum, when first presented by the plaintiff, referenced the defendant individually, but the defendant revised those references and both parties signed the addenda, with the defendant signing as Managing Member of LLC. Both parties executed a waiver of any claims for personal liability under this agreement.

Shortly thereafter, payments to the plaintiff slowed. When the plaintiff contacted the defendant regarding the payments, the defendant assured that the properties would soon be sold. Although both properties had been sold, the buyers subsequently defaulted on a mortgage and the defendant received only a small portion of the sale. According to the plaintiff, none of the proceeds from the sale of the lots were deposited in the defendant's business account. 

The plaintiff sued, and the defendant LLC filed for bankruptcy protection. After a bench trial, the circuit court deemed it necessary to pierce the corporate veil to enforce a paramount equity. Accordingly, it entered a verdict against the individual defendant. The defendant appealed.

Analysis: On appeal, the Court affirmed that "except as otherwise provided [in this title], no member shall be personally liable for the obligations of a limited liability company, whether arising in contract, tort or otherwise, solely by reason of being a member of the limited liability company." The Court noted, however, that the corporate shield may be disregarded under certain circumstances. Specifically, "shareholders generally are not held individually liable for debts or obligations or 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 (1975).

The Court qualified this by stating the standard is so narrowly construed, that no appellate court finds an "equitable interest more important than the state's interest in limited shareholder liability." Residential Warranty v. Bancroft Homes Greenspring Valley, Inc., 126 Md. App. 294 (1999). Further, there is no precedent in the court's history of approving this extraordinary remedy of paramount equity. Even Maryland decisions that recognize alternate grounds for piercing the corporate veil do not do so absent a finding of fraud.

The Court compared this case to Hildreth v. Tidewater, where the trial court found circumstances establishing paramount equity that would warrant disregarding the entity shield based on the fact that defendant was the sole shareholder, personally involved in the transaction at issue, there was evidence of bad faith, the business conducted by the corporation was illegal because it was not registered in Maryland, Maryland law precluded an unregistered foreign corporation from engaging in business in Maryland, and there was evidence of a conscious evasion of responsibility. 378 Md. 724 (2006). The Court of Appeals, however, reversed, holding that those circumstances, individually or in combination did not warrant piercing the corporate veil. Id. at 734.

In discussing one possible ground where a corporate entity will be disregarded, the Court discussed the "alter ego" doctrine, and found it would only apply in exceptional circumstances and with great caution where a plaintiff shows "(1) complete domination, not only of the finances, but of the policy and business practice...(2) such contract was used by the defendant to commit fraud or wrong.. and (3) that such control and breach of duty proximately caused injury or unjust loss." Id. at 735. Further factors include whether the corporation was adequately capitalized, the company's solvency when entering the transaction, the observance of corporate formalities, and evidence that the corporation "has no separate mind, will or existence of its own." Id. at 736. The Court also touched upon the theory of whether the conduct was for the purpose of evading legal obligation, but found that the court's narrow interpretation of this ground did not warrant the defendant being held personally liable. The court found, moreover, the decisions of this Court and the Court of Appeals have made clear that 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. In sum, Maryland is averse to disregarding the entity shield in a business situation in the absence of fraud. 

Here, the circuit court did not find fraud, but found circumstances that warranted paramount equity. The circuit court viewed the defendant's failure to deposit the funds from the sale of the lots into the defendant's bank account and the fact that the defendant later filed for Chapter 7 bankruptcy as evidence of an intent to evade the company's legal obligations to the plaintiff. When reviewing these circumstances, this Court saw a greater parallel to 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." 275 Md. at 305. This Court also refused to pierce the corporate veil in a situation where a shareholder placed corporate funds into his personal account and lied regarding matters affecting public safety. See Bancroft, 126 Md. App. 294.

The Court concluded that the defendant fulfilled the contract with the plaintiff until, as the defendant testified, the collapse of the housing market caused problems. The plaintiff was an established building contractor who understood and agreed that it was doing business with another limited liability company, as reflected in the Agreement, and their continuing court of business. Under those conclusions, the Court found that the circuit court abused its discretion in finding the defendant personally liable for the obligations of the defendant.

The full opinion is available in pdf.