Business Law Chapter 33 Homework Its s Rent For The Linn Station Road property

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III. RECOGNITION OR DISREGARD OF

CORPORATENESS

Errors or omissions in incorporation procedures may or may not cause the

courts to regard an organization as a non-corporation. Conversely, even a

properly formed corporation may be regarded as a non-corporation if justice

requires.

*** Question to Discuss ***

Distinguish between statutory and common law approaches to defective formation of a

corporation.

A. DEFECTIVE INCORPORATION

Common Law Approach

Under the common law, a defectively formed corporation was, under certain

circumstances, accorded corporate attributes.

Corporation de Jure — Refers to a corporation that has been created in

substantial conformance with state law and organizational procedure.

Corporation de Facto — A failure to comply substantially with the

incorporation statute. A de facto corporation will be recognized if a general

corporation statute exists, there is a bona %de e&ort to meet statutory

requirements, and the company transacts business, demonstrating a belief

that the corporation has been properly formed. De facto status may not be

challenged by anyone other than the state.

Statutory Approach

The common law approach is cumbersome, but incorporation statutes now

address the issue more simply. All States provide that corporate existence

begins either upon the %ling of the articles of incorporation or their

acceptance by the Secretary of State. The Revised Act imposes liability only

on persons who purport to act as a corporation knowing there was no

incorporation.

CASE 33-3

HARRIS v. LOONEY

Court of Appeals of Arkansas, 1993

43 Ark.App. 127, 862 S.W.2d 282

http://scholar.google.com/scholar_case?case=145280640899400887&q=862+S.W.2d+282&hl=en&as_sclt=2,34

Pittman, J.

On February 1, 1988, appellant, Robert L. Harris, sold his business and its assets to J & R

Construction. The articles of incorporation for J & R Construction were signed by the

incorporators on February 1, 1988, but were not filed with the Secretary of State’s office

until February 3, 1988. In 1991, J & R Construetion defaulted on its contract and promissory

note, and appellant sued the incorporators of J & R Construction, Joe Alexander and

appellees, Avanell Looney and Rita Alexander, for judgment jointly and severally on the

corporation’s debt of $49,696.21. In his amended complaint, appellant alleged that the

On appeal, appellant contends that the trial court erred in not holding appellees jointly

and severally liable, along with Joe Alexander. It was undisputed that the contract and

promissory note were signed by Joe Alexander on behalf of J & R Construction and that J &

R Construction had not yet been incorporated when the contract was executed. [Court’s

footnote: Arkansas Code Annotated §4–27–203, which provides that, “[u] nless a delayed

In support of his argument, appellant cites [citation], where the supreme court held that:

[W]here an incorporator signs a contract or agreement in the name of the corporation

before the corporation is actually formed and the other party to the agreement believes at

the time of the signing that the corporation is already formed, then the incorporators are

responsible as a partnership for the obligations contained in the contract or agreement,

including damages resulting from any breach of the contract on their part. * * *

[Citations.] These cases, however, were decided before the Arkansas General Assembly

had specifically addressed the issue of liability of individuals for preincorporation debt.

* * * Section 204 of [the Arkansas Business Corporation] Act, [citation], concerns

liability for pre-incorporation transactions and is identical to Section 2.04 of the Revised

* * * [I]t seemed appropriate to impose liability only on persons who act as or on behalf

of corporations “knowing” that no corporation exists.

* * * The Act requires that, in order to find liability under §4–27–204, there must be a

finding that the persons sought to be charged acted as or on behalf of the corporation and

knew there was no incorporation under the Act.

The evidence showed that the contract to purchase appellant’s business and the

promissory note were signed only by Joe Alexander on behalf of the corporation. The only

evidence introduced to support appellant’s allegation that appellees were acting on behalf of

The trial court denied appellant judgment against appellees because he found appellees

had not acted for or on behalf of J & R Construction as required by §4–27–204. The findings

of fact of a trial judge sitting as the fact finder will not be disturbed on appeal unless the

findings are clearly erroneous or clearly against the preponderance of the evidence, giving

due regard to the opportunity of the trial court to assess the credibility of the witnesses.

*** Question to Discuss ***

Explain how the doctrine of piercing the corporate veil applies to

closely held corporations and parent-subsidiary corporations.

B. PIERCING THE CORPORATE VEIL

The courts will disregard the corporate entity when it is used to defeat public

convenience, commit a wrongdoing, protect fraud, or circumvent the law.

Going behind the corporate entity to confront those involved in wrongdoing

is known as piercing the corporate veil, and is not done frequently.

Closely Held Corporations

Creditors unable to recover completely against the corporation will often

request that a court impose liability on the individual shareholders. Courts

have responded by piercing the corporate veil if business was not conducted

on a corporate basis, the company su&ered from inadequate capitalization,

or the corporation was used to defraud.

Parent-Subsidiary Corporations

A subsidiary is a corporation in which another corporation (the parent) owns

at least a majority of the shares. Courts will pierce the corporate veil in this

situation if there is inadequate capitalization, formalities are not observed,

each corporation is not held out to the public as separate enterprises, funds

are co-mingled, or the parent %rm dominates the operations of the

subsidiary.

CASE 33-4

INTER-TEL TECHNOLOGIES, INC. v. LINN STATION

PROPERTIES, LLC

Supreme Court of Kentucky, 2012

360 S.W.3D 152

http://scholar.google.com/scholar_case?case=17219243320060826011&q=Inter-Tel+Technologies,+Inc.+v.

+Linn+Station+Properties,+LLC&hl=en&as_sdt=2,10&as_vis=1

Abramson, J.

[Integrated Telecom Services Corp. (ITS) was acquired by and became a wholly-owned

subsidiary of Inter–Tel Technologies, Inc. (Technologies), which in turn is a wholly-owned

subsidiary of Inter–Tel, Inc. (Inter–Tel). Inter–Tel designs, manufactures, sells, and services

After ITS was acquired by Technologies, ITS was not permitted to maintain a bank

account, hold any funds, or pay any bills. All of ITS’s regional offices were transformed

from independent dealers of communications equipment into direct sales “branches” of

Inter–Tel. ITS employees became employees of Inter–Tel and were paid by Inter–Tel from

its headquarters in Arizona. When a customer purchased a telecommunications system from

ITS did not hold an annual board of directors or shareholders meeting from 1999

through 2002. Nor did Technologies hold an annual board of directors or shareholders

meeting from 1998 through 2002. During the four-year period from 1999 through 2002, ITS

and Technologies had identical boards of directors; each ITS and Technologies director

served as an officer of Inter–Tel; the President and CEO of Inter–Tel served on the boards of

ITS, Technologies and Inter–Tel; and all of ITS’s officers served as officers of both

Technologies and Inter–Tel.

Although all Inter–Tel business conducted in Kentucky since 2001 was performed by

ITS in its own name, Inter–Tel, Technologies, and another Inter–Tel subsidiary filed sales

and use tax returns with the Kentucky in 2001, 2002 and 2003.

On June 19, 2002, Linn Station filed suit against ITS, seeking damages for failure to

repair and maintain the premises and for unpaid rent. ITS failed to respond, and on August

12, 2002, a default judgment was entered against ITS for $332,900.00 plus interest. After

repeated, unsuccessful attempts to satisfy the judgment against ITS, on June 20, 2003 Linn

Piercing the corporate veil is an equitable doctrine invoked by courts to allow a creditor

recourse against the shareholders of a corporation. In short, the limited liability which is the

hallmark of a corporation is disregarded and the debt of the pierced entity becomes

enforceable against those who have exercised dominion over the corporation to the point

that it has no real separate existence. A successful veil-piercing claim requires both this

element of domination and circumstances in which continued recognition of the corporation

as a separate entity would sanction a fraud or promote injustice. The leading Kentucky case

on piercing, White v. Winchester Land Development Corp. , [citation], like decisions from

courts across the country, refers to this two-part test as the “alter ego” test. In recent years,

courts and commentators have recognized piercing by using various tests and formulations,

* * *

The instrumentality theory requires the co-existence of three elements: “(1) that the

corporation was a mere instrumentality of the shareholder; (2) that the shareholder exercised

control over the corporation in such a way as to defraud or to harm the plaintiff; and (3) that

a refusal to disregard the corporate entity would subject the plaintiff to unjust loss.” * * *

* * *

* * * The Seventh Circuit Court of Appeals, when applying Illinois law, uses the

two-part alter ego test and considers the following factors under the first prong of that test:

(1) inadequate capitalization; (2) failure to issue stock; (3) failure to observe corporate

formalities; (4) nonpayment of dividends; (5) insolvency of the debtor corporation; (6)

* * *

* * * The alter ego test * * * expressly refers to “promoting injustice” and, indeed,

piercing should not be limited to instances where all the elements of a common law fraud

claim can be established. [Citations.] * * * We agree * * *, however, that the injustice must

be something beyond the mere inability to collect a debt from the corporation.

* * *

The trial court and Court of Appeals were correct in concluding the undisputed facts of

this case justified piercing ITS’s corporate veil. ITS lost all semblance of separate corporate

a creditor’s inability to collect a debt from ITS. In brief, the alter ego test is satisfied and

numerous of the equities factors are present. * * *

* * *

* * * The equitable doctrine of veil piercing cannot be thwarted by having two entities,

rather than one, dominate the subsidiary and dividing the conduct between the two so that

each can point the finger to some extent at the other. Technologies was 100% owned and

controlled by Inter–Tel and the two corporations acted completely in concert in dominating

* * *

ITS had grossly inadequate capital for day-to-day operations because it had no funds at

all, literally nothing of its own. * * *

* * *

Inter–Tel paid the employees’ salaries and other expenses of ITS. ITS had no assets of its

own, only those it was allowed to use by Technologies or Inter–Tel. ITS simply had no

independent financial existence. * * * Both Technologies and Inter–Tel used the Linn

Station lease premises and any other assets previously held by ITS solely for the benefit of

Inter–Tel, not for ITS’s benefit. Certainly the ITS officers and directors failed to act in that

corporation’s best interest because they allowed it to be stripped of its income and assets by

* * *

Courts should not pierce corporate veils lightly but neither should they hesitate in those

cases where the circumstances are extreme enough to justify disregard of an allegedly

separate corporate entity. This case is clearly within the boundaries of proper application of

the equitable doctrine and thus we conclude that the trial court and Court of Appeals did not

err in piercing ITS’s veil to hold Inter–Tel and Technologies responsible for ITS’s debt to

IV. CORPORATE POWERS

*** Question to Discuss ***

Identify the sources of corporate powers and explain the legal consequences

of a corporation’s exceeding its powers.

A. SOURCES OF CORPORATE POWER

Statutory Powers

Typical of the powers granted by state incorporation statutes are those

provided by the Revised Act, including: to have perpetual succession; to sue

and be sued in the corporate name; to acquire and dispose of property; to

make contracts, borrow money, and secure corporate obligations; to lend

money; to be a promoter, partner, etc., of any other entity; to conduct

business in and out of the state of incorporation; to establish pension plans,

pro%t sharing plans, etc.; and to make charitable donations.

Purposes

All State statutes provide that a corporation may be formed for any

lawful purposes. The Revised Act permits a corporation’s articles of

incorporation to state a more limited purpose. Many State statutes, but not

B. ULTRA VIRES ACTS

Acts that exceed a corporation’s powers are ultra vires — literally, “beyond

the powers.” Nowadays, few corporate acts are ultra vires because modern

statutes permit incorporation for any lawful purpose, and most articles of

incorporation do not limit corporate powers.

Effect of Ultra Vires Acts

The traditional rule was that ultra vires acts were void. Under the modern

approach, courts allow the ultra vires defense where the contract is wholly

executory on both sides.

Remedies for Ultra Vires Acts

RMBCA remedy options include; a) injunctive action by shareholder to enjoin

C. LIABILITY FOR TORTS AND CRIMES

Under the doctrine of respondeat superior, a corporation is liable for the torts

and crimes committed by its agents in the course of their employment. The

doctrine of ultra vires is no defense.