You might remember the case of Cold Springs Ventures, LLC v. Gilead Sciences, Inc.. Last year, Judge Jolly stayed an arbitration proceeding pending a ruling on a piercing the corporate veil claim. If you are a reader of this blog, you will remember that I wrote about that decision last April. Now, assuming that you’ve gone and reread that post, you are up to speed on the issue.
Judge McGuire, taking over the case and stepping into Judge Jolly’s shoes, undertook the summary proceeding mandated by G.S. § 1-569.7(b), which says that "[o]n motion of a person alleging that an arbitration proceeding has been initiated or threatened but that there is no agreement to arbitrate, the court shall proceed summarily to decide the issue."
This month’s ruling is in 2015 NCBC 1
The issue for the Court was whether the individual Plaintiffs, directors of NC Kyro, could be obligated to arbitrate based on a contract that their corporation had signed with Gilead. The individuals had not signed the contract, but Gilead argued that it was entitled to pierce the corporate veil and thus make the individuals subject to arbitration. Gilead is contending in the arbitration it commenced that the individuals are personally liable to it on that contract, again on a piercing the corporate veil theory.
Given that deciding the question of arbitrability involved the consideration of issues basic to Defendant’s claim on the merits, Judge McGuire was exceedingly careful to abide by the U.S. Supreme Court’s admonition that "in deciding whether the parties have agreed to submit a particular grievance to arbitration, a court is not to rule on the potential merits of the underlying claims." AT&T Technologies, Inc. v. Communications Workers of America, 475 U.S. 643, 649 (1986). He said that his "decision will not have collateral estoppel or res judicata consequences." Order ¶10.
But, even with that caution, Judge McGuire’s Order should send a pretty clear signal to the Defendant’s counsel that its piercing the veil claims aren’t likely to succeed. And for lawyers contemplating bringing such claims in the Business Court, it clarifies some of the standard "magic words" enunciated by courts when considering motions to pierce the corporate veil.
"Control and Domination"
A party seeking to pierce the corporate veil must show "control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice . . . so that the corporate entity . . . had at the time no separate mind, will or existence of its own." Green v. Freeman, 367 N.C. 136, 145, 749 S.E.2d 262, 270 (2013).
This element "is a critical, if not the most critical, element in a court’s piercing analysis." Order ¶28.
Gilead came up short on this critical element despite its showing of the individual Plaintiffs’ direct involvement in key actions taken by NC Kyro, including its winding down and its dissolution.
Those actions were taken in their capacities as directors of NC Kyro, and Judge McGuire observed that:
directors of North Carolina business corporations are charged with exercising, or directing the exercise of, all corporate powers. Gilead’s argument regarding the control exercised by [the individuals] is based almost entirely on actions taken by those individuals pursuant to their statutory authority as directors.
Another factor considered by the Courts in determining whether to pierce the corporate veil is "inadequate capitalization." Green, supra, 367 N.C. at 1455, 749 S.E.2d at 270. But there is a difference between "inadequate capitalization borne [sic] out of deception or fraud, and inadequate capitalization ‘arising simply out of a lack of funds available for contribution to the enterprise.’" Order Par. 39 (quoting R. Robinson, Robinson on North Carolina Corporation Law § 2.10.
Although NC Kyro did suffer from inadequate capitalization (one of the Plaintiffs had testified that it "was always insolvent" and "never a going concern"), it was a startup struggling to raise capital.
Judge McGuire held that "the mere fact that NC Kyro’s capitalization efforts did not ultimately yield enough capital for the company to survive should not, without more, support the drastic remedy of disregarding the corporate form. Order ¶40.
So, if you are making a piercing the corporate veil claim, be careful to distinguish actions taken pursuant to corporate authority from "domination and control," and watch out before you take a lack of funds to be the necessary "inadequate capitalization."
Before getting to the published Order, the Judge had to step through ruling on a Motion to Disqualify Gilead’s counsel because it had previously represented the Plaintiffs. He denied that Motion in an unpublished Order. If you are interested in reading that Order, it is here.