CAN A BREACH OF
CONTRACT JUSTIFY CORPORATE VEIL PIERCING?
In a recent North Carolina Business Court decision, the court
reviewed whether a breach of contract itself was sufficient to pierce the
corporate veil.
Plaintiff Kerry Bodenhamer Farms (KB Farms) and Defendant
Nature’s Pearl entered into a written supply agreement for Plaintiff to supply
grapes to Nature’s Pearl, a juice manufacturer[1].
The turning point in the relationship was when Nature’s Pearl received a load
of grapes which revealed after processing that the alcohol content of the
grapes was too high. Nature’s Pearl
notified KB Farms that it was not willing to pay for the grapes because they
were not of suitable quality. The
relationship between the parties worsened and Nature’s Pearl notified KB Farms
that it was terminating the supply agreement.
KB Farms did not acknowledge the termination and instead continued to
supply grapes to Nature’s Pearl. Nature’s
Pearl owner Jerry Smith sent a check for the previous load of grapes using the
bank account of Le Bleu, another company owned by Smith. KB Farms rejected
the check and soon after filed a lawsuit against Nature’s Pearl, Le Bleu, and
Smith for breach of contract. KB Farms alleged that Le Bleu and Smith should
also be liable because they got involved in the breach of contract when Smith
used Le Bleu’s check to pay for the grapes.
In North Carolina,
the test for piercing the corporate veil is called the “instrumentality rule.”
To pierce the corporate veil the plaintiff must demonstrate that (1) the
defendant (either an entity or person) dominated and controlled a corporation;
(2) the defendant used that domination and control to perpetrate a fraud or
wrong; (3) the defendant’s domination and control was the proximate cause
of the wrong. The court held that there was insufficient evidence to pierce the
corporate veil under the instrumentality test. In the past, the court only
pierced the corporate veil when there were other compelling factors aside from
the breach of contract. Typically, there must be some evidence of fraudulent or
inequitable conduct; for example, evidence that the entity was created only as
a puppet entity to limit its liability or for the purpose of entering into the
relevant contract. Another common example would be if all of the entity’s
assets have been transferred to render it judgment-proof. Here, KB Farms was
unable to demonstrate that either Le Bleu or Smith were otherwise engaged in
wrongful conduct that would give rise to liability under the Instrumentality
Rule. Thus, the court dismissed Le Bleu and Smith from the case.
What are the takeaways from this case?
Generally,
business owners who operate several companies should take special care to
observe corporate formalities. Commingling
one entity’s assets with another entity’s assets is a significant factor in
favor of veil piercing. Here, Le Bleu and Smith narrowly avoided this fate
based upon a detailed review of the surrounding facts. A mere breach of contract was not enough to
justify piercing the corporate veil, and Smith’s use of another company’s check
did not rise to the level of “commingling” in light of all the evidence
presented.
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