Litigation

Earlier this year, Houston Harbaugh wrote on the then-pending Pennsylvania Supreme Court case of Mortimer v. McCool,[1] which presented the question of whether the Court would adopt the “enterprise” or “single entity” theory of the piercing-the-corporate-veil doctrine. The Court has now issued its opinion in Mortimer, and not only did the Court adopt the enterprise theory, it indicated that it would also consider “reverse” piercing, where a corporation may be held liable for the acts of its owners. This decision represents a significant shift in Pennsylvania law, which may increase liability for related businesses, expand the available circumstances under which Pennsylvania courts may disregard the corporate form, and reduce the liability shield offered by such structures as holding companies.

Corporations, limited-liability companies, and similar businesses are separate legal entities that are independent from their shareholders and owners, and prior to the Mortimer decision, the Supreme Court had been loath to expand doctrines that disregard that independent status. Under the doctrine of “piercing the corporate veil” as it existed before Mortimer, the separate legal form of a corporation or similar entity could be disregarded—or “pierced”—in order to hold owners of the business personally liable where a corporation was operating as a “facade” or “alter ego” of its owners. The non-exhaustive list of factors used to determine whether a corporation, LLC, or other similar business entity is an “alter ego” of its owners includes insolvency; the failure to observe corporate formalities; gross undercapitalization; a lack of (or non-functioning) officers, directors, or managers; domination of the company by a controlling member or shareholder; siphoning of funds by a dominant member or shareholder; commingling of personal and corporate funds; and the use of the corporate form to commit fraud, wrongdoing, or injustice.

Under Pennsylvania’s prior version of the piercing-the-corporate-veil doctrine, only the owners of the subject business could be held liable. For example, assume that John Smith is the owner of two companies, Alpha and Bravo. A business to whom Alpha is indebted files suit and argues that Alpha is being operated as an alter-ego of John Smith, and therefore Smith should also be liable for Alpha’s debts to that business. If the evidence showed, for example, that Alpha did not observe corporate formalities, was undercapitalized from its formation, and that Smith treated Alpha’s corporate bank account as if it were his personal account, then the separate existence of Alpha could be pierced, and Smith could be held liable for Alpha’s debts. But that same plaintiff would not likely have been able to pursue damages from Bravo, because Bravo is not an owner of Alpha. Only owners could be liable.

The Mortimer case eliminates that distinction and makes the enterprise or single-entity theory the law of Pennsylvania. This form of the veil-piercing doctrine provides that separate corporate forms of related companies may be disregarded; the doctrine is not limited to owners.

Mortimer arose out of a drunk-driving suit in which the plaintiff was struck and injured by an intoxicated driver who had been served alcohol at a restaurant operated by 340 Associates. 340 Associates was formed by members Michael and Raymond McCool to hold the liquor license. A separate LLC with the same two members—namely, McCool Properties, LLC—owned the building that housed the restaurant. Mortimer sued 340 Associates for dram-shop liability, and obtained a judgment for $6.8 million. Mortimer, however, was unable to recover the full amount of the judgment from 340 Associates and sought to recover the remaining damages from McCool Properties and the McCools personally. Among the theories advanced by Mortimer was that 340 Associates and McCool Properties should be treated as a “single enterprise” for purposes of liability, thereby allowing for execution against McCool Properties’ assets in order to satisfy the judgment against 340 Associates. Mortimer argued that the separate legal status of the two LLCs should be disregarded due to their “overlapping ownership and management” and the “financial dependence” of 340 Associates on the building owned by McCool Properties.

Both the trial court and the Superior Court rejected Mortimer’s claims based on the enterprise theory. The Supreme Court did as well and held that under the facts of the case, 340 Associates and McCool Properties should not be treated as a “single enterprise” for purposes of liability. But in doing so, the Supreme Court expressly adopted the enterprise theory as a viable theory for piercing the corporate veil in Pennsylvania.

The Supreme Court’s decision provides a recitation of relevant law throughout the country, but not necessarily the direction needed to provide predictability in the Commonwealth. Most of the opinion is devoted to the history and philosophical grounds of the veil-piercing doctrine. The opinion devotes little space to the practical implications or implementation of its ultimate holding. For example, the Supreme Court’s opinion says that the “single enterprise” veil-piercing doctrine applies to companies that have “common owners and/or an administrative nexus above the sister corporations,” and therefore liability may “run up from the debtor corporation to the common owner, and from there down to the targeted sister corporation(s).” The Supreme Court however, did not provide any definition of what it meant by “administrative nexus.” Is that different from common ownership? If so, what does it mean? The Supreme Court does not say, and it will apparently be left to the trial courts and future appellate cases to define an “administrative nexus.”

The Supreme Court also refused to create any list of “predefined factors embodying the many considerations that might aid in determining whether the corporate form has been abused.” Rather, the Supreme Court stated that courts in Pennsylvania will simply use their “equitable powers” to pierce the corporate veil based upon their evaluation of “the actions (or omissions) of the common owner to exploit limited liability while failing to observe the separation between the corporations.” The Supreme Court explained that it was expressly leaving it up to future cases to determine the scope of the new doctrine: “[W]e must aspire by the geologic accumulation of cases in which we find narrow answers in broad principles to guide the bar and the business community to anticipate the likelihood that piercing will apply in a given circumstance.” It thus remains to be seen whether lower courts will continue to utilize the existing factors (e.g., domination, commingling, the use of the corporate form to commit injustice, the failure to observe formalities, etc.) or whether trial courts are free to range further afield in their analysis. In the meantime, corporations and their legal counsel will have to wait for the “geologic accumulation” of precedent to have any idea as to what behaviors may lead to enterprise-theory veil piercing.

Not only did the Supreme Court adopt the enterprise theory, it also adopted the “reverse” veil-piercing doctrine, which applies when a plaintiff seeks to hold a corporation liable for the debts, acts, or omissions of its owners. The Supreme Court wrote, “To rule out reverse-piercing as a viable doctrine would be tantamount to saying either that it is not possible for a corporation’s owner to use that corporation as a shield against personal liability by the creative movement of assets or liabilities between himself and the corporation, or that equity cannot reach such an event even when it happens.” Like with the adoption of the enterprise theory, however, the Supreme Court’s opinion refused to issue any guidance or to place any bright-line rules on the new implementation of reverse veil-piercing. Instead, the Supreme Court again indicated that trial courts will apply their equitable powers to apply the doctrine in appropriate cases, but it provided no examples of an appropriate case.

This expansion of the veil-piercing doctrine will expand the number of entities facing potential liability, increase the potential legal liability for related business entities, expand the scope and expense of litigation, and bring more companies into court and force more corporate defendants to endure the time and expense of the discovery process. Prior to Mortimer, if a plaintiff tried to sue anyone other than a corporate owner under a veil-piercing theory, those other defendants could immediately move to dismiss the claims on the basis that veil-piercing liability can only extend to owners. That is no longer the case. Now, a plaintiff may not only bring suit against the owners of the corporation, the plaintiff may sue other corporations under common ownership (or under a common “administrative nexus,” whatever that may be). Using the prior example, the plaintiff owed money by Alpha may not only sue John Smith as Alpha’s owner, that plaintiff may also sue Bravo under the enterprise theory for being under common ownership with Alpha. Also, a plaintiff owed money by John Smith personally could bring suit against both Alpha and Bravo under the reverse veil-piercing theory and argue that both companies should be liable for John Smith’s personal debts. While the plaintiff would still hold the burden of proving that “the corporate form has been abused” and the separate identities of the defendants should be disregarded, Pennsylvania now permits all of these claims to be brought in the first place. And because the Mortimer opinion provides no bright-line rules and makes veil-piercing determinations highly dependent on the facts of each case,  defendants will most likely have to proceed through complex and expensive discovery and permit the plaintiff to review though their books and records in order to determine whether any of the defendants actually commingled their assets, failed to observe formalities, or used the corporate form to commit wrongdoing.

The Supreme Court’s Mortimer decision will likely have a profound effect on how suits are brought against related entities. Going forward, it is likely that when businesses are under common ownership and control, a plaintiff with a cause of action against any business will bring suit against every business and assert that they should all be liable because they “abusing” their corporate forms as part of a common enterprise. Even if that is not in fact true—and all of the companies have been maintaining their separate forms and corporate formalities—it is likely that the defendant corporations accused of operating as an enterprise will not be able to get out of the case at the preliminary objection/ motion-to-dismiss stage. Instead, defendants will be forced to proceed through discovery to at least the summary-judgment stage, if not to trial.

One case already foreshadows this future. In SWB Yankees, LLC v. CNA Financial Corporation,[2] a minor-league baseball team brought suit over its insurer’s refusal to cover lost revenues due to the Covid-19 pandemic. The team sued CNA Financial, Continental Insurance, and Continental Casualty. The insurers’ answer to the suit admitted that the policy in question was issued by Continental Casualty, and it further explained that CNA is the parent company of Continental Insurance, which in turn is the parent company of Continental Casualty. CNA and Continental Insurance argued that they had no contract with the plaintiff, so the only party that could be potentially liable was Continental Casualty, which was admitted to be the actual issuer of the insurance policy in question. The Lackawanna Court of Common Pleas refused to grant a motion for judgment on the pleadings to dismiss CNA and Continental Insurance from the suit because “discovery may establish a basis for imposing liability upon CNA and Continental Insurance based upon the enterprise or single entity theory for piercing the corporate veil, as recently adopted by our Supreme Court [in Mortimer].” Thus, even if discovery ultimately shows that none of the factors for piercing the corporate veil are present, CNA and Continental Insurance were nonetheless forced to stay in the suit and participate in discovery. This is a likely future for corporate litigation in Pennsylvania: more claims against more defendants, who will be forced to participate in more discovery.

The Supreme Court’s Mortimer decision may also diminish or even negate many of the benefits of common business structures, such as the holding-company structure. Before Mortimer, a holding company with multiple subsidiaries could be used to insulate the liability of each subsidiary from the others. If a plaintiff had a claim against one subsidiary, it could at best pierce the corporate veil to reach the common owner (i.e., the holding company), but the plaintiff would not have been able to reach any of the other subsidiaries’ assets. Post-Mortimer, a plaintiff with a claim against one subsidiary may now viably assert that the holding company and all of the other subsidiaries are part of a common enterprise, and thus the assets of every subsidiary should be available to satisfy that plaintiff’s claims. Whether the corporations are in fact amenable to veil-piercing would be a question for the trial court to determine in its “equitable powers.”

 Mortimer blurs the independence of the corporate form and makes it much easier for a plaintiff to simply adopt a “sue them all and let discovery sort it out” approach to companies under common ownership and control. Mortimer will likely have a far-reaching effect on the scope, complexity, and expense of business litigation in Pennsylvania.

Houston Harbaugh will continue to monitor this significant change to Pennsylvania law. If you have any questions, please contact any of the following attorneys:

Matthew J. Lautman-  412-288-5017, lautmanmj@hh-law.com

Robert H.C. Ralston- 412-288-2265, ralstonrhc@hh-law.com

Samuel H. Simon- 412-288-2263, ssimon@hh-law.com

[1] Mortimer v. McCool, 37 MAP 2020, — A.3d —-, 2021 WL 3073332 (Pa. July 21, 2021).

[2] SWB Yankees, LLC v. CNA Financial Corp., 2021 WL 3468995 (C.P. Lackawanna Co. August 4, 2021).