Posts tagged with "Reverse Piercing"

Owners of a Limited Liability Company Cannot Claim Homestead Exemption for Real Property Held by the LLC

Owners of a Limited Liability Company Cannot Claim Homestead Exemption for Real Property Held by the LLC

In re Kochman, 11-50111, 2011 WL 5325792 (Bankr. D. Conn. Nov. 3, 2011)

In a case before the United States Bankruptcy Court for the District of Connecticut, the Chapter 7 trustee objected to an aggregate homestead exemption claimed by the debtors for property owned by a limited liability company that they controlled at the time of the bankruptcy filing. The court sustained the objection and denied the homestead exemption.

The debtors were joint owners of Kochman Holdings Group, LLC (“the LLC”), which was a single asset real estate holding company established to hold title to a two-story building in West Cornwall, Connecticut. The first floor of the building was used by the debtors to conduct their respective businesses. A portion of second floor of the building was used as the debtors’ residence, and the remainder of the second floor was used for unspecified personal and business purposes.
In January 2011, the debtors filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code, 11 U.S.C. §§ 701 et seq. The petition listed their street address as the address of the building owned by the LLC. Pursuant to 11 U.S.C.§ 522(b)(3), the debtors listed personal exemptions allowed by state law, including an aggregate homestead exemption for their primary residence. See Conn. Gen. Stat. § 52-352b(t) (2009). The debtors calculated the value of their exemption to be approximately $88,000, which was the total net equity in the building owned by the LLC. The trustee objected to the homestead exemption.

In Connecticut, any “natural person” is entitled to claim an exemption for his homestead up to $75,000, which is calculated based on the fair market value of the property less the amount of any statutory or consensual lien. Conn. Gen. Stat. § 52–352b(t) (2009). A “homestead” is defined as “owner-occupied real property … used as a primary residence.” Id. at § 52–352a (e) (2005) Case law has further refined this definition to establish three requirements for real property to constitute an individual’s statutory homestead: (1) the individual must “own[ ]” the subject real property within the meaning of Section 52–352a as of the relevant time; (2) the individual must “occup[y] ” the subject real property within the meaning of Section 52–352a as of the relevant time; and (3) the subject real property must be “used as a primary residence” within the meaning of Section 52–352a as of the relevant time. In re Kujan, 286 B.R. 216, 220–21 (Bankr.D.Conn.2002); see also KLC, Inc. v. Trayner, 426 F.3d 172, 175 (2d Cir. 2005) (citing Kujan as “setting out ‘homestead’ requirements for invocation of homestead exemption”).

The exemptions afforded by Section 52-352a only apply to the property of persons, not artificial entities. Shawmut Bank, N.A. v. Valley Farms, et al., 222 Conn. 361, 366 (1992). When a person elects to own assets through an artificial entity for a legal advantage, such as limiting personal liability, he must accept the corresponding legal disadvantage arising from the limitation of Section 52-352a. Id.

The debtors admitted that the property for which they were claiming a homestead exemption was owned by the LLC. However, the debtors argued that the equitable doctrine of reverse piercing of the corporate veil should be applied so that they, as sole joint owners of the LLC, could be considered owners of the property for the purposes of claiming the homestead exemption. The debtors testified that forming an LLC and putting legal title to the property in the name of the LLC were good faith technical transactions that they executed upon the advice of their attorney with no understanding of the implications.

The Bankruptcy Court rejected the debtors’ argument. In recommending an LLC to hold title to the property, the debtors’ attorney fully understood that the benefits of such an arrangement included preventing the debtors’ individual creditors from reaching the property. An individual cannot place ownership of a property in an artificial entity so as to be unreachable by his individual creditors, and then later assert ownership of the property so as to be entitled to claim a homestead exemption in it. The court reinforced precedent by asserting that when an individual choose to take advantage of the benefits of an artificial entity, he must also bear the corresponding burdens. Because the LLC, and not the debtors, owned the property, the Bankruptcy Court found no basis for the debtors to claim a homestead exemption.

The Bankruptcy Court made the additional finding that, even if the debtors were entitled to claim a homestead exemption, the claim of $88,000 was “patently objectionable” because it represented the entire net equity in the property. Only the net equity in the portion of the property used as a primary residence could be claimed as a homestead exemption. Because the record contained no evidence as to the value of the residential portion, the Bankruptcy Court would be unable to calculate the value of the homestead exemption, had the exemption been allowed.

Because the Bankruptcy Court found that the debtors did not own the property at the time they filed for bankruptcy protection, they could not claim a homestead exemption in the property. Therefore, the court sustained the trustee’s objection to the claimed homestead exemption.

Should you have any questions relating to bankruptcy or asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.

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Connecticut Supreme Court Protects Corporate and Personal Assets By Denying Reverse Piercing of the Corporate Veil

Connecticut Supreme Court Protects Corporate and Personal Assets By Denying Reverse Piercing of the Corporate Veil

Commissioner of Environmental Protection, et al., v. State Five Industrial Park, Inc., et al, 304 Conn. 128, 37 A.3d 724 (2012)

In a recent case before the Supreme Court of Connecticut, State Five Industrial Park, Inc., (“State Five”) and Jean L. Farricielli (“Jean”) appealed a trial court judgment holding them liable for a $3.8 million judgment rendered in 2001against Jean’s husband, Joseph J. Farricielli (“Joseph”) and five corporations that he owned and/or controlled. The Supreme Court transferred the case from the appellate division, reversed the lower court judgment and remanded the case with direction to render judgment in favor of State Five. Although the Supreme Court concluded that the facts of this specific case did not support the application of reverse veil piercing, the court refused to address whether that doctrine should be disallowed in Connecticut under any and all circumstances.

In 1999, the Commissioner of Environmental Protection (“commissioner”), the town of Hamden (“town”) and the town’s zoning enforcement officer (collectively, “the plaintiffs”) brought an environmental enforcement action against Joseph and the five corporations that he owned and/or controlled alleging egregious violations of state solid waste disposal statutes. A bench trial took place in 2000 and, in 2001, a memorandum of decision was issued awarding the plaintiffs all relief sought, including civil penalties for each day of each alleged violation, which totaled approximately $3.8 million. Joseph appealed and, in 2004, the Supreme Court affirmed the trial court judgment against him and the five corporations.

In 2005, the civil penalties of approximately $3.8 million were still largely unpaid; therefore, the plaintiffs initiated the present action. They argued that principles of reverse piercing of the corporate veil should be applied to hold State Five liable for the 2001 judgment against Joseph and that principles of traditional piercing of the corporate veil should be applied thereafter to hold Jean liable for the resulting judgment against State Five. The trial court concluded that reverse veil piercing was warranted because Joseph used State Five to hide assets and used State Five funds to pay thousands of dollars in personal expenses; both actions complicated the plaintiffs’ normal efforts to collect their judgment. Once Joseph’s liability was imputed to State Five, the trial court concluded that traditional veil piercing principles applied to Jean, who was the majority shareholder in State Five. Therefore, the lower court held both State Five and Jean liable for the 2001 judgment against Joseph, plus pre-judgment interest on the outstanding amount, for a total liability of over $4.1 million.

The appeal raised the question of whether the equitable doctrine of reverse piercing of the corporate veil is a viable remedy in Connecticut. State Five and Jean argued that the trial court improperly applied veil piercing principles because that remedy should not be recognized in Connecticut under any circumstances. In the alternative, State Five and Jean argued that the trial court should not have applied veil piercing principles given the facts of the instant case.

A corporation generally is a distinct legal entity, and stockholders are not personally liable for the acts and obligations of the corporation. Saphir v. Neustadt, 177 Conn. 191, 209, 413 A.2d 843 (1979). This corporate shield of liability is pierced in only exceptional circumstances, such as where the corporation is a “mere shell, serving no legitimate purpose, and used primarily as an intermediary to perpetuate fraud or promote injustice.” Angelo Tomasso, Inc. v. Armor Construction & Paving, Inc., 187 Conn. 544, 557, 447 A.2d 406 (1982). (internal quotation marks omitted.) In veil piercing cases, the party seeking to disregard the corporate form bears the burden of proving that there is a basis to do so. In a traditional veil piercing case, the corporate veil shields a majority shareholder or other corporate insider who is abusing the corporate fiction in order to perpetuate a wrong; therefore, the claimant requests that the court disregard the corporate form in order to reach this individual’s assets. C.F. Trust, Inc. v. First Flight, L.P., 266 Va. 3, 10, 580 S.E.2d 806 (2003). In a reverse veil piercing case, however, the corporate form protects the corporation which gets used by a dominant shareholder or other corporate insider to perpetuate a fraud or defeat a rightful claim of an outsider; therefore, the claimant seeks to reach the assets of the corporation to satisfy claims or a judgment obtained against the corporate insider. Tomasso, 187 Conn. at 557, 447 A.2d 406. Three specific concerns have been identified in the distinction between these two doctrines: (1) reverse piercing bypasses normal judgment collection procedures, prejudicing the rightful creditors of the corporation who relied on the entity’s separate corporate existence; (2) reverse piercing prejudices the rights of the non-culpable shareholders; and (3) when the judgment creditor is a shareholder or other insider, there other legal remedies are potentially available to obviate the need for the more drastic remedy of corporate disregard. Therefore, a court contemplating reverse veil piercing must weigh the impact of this action on innocent investors and creditors, and consider the availability of other remedies to satisfy the debt. C.F. Trust, 266 Va. at 12–13, 580 S.E.2d 806.

In Connecticut jurisprudence, two rules form the legal standard for the application of traditional veil piercing doctrine and reverse veil piercing doctrine: the identity rule and the instrumentality rule. The instrumentality rule requires proof of three elements: (1) control, equivalent to the complete domination of finances, policy and business practice such that the corporate entity had no separate mind, will or existence of its own with respect to the contested transaction; (2) that such control was used to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest or unjust act in contravention of the plaintiff’s legal rights; and (3) that such control and breach of duty proximately caused the injury or unjust loss complained of. Naples v. Keystone Building & Development Corp., 295 Conn. 214, 232, 990 A.2d 326 (2010) (internal quotation marks omitted.) The identity rule requires that the plaintiff show that there was such a unity of interest and ownership between the shareholder and the corporation that the independence of the corporation had in effect ceased or had never begun, and adhering to the legal fiction of separate identity would serve only to defeat justice and equity by permitting the economic entity to escape liability. Id.

Whether the circumstances of a particular case justify the piercing of the corporate veil presents a question of fact. Therefore, the Supreme Court defers to the trial court decision to pierce the corporate veil, as well as any subsidiary factual findings, unless these factual findings are clearly erroneous, which means that either the record contains no evidence to support the findings or the reviewing court is left with the “definite and firm conviction” that a mistake has been made.

The Supreme Court concluded that, in the present matter, the trial court should not have applied reverse veil piercing, regardless of whether it is a viable theory in Connecticut. Certain subsidiary factual findings related to crucial factors that necessarily render reverse veil piercing inequitable lacked evidentiary support and, therefore, were clearly erroneous. Furthermore, after reviewing the trial court’s application of the instrumentality and identity rules, the Supreme Court was left with the definite and firm conviction that a mistake has been made.

The Supreme Court determined that the trial court did not adequately ensure that third party creditors did not exist or, if they did, that these creditors would not be harmed by applying reverse veil piercing principles that made all of the corporation’s assets available to satisfy the 2001 judgment. Permitting direct attachment of corporate assets to satisfy an individual insider’s debt undermines corporate viability, reasonably relied upon by creditors, with no forewarning. Testimony and printed statements in evidence at trial indicated that State Five had a line of credit with a local bank; however, the trial court concluded that this bank would not be harmed by the reverse piercing because the line of credit had been paid off in 2007 and the line was secured with Jean’s personal assets rather than corporate property. The Supreme Court determined that this finding was clearly erroneous because the record was silent as to the outstanding balance on the line of credit as of the date of trial and the precedent in Connecticut is that a lender in this context extends credit in reasonable reliance on the existence of both a viable borrower in possession of assets and the additional security provided by a secondary obligor.

Evidence that certain State Five shareholders were not involved in running the corporation, making necessary business decisions or suggesting changes did not support the trial court’s factual finding that these shareholders were complicit in Joseph’s activities. Because the plaintiffs did not establish that these shareholders were not innocent, the Supreme Court determined that it was improper for the trial court to apply reverse piercing without regard to whether the interests of these individuals would be impacted.

Finally, the Supreme Court was convinced that the trial court improperly concluded that the equitable remedy was warranted in this case. To justify any veil piercing action pursuant to the instrumentality rule, it must be shown that the insider debtor exercised complete control over the subject corporation and used such control “to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest or unjust act in contravention of [the plaintiffs’] legal rights; and … that the aforesaid control and breach of duty … proximately cause[d] the injury or unjust loss complained of.” Tomasso, 187 Conn. at 553, 447 A.2d 406. To justify imposing the entire obligation of the 2001 judgment on State Five, the plaintiffs needed to show that Joseph exercised his control over State Five to divert or hide assets that belonged to him personally or to his corporations and that otherwise would have been available to satisfy that judgment. Additionally, the plaintiffs needed to demonstrate that these maneuvers were the proximate cause of the plaintiffs’ inability to collect $3.8 million that it otherwise would have been able to recover. The Supreme Court found that the trial court’s analysis failed to specifically establish the necessary connection between Joseph’s improper actions in relation to State Five and the plaintiffs’ inability to collect on the 2001 judgment.

The Supreme Court found that the identity rule was not satisfied in the present case. It was neither unjust nor inequitable to permit State Five to avoid liability for the judgment against Joseph and his other corporations when State Five received little in the way of assets from those parties and much in the way of liabilities. Additionally, in paying personal expenses for Joseph, State Five has been caused to pay other expenses for which it is not legally obligated.

Because the Supreme Court concluded that the trial court improperly applied reverse veil piercing, Joseph’s liability for the 2001 judgment could not be imputed to State Five. Therefore, there was no liability to transfer from State Five to Jean.

The Supreme Court had a definite and firm conviction that a mistake has been made because the trial court’s application of the equitable remedy of reverse veil piercing was based in part on unsupported factual findings, and the court employed improper reasoning when analyzing other facts. Therefore, the Supreme Court set aside the trial court’s factual determinations as clearly erroneous, reversed the lower court judgment, and remanded the case with direction to render judgment in favor of State Five and Jean Farricielli.

Should you have any questions relating to corporate or personal asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.

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