piercing the corporate veil

Avoiding Litigation RiskRecently, my firm Cooley Manion Jones LLP, successfully obtained summary judgment (download pdf) on behalf of its clients, Boca Raton-based private equity firm Sun Capital Partners, Inc. and six of its affiliated entities.  The claims were brought by two entities that had entered into contractual relationships to serve as independent sales representatives on behalf of Sun Capital portfolio company ACT Electronics, Inc.  Plaintiffs asserted numerous contractual related claims under veil piercing theories, together with claims for tortious interference, violations of the Massachusetts unfair trade practices statute, and state law statutory claims for commissions.  The gravamen of Plaintiffs’ claims was that Sun Capital and its affiliated entities pervasively controlled ACT Electronics and siphoned off corporate assets to the detriment of Plaintiffs.  While much of the Plaintiffs’ allegations were baseless and rejected by the Court, this case is a perfect example of the increased risk of liability associated with majority ownership and control of portfolio companies for the private investment industry, and illustrates steps companies can take to limit exposure in such cases.

Shareholder or control person liability arises in an increasing number of situations faced by private equity firms, including common law veil piercing claims, as well as WARN Act and Wage and Hour claims, and claims brought under provisions of the Securities Act and Securities Exchange Act.  While the factors considered by courts to determine whether a controlling shareholder should be held liable for the acts of a portfolio company vary from state to state and vary based on the context in which the claims are brought, all generally boil down to the following:

  • Disregard of corporate formalities
  • Disregard of corporate governance structure
  • Disregard of the corporation’s economic separateness
  • Undercapitalization
  • Siphoning of funds
  • Common ownership
  • Common directors and officers
  • Exercise of impermissible control

As these factors are used in guiding courts’ consideration of whether to extend liability to private investment firms and other controlling shareholders, these controlling shareholders must keep these factors in mind when structuring relationship with each of their portfolio companies.  Moreover, they should be mindful of the measures detailed below in order to reduce or eliminate the risk of such claims.

Recognize corporate formalities.  Private equity firms and their affiliated entities, by their very nature, must have inter-corporate relationships with their portfolio companies due to their interests as shareholders in those companies, and due to various other economic interests associated with their investment in those companies.  As a result, it is imperative that private investment firms and their affiliated entities observe proper corporate formalities.

In addition, private equity firms must encourage their portfolio companies to do the same.  All of the companies involved must take steps to create “corporate separateness.”  For instance, they should “separately: (a) conduct regularly scheduled meetings of their board of directors; (b) conduct and record shareholder votes; (c) prepare and record timely corporate minutes; (d) issue and record stock certificates; (e) make routine filings with the appropriate offices of the appropriate secretaries of states; and (f) maintain individual

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