Corporate Direct Articles and Resources

Do you remember the crane collapse on 91st Street in New York City? Two people died, and now two corporations have had their veils pierced to pay for the wrongful deaths.
The State of New York is quite willing to pierce the veil in certain cases. This was one of them.

In In re 91st Street Crane Collapse Litigation, 154 A.D.3d.139, 62 (1st Dept., decided Sept. 12, 2017), the survivors of a crane operator and a worker, both killed during the tragic crane collapse on May 30, 2008, brought wrongful death actions.

The defendants, New York Crane & Equipment Corp. (“N.Y. Crane”), J.F. Lomma, Inc. (“JF Lomma”), and James F. Lomma (“Lomma”) appealed from the first judgments in the plaintiffs’ favor, arguing among other things that the trial court erred in allowing the jury to pierce the corporate veils of N.Y. Crane and JF Lomma, and in subjecting Lomma to personal liability. The trial lasted nearly a year and 87 witnesses were called to testify.

The evidence established that N.Y. Crane and JF Lomma, both incorporated in Delaware, rented cranes, while a second corporation named JF Lomma, incorporated in New Jersey, trucked the cranes to and from customers. Most of the cranes rented out by defendants were owned by nonparty Lomma Corporation, JLJD, which leased them to other Lomma companies for sublease to customers. Lomma’s entities rented out each other’s equipment at will; actual ownership did not matter. Lomma would decide later how much one company should pay the other, and thus had the ability to shift profits between companies. Lomma signed blank DOB CD forms–the forms necessary for the registration of a crane for use at a particular construction site–so that the general manager could fill in which company was renting out which crane on any particular job. Although N.Y. Crane’s tax returns stated that all the company’s equipment was stored in Brooklyn, the various Lomma entities kept their equipment, including the crane involved in this accident, at a yard in New Jersey personally owned by Lomma. None of the Lomma companies paid rent for use of the yard, and JF Lomma (NJ) paid the taxes. All Lomma companies shared the same offices and email system, and there was overlap of management and administrative personnel. All senior management, including Lomma and in-house counsel, were paid by JF Lomma (NJ), and all salaried employees in the organization were paid through the web-based ADP payroll account of JF Lomma.

The crane at issue was purchased by N.Y. Crane, and then $500,000 in refurbishment was spent. Lomma testified that although JF Lomma paid for the crane bearings from RTR (a China-based distributor, which subcontracted work to factories in China), the amount was charged back to N.Y. Crane. However, no proof of that was presented. Repairs to the Kodiak’s turntable bearing in 2007 were made in New York and supervised by JF Lomma. JF Lomma also paid for all replacement and new crane bearings and received any applicable insurance proceeds.

The Decision in In re 91st Street Crane Collapse Litigation

With respect to N.Y. Crane and JF Lomma, the New York Supreme Court, concluded, based upon the above evidence, that there was sufficient evidence to permit the jury to pierce the corporate veils of N.Y. Crane and JF Lomma, and that the evidence supported the jury’s conclusion that the multiple Lomma corporations conducted business as a single entity.

With respect to Lomma personally, the Court noted that, contrary to Lomma’s arguments, plaintiffs presented substantial evidence of Lomma’s personal participation in the corporate defendants’ affirmatively tortious acts launching the dangerous instrumentality that caused the deaths of plaintiffs’ decedents. As such, the Court found that the evidence sufficiently established that this was more than what defendants asserted–that Lomma was simply “one person who is a shareholder, officer and director in two or more corporations.” The Court emphasized that this one individual exercised domination and control over three separate corporations which he treated as one entity. Based upon this evidence, the Court concluded that there was sufficient evidence to permit the jury to assess personal liability against Lomma.

BRIEF DISCUSSION

New York law historically has allowed the corporate veil to be pierced either when there is fraud or when the corporation has been used as an alter ego. See, Itel Containers Int’l Corp. v. Atlanttrafik Exp. Serv. Ltd., 909 F.2d 698, 703 (2d Cir. 1990). In New York, the determinative factor in piercing the corporate veil under the alternative alter ego theory is whether the corporation is a “dummy” for its individual stockholders, who are, in reality carrying on the business in their personal capacities for purely personal reasons. See, Port Chester Elec. Const. Corp. v. Atlas, 40 N.Y.2d 652, 656-57, 389 N.Y.S.2d 327, 357 N.E.2d 983 (1976). Thus, under New York law, when a corporation has been so dominated by an individual or another corporation and its separate entity so ignored that it primarily transacts the dominator’s business instead of its own and can be called the other’s alter ego, the corporate form may be disregarded to achieve an equitable result. See, Austin Powder Co. vv. McCullough, 216 A.D.2d 825, 827, 628 N.Y.S.2d 855 (3rd Dept., 1995).

Furthermore, in New York, it is not necessary to plead or prove fraud in order to pierce the corporate veil under the alter ego theory. Wrongdoing in this context does not necessarily require allegations of actual fraud. While fraud certainly satisfies the wrongdoing requirement, other claims of inequity or malfeasance will also suffice. See, Baby Phat Holding Co., LLC v. Kellwood Co., 123 A.D.3d 405, 997 N.Y.S.2d 67 (1st Dept., 2014). Indeed, in Passalacqua Builders, Inc. v. Resnick Developers South, Inc., 933 F.2d 131, 140-41(2d Cir. 1991), the U.S. Court of Appeals for the Second Circuit held that it was error to instruct a jury that a plaintiff is required to prove fraud in order to pierce the corporate veil.

In applying the alternative alter ego theory, New York courts traditionally rely upon the following ten factors: (1) the absence of the formalities and paraphernalia that are part and parcel of the corporate existence, i.e., issuance of stock, election of directors, keeping of corporate records and the like; (2) inadequate capitalization; (3) whether funds are put in and taken out of the corporation for personal rather than corporate purposes; (4) overlap in ownership, officers, directors, and personnel; (5) common office space, address, and telephone numbers of corporate entities; (6) the amount of business discretion displayed by the allegedly dominated corporation; (7) whether the related corporations deal with the dominated corporation at arms length; (8) whether the corporations are treated as independent profit centers; (9) the payment or guarantee of debts of the dominated corporation by other corporations in the group; and (10) whether the corporation in question had property that was used by other of the corporations as if it were its own. See, Gateway I Group, Inc. v. Park Ave. Physicians, P.C., 62 A.D.3d 141, 146, 877 N.Y.S.2d 95 (2d Dept., 2009), quoting, Shisgal v. Brown, 21 A.D.3d 845, 848-49, 801 N.Y.S.2d 581 (1st Dept., 2005).

Therefore, the inescapable conclusion to be drawn from even a cursory examination of New York law with respect to piercing the corporate veil, is that the evidence relied upon by the New York Supreme Court, in In re 91st Street Crane Collapse Litigation in piercing the corporate veil, is in conformity with the factors traditionally relied upon by New York courts in piercing the corporate veil under the alternative alter ego theory.

CONCLUSION

In In re 91st Street Crane Collapse Litigation, the New York Supreme Court, simply applied the alternative alter ego theory under well-established New York law to the above facts.

Thus, the mere fact that the Court did not discuss fraud in its opinion is of little or no consequence to small business owners in New York or elsewhere. The Court’s decision appears to have been well in keeping with established New York precedent.

The significant “take away” from In re 91st Street Crane Collapse Litigation, is not that the Court did not discuss fraud in its opinion, but rather that New York, unlike some other jurisdictions, historically has allowed the corporate veil to be pierced either when there is fraud or when the corporation has been used as an alter ego.

It is very important to know the parameters of corporate law and to follow the formalities which establish those boundaries.

P.S. Not sure if your company is protecting you as it should? Get an evaluation by an expert. Get a Corporate Cleanup.

The IRS has instituted new audit rules which require every LLC Operating Agreement and Limited Partnership (LP) Agreement to be amended. While we have never experienced such a dramatic requirement, it is important to make document amendments before December 31, 2017. The IRS likes to penalize non-compliance.

Why the big change? In the past, when the IRS audited an LLC or LP taxed as a partnership, they eventually had to interact with all of the LLC members or LP partners. (From here on we will just use the word ‘partner’.) Identifying and monitoring all the partners was a difficult task, especially in very complex, multi-tiered partnership structures (think oil and gas and real estate syndications.) Partners could intervene in the proceedings, complicate the audits and even litigate over them. As well, the IRS usually needed the agreement of every partner to settle the audit. You can imagine how difficult this would be in a sophisticated LP with 10,000 partners in seven separate tiers of rights. As well, even if the aggregate post audit tax obligation amount was large, the costs of collecting small amounts from (or getting refunds to) many partners was forbidding.

So you can kind of understand why the IRS would want to change the whole process. You would too in their shoes.

Immediate Action Required for LLCs and LPs

The new rules allow the IRS to deal directly with the LLC or LP. It is called the Centralized Partnership Audit Regime. Unlike the past, individual partners have no rights to receive notice, engage in the proceedings, or disagree with the result. A single Partnership Representative (who need not be a LP partner or LLC member) interacts with the IRS.

When the audit is finished, the IRS calculates an ‘inputed underpayment’ that the partnership owes the IRS. This will equal the understatement of income multiplied by the highest tax rate assessed during the year in question. By collecting directly from the partnership the IRS doesn’t have to track down and collect from individual partners through layers and layers of partnerships and entities.

It is the Partnership Representative who deals directly and exclusively with the IRS. An entity may be appointed to serve in this role, but an individual with a substantial presence in the United States also must be identified. In the eyes of the IRS the Partnership Representative has absolute authority to bind the partnership. Typically, an LLC Manager/Member or LP General Partner is listed, with the ability to later appoint a CPA or tax lawyer, if you desire, if an audit comes your way. If a Partnership Representative is not appointed in your operating document, the IRS may select anyone they want to serve in this key role.

This is why you want to promptly amend your documents to appoint yourself or someone else who is on your side as the Partnership Representative. You don’t want the IRS making this decision for you.

There are other new technical rules in place which will only be necessary to know if you are ever audited. The only other general rule of import is that some small partnerships may opt out of the new rules.

For reasons we shall discuss, opting out is not your best choice.

Who Can Opt Out of the New Rules?

Partnerships with less than 100 eligible partners may elect out of the new rules and stay with the old ones. Eligible partners include individuals, C corporations and S corporations (but each S corporation shareholder counts towards the 99 partner limit).

Single Member LLCs and Trusts Can’t Opt Out

Importantly, disregarded entities (i.e. single member LLC’s) and living – or revocable – trusts aren’t eligible partners. Virtually all of our clients use a mix of single member LLCs and living trusts for their combined asset protection and estate planning goals. Under the new rules, opting out is not allowed for such clients. Even if you opt out you must affirmatively opt out every year with the IRS, and provide the names and tax identification numbers of all partners. The burden of such annual reporting is greater, in our opinion, than just complying with the new rules.

It gets worse. If you opt out and a partner changes their ownership to a Wyoming LLC or your CPA doesn’t make the annual election, you are automatically back into the new rules. However, because you didn’t opt in, amend your agreement and appoint a Partnership Representative, the IRS gets to appoint one for you. This is not a good position to be in.

The IRS has made it clear what they think about opting out. From their website:

“To ensure that the election out rules are not used solely to frustrate IRS compliance efforts, the IRS intends to carefully review a partnership’s decision to elect out of the centralized partnership audit regime. This review will include analyzing whether the partnership has correctly identified all of its partners for federal income tax purposes notwithstanding who the partnership reports as its partners. For instance, the IRS will be reviewing the partnership’s partners to confirm that the partners are not nominees or agents for the beneficial owner.”

Again, these rules are aimed at large partnerships. In most cases, it doesn’t really make a difference whether an audit is done at the entity level or the partner level. In closely held entities they are really one and the same. There is no great burden to following the new rules. Indeed, they involve less ongoing IRS surveillance.

There are a number of new technical rules, which will only be necessary for you and your CPA to know if you are ever audited. The only other requirement to know is that if money is owed after an audit the IRS will collect from the partnership, or, if the 6226 election is made, from the existing partners. You could have a situation where partners who owed the tax in an Adjustment Year (i.e. 3 years ago) are no longer partners of the entity today.

We have added language in the amended agreements which allows the Manager or General Partner, in their discretion, to collect monies owed from previous partners. We have also included provisions in the transfer of ownership sections where the responsibility for any tax audit obligation is assigned.

It is helpful to know why the IRS (as authorized by Congress) made this change. As mentioned, the large and complicated master LP structures made it nearly impossible for the IRS to collect from individual partners. Audits of large partnerships were few. The new rules allow the IRS to deal with these entities. Large and complex partnerships are the target here – not smaller LLC and LP asset holding entities.

By amending your LLC Operating Agreement and/or LP Partnership Agreement, by designating a Partnership Representative, and by providing the IRS with accurate returns as you have always done, you will be fine.