Update on Piercing the Corporate Veil

In Pertuis v. Front Roe Restaurants, Inc., 423 S.C. 640, 817 S.E.2d 273 (2018), the South Carolina Supreme Court has provided important new guidance in the area of “piercing the veil” of brother-sister corporations. All five judges agreed: “[w]e formally recognize today [the] single business enterprise theory.” Id. at 655, 817 S.E.2d at 280. This new precedent will make it more difficult to pierce the veil of brother-sister corporations.

The single business enterprise theory (“SBE theory”) “is an equitable doctrine applied to reflect partnership-type liability principles when corporations integrate their resources and operation to achieve a common business purpose.” (William Meade Fletcher et al.,Fletcher Cyclopedia of the Law of Corporations §43 (perm. ed., rev. vol. 2015) (emphasis added). In other words, a court can pierce the corporate veil of two or more affiliated corporations and treat them as one (1) corporation, which can benefit a plaintiff-creditor.

The South Carolina Court of Appeals has considered the “amalgamation” of two or more corporations several times. In Pertuis, the South Carolina Supreme Court recognized the SBE theory for the first time. The SBE theory is comparable to the amalgamation of interest theory (“AOI theory”). However, the new Supreme Court’s approach (the SBE theory) is more conservative than the previous Court of Appeals’ approach (the AOI theory).

For the SBE theory to apply, there must be “[E]vidence of abuse, or … injustice and inequity. . . . ‘[I] njustice’ and ‘inequity’ . . . are used … as shorthand references for the kinds of abuse, specifically identified, that the corporate structure should not shield—fraud, evasion of existing obligations, circumvention of statutes, monopolization, criminal conduct, and the like. Such abuse is necessary before disregarding the existence of a corporation as a separate entity.” Pertuis, 423 S.C. at 654-655, 817 S.E.2d at 280 (quoting SSP Partners v. Gladstrong Invs. (USA) Corp., 275 S.W.3d 444, 455 (Tex. 2008)). The South Carolina Supreme Court stated: “We agree with the reasoning of the Texas Supreme Court.” Pertuis, 423 S.C. at 655, 817 S.E.2d at 280.

“Piercing the corporate veil is a common law doctrine by which courts disregard the separate corporate entity in particular circumstances and impose liability on the participants behind the entity’s veil.” Robert B. Thompson, Piercing The Veil Within Corporate Groups: Corporate Shareholders As Mere Investors, 13 conn. J. int’l l. 379, 383 (1999). See generally Shawn M. Flanagan, Piercing the Corporate Veil in South Carolina, SC Law, Nov. 2006, at 35. (discussing piercing the corporate veil in South Carolina); Stephen B. Presser, Piercing the Corporate Veil, (West 2013) (discussing a nationwide study of piercing the corporate veil).

Mark and Larkin Hammond built and operated three restaurants. The Hammonds hired Kyle Pertuis (“Pertuis”) to manage the three restaurants. As part of his compensation, Pertuis acquired minority ownership interests in the corporations that owned the restaurants. The dispute primarily concerns the percentage and valuation of Pertuis’ ownership interests in the three corporations. The trial court found the three corporate entities should be amalgamated into one legal entity. The Court of Appeals affirmed. The Supreme Court reversed on the issue of “amalgamation.” As a result of the guidance provided by the Supreme Court in Pertuis, this author suggests using “single business enterprise theory” in place of “amalgamation of interests theory” to distinguish the new test from the old test.

Lake Point

In 1998, the Hammonds formed Lake Point Restaurants, Inc. (“Lake Point”) in North Carolina. Lake Point purchased a restaurant operated as Larkin’s on the Lake. The Hammonds were the initial shareholders with equal ownership in Lake Point. In 2000, the Hammonds hired Pertuis as a manager of the restaurant. As part of Pertuis’ compensation package, the parties agreed Pertuis would earn (a) a base salary plus bonuses based on profitability benchmarks and (b) a 10% share in the business over the course of a five-year period at an agreed vesting schedule. The vesting schedule was time-based to incentivize Pertuis to remain with the company for a period of time. In accordance with the vesting schedule, by 2007, Pertuis owned a 10% share in Lake Point.

Beachfront

In 2001, the Hammonds formed Beachfront Foods, Inc. (“Beachfront”) in North Carolina. As with Lake Point, the Hammonds were the initial shareholders with equal ownership interests, and the parties agreed upon a five-year vesting schedule for Pertuis to attain a 10% ownership interest. Pertuis’ duties included oversight of both restaurants. As with Lake Point, by 2007, Pertuis owned a 10% share in Beachfront. Beachfront first operated a restaurant named MaLarKie’s, which was not as successful as Larkin’s on the Lake and was eventually sold. Beachfront then began operating a restaurant named Larkin’s Carolina Grill, which was the least profitable of the three restaurants at the time of trial, with a negative net income reported each year from 2008–2012.

Front Roe

In 2005, the Hammonds formed Front Roe Restaurants, Inc. (“Front Roe”) in South Carolina. As with the other two corporations at the time of their formation, the Hammonds were the sole shareholders of Front Roe with equal ownership interests. Front Roe operated Larkin’s on the River in Greenville, South Carolina. At the time of trial, Front Roe was the most profitable of the three corporations.

Although the parties agreed upon a vesting schedule for Pertuis to acquire up to a 10% interest in Front Roe, this agreement, unlike the others, was based on restaurant profitability benchmarks – rather than length of service. Mark Hammond testified the agreement was for Pertuis to receive a 1% interest the year Front Roe first became profitable and an additional 9% once the company achieved a net operating profit of $500,000. By 2007, Pertuis owned a 1% share of Front Roe. However, at the time of trial, Front Roe had never reached the $500,000 net profit benchmark.

Pertuis never made any capital contributions or personal loans to the corporations, either during or after his employment.

It appears that Pertuis’ employment terminated in late 2009, although it is unclear from the record whether it was Pertuis’ decision, the Hammonds’ decision or a mutual decision. After the parties’ unsuccessful attempts to negotiate the Hammonds’ purchase of Pertuis’ shares of the corporations, suit was filed. Pertuis argued he owned a 10% share in Front Roe. The trial court found the three corporate entities—Lake Point (NC), Beachfront (NC), and Front Roe (SC)—should be amalgamated into a single business enterprise located in and operating out of Greenville, South Carolina. The trial court awarded Pertuis a 7.2% ownership interest in Front Roe. The trial court valued each of the three corporations and ordered a buyout of Pertuis’ shares. The South Carolina Court of Appeals affirmed. Pertuis v. Front Roe Restaurants, Inc., No. 2016-UP-091, 2016 WL 757503, at *8 (SC Ct. App. Feb. 24, 2016).

The South Carolina Supreme Court agreed with the Hammonds’ claim that the Court of Appeals erred in affirming the trial court’s finding that amalgamation of the three corporate entities was warranted. Pertuis v. Front Roe Restaurants, Inc., 423 S.C. 640, 817 S.E.2d 273 (2018).

The Supreme Court concluded the application of South Carolina law was appropriate. “The choice of law rule generally applied to corporate law issues is the internal affairs doctrine, which provides that the internal matters of corporate governance are governed by the law of the state of incorporation.” Id. at 649, 817 S.E.2d at 277. The “amalgamation issue is not as much a question of the inner-workings of foreign corporations as it is an assessment of whether these entities actually operate as a single business enterprise, and thus should be treated as a single entity.” Id. at 650, 817 S.E.2d at 278.

Front Roe was a South Carolina corporation and its restaurant was located in Greenville, South Carolina. Much of the conduct at issue occurred in Greenville, South Carolina. Pertuis was a South Carolina resident. “Accordingly, we conclude the application of South Carolina law is appropriate and that the internal affairs doctrine does not bar our review of this issue.” Id.

The seminal case in South Carolina is Kincaid v. Landing Development Corp., 289 S.C. 89, 344 S.E.2d 869 (Ct. App. 1986). The statement of facts and the discussion of law in Kincaid is limited. Kincaid involved three brother-sister corporations involved in the development of a subdivision. One corporation owned the land. A second corporation handled sales and marketing. A third corporation constructed homes. The plaintiffs’ lawsuit was based on negligent construction. The plaintiffs sought recovery from the sales and marketing corporation as well as the other two corporations. The Court of Appeals recited facts that the three corporations had common shareholders and common officers, and that they shared corporate offices and business...