IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT
No. 96-30780
K.B.R., INC.,
Plaintiff-Appellant- Cross-Appellee,
versus
L.A. SMOOTHIE CORP.,
Defendant-Appellee- Cross-Appellant
and
A. ALBERT GARDES and STANTON MIDDLETON, III,
Defendants-Appellees
Appeal from the United States District Court For the Eastern District of Louisiana (95-CV-116)
January 22, 1998
Before REYNALDO G. GARZA, SMITH, and WIENER, Circuit Judges.
PER CURIAM:*
Plaintiff-Appellant-Cross-Appellee K.B.R., Inc. (KBR) appeals
the district court’s amended judgment rendered following the motion
* Pursuant to 5TH CIR. R. 47.5, the Court has determined that this opinion should not be published and is not precedent except under the limited circumstances set forth in 5TH CIR. R. 47.5.4. for a new trial filed by Defendant-Appellee L.A. Smoothie
Corporation (LASC) and Defendants-Appellees A. Albert Gardes and
Stanton Middleton, III (collectively, Defendants). In its amended
judgment, the district court vacated its previous finding of fraud
and its determination that the corporate veil should be pierced,
and held LASC —— but not Gardes or Middleton —— liable for breach
of contract only. Discerning no reversible error in the district
court’s resolution, we affirm.
I
FACTS AND PROCEEDINGS This case stems from a failed joint venture (Venture) between
two corporations —— KBR and LASC —— to create and operate a
smoothie store at the corner of Canal Street and St. Charles Avenue
in New Orleans. The events leading to this appeal began in 1992
when Richard Kirschman, the sole shareholder of KBR, and Gardes and
Middleton, LASC’s shareholders,1 began discussing commercial rental
space on Canal Street as a possible location for a smoothie store.2
The parties had done business together previously.
Middleton and Gardes, on behalf of LASC, attempted to lease
the space in conjunction with a sublease to a third party. The
1 For a period of time, Middleton’s father, now deceased, was a LASC shareholder. 2 For the benefit of those who may not know, a smoothie is a made-to-order beverage blended from a number of available ingredients as selected by the purchaser, and can be obtained from an authorized vendor only.
2 lessor, the Pickwick Club, requested a financial statement from
LASC. In response, Middleton and Gardes supplied a financial
statement roughly estimating the business’s possibilities, which
prompted the lessor to require their personal guaranties of the
lease. When the potential sublease failed to materialize, LASC
abandoned the potential location. According to the Defendants,
Kirschman thereafter encouraged them to rent and occupy the entire
space alone and to form a joint venture partnership between LASC
and KBR.
In late 1992, LASC and KBR formed the Venture as set forth in
their jointly-drafted Joint Venture Agreement (Agreement); each was
represented by counsel. KBR agreed to contribute $75,000 to
construct, furnish, equip and stock the store, and LASC agreed to
ensure that these start-up tasks were accomplished according to a
comprehensive plan and thereafter to conduct the store’s daily
operations.
LASC engaged Woodward Construction (Woodward) to build out the
store for a contract price of $42,975. The Defendants assert that
Woodward requested and received a Venture check of $15,475, which
was recorded in the Venture checkbook, when Woodward commenced
construction. Woodward erroneously credited this check for work
done on the City Park store, a different smoothie store in which
KBR and Kirschman had no interest.
The Venture’s store at Canal and St. Charles was outfitted
3 with both new and used equipment obtained from another smoothie
shop which was closing. The initial inventory comprised new goods.
LASC maintains that of Kirschman’s $75,000, $42,975 went to
construction, $8,800 went to new equipment, and $7,000 went to
inventory, leaving $16,000 for the remainder of the equipment.
Middleton and Gardes contend that they entered the Venture in
reliance on Kirschman’s known expertise in Canal Street business.
They insist that neither Kirschman nor his counsel requested
financial information prior to executing the Agreement; by the same
token, they made no investigation to determine whether Kirschman
could meet his initial financial commitments. LASC maintains that
it did not have financial information available for its stores at
that time, but that commencement of the Venture could have been
delayed pending acquisition of such information had it been
required.
In contrast, Kirschman contends that in entering the Venture
he relied on LASC’s pro forma projections —— given to induce his
investment —— and on LASC’s statement of financial condition
provided to the lessor. He maintains that both documents contained
false information and failed to disclose material information.
According to the Defendants, however, the pro forma consisted of
nothing more than Middleton and Gardes’ rough estimate of
anticipated expenses and necessary sales level, and that the pro
forma had been prepared when Kirschman was trying to convince them
4 to lease the downtown space. Kirschman asserts that Middleton and
Gardes made false representations as to LASC’s estimated sales and
expenses, their smoothie expertise, and the existence of a
comprehensive plan. Further, Kirschman asserts that the Defendants
failed to disclose that the Venture store would be equipped in part
with used fixtures from a store of theirs that was closing and that
their stores had been unprofitable. Finally, Kirschman emphasizes
that he relied on the Agreement’s anti-commingling provision in
choosing to invest.
The Venture proved unsuccessful. KBR insists that Gardes and
Middleton’s management skills were deficient and that they kept
improper records, even failing for well over six months to obtain
the financial data needed to determine whether the business was
operating successfully. The Defendants, in contrast, assert that
they did all that they could to ensure a successful Venture; they
blame the Venture’s failure on obstacles unique to the Canal Street
location, which led to an increase in the costs of goods sold and
caused sales to suffer. The Defendants contend that, even though
both parties were aware of the store’s problems before its first
financial reports were released in July 1993, Kirschman encouraged
continued operation.
In March 1994, KBR initiated an arbitration action to void the
Agreement and recover damages, alleging fraud. In November 1994,
the Defendants filed a petition in state court to enjoin the
arbitration. That court granted a temporary restraining order and
5 stayed the pending arbitration. KBR then dismissed the arbitration
proceeding and filed suit in federal district court on a revised
claim, alleging violations of federal and state securities laws.
The Defendants filed a summary judgment motion, seeking a
determination that the Agreement was not a security under the 1934
Securities Act and that, therefore, federal jurisdiction was
improper. The district court denied the motion.
Following a non-jury trial, the district court, in April 1996,
entered judgment for KBR against the Defendants in solido for
damages, interest, and attorney’s fees, finding them liable for
fraud, violations of federal securities law, and breach of
contract. The court determined that, as the parties intended that
KBR would not have any management role in the Venture, the
Agreement was an investment contract under the 1933 Securities Act.
It further determined that Kirschman had relied on the anti-
commingling provision of the Agreement in making his investment
decision and would not have agreed to the alleged violative use of
his contribution, i.e., commingling. The court concluded that
KBR’s consent to the Agreement was vitiated by fraud, entitling it
to rescission and damages. Finally, the court pierced the
corporate veil, holding Gardes and Middleton personally liable to
KBR for the damages owed by LASC.
After the Defendants filed a motion for a new trial, the court
entered an amended judgment, holding LASC liable for breach of
contract only and vacating the previous holdings of fraud and veil
6 piercing, thus relieving the individual defendants from personal
liability. In reversing its earlier decision, the court concluded
that Kirschman did not rely on the Agreement’s anti-commingling
provision. Further, the court found that representations in the
pro forma made before the Venture was formed did not rise to the
level of fraud, and that changes in the figures for costs of goods
sold did not cause further damage to the Venture and did not amount
to fraud. The court also determined that as the commingling caused
no financial harm to the Venture, it did not constitute fraud; but
that the commingling was a breach of the Agreement, making LASC
liable to KBR for damages. Finally, the court found that, as no
legal fraud was proven, KBR was not entitled to pierce the
corporate veil. Both parties timely appealed.
II
ANALYSIS
KBR asserts that the district court erred as a matter of law
in granting the Defendants’ motion for a new trial. It also
complains that the court erred in finding that Kirschman did not
rely on the Agreement’s commingling provision in making his
investment decision. KBR argues further that the court erred in
determining that the Defendants had not committed fraud in the
inducement of a contract and that no securities fraud existed. KBR
contends that, even assuming that there was no fraudulent conduct,
the corporate veil should be pierced, as Gardes and Middleton
7 failed to observe corporate formalities. On cross appeal, the
Defendants contend that the district court erred in awarding
$52,531 in damages to KBR.
We have now heard the arguments of able counsel, studied their
appellate briefs, reviewed the record on appeal, and considered the
applicable law. From this review, we are satisfied that the
district court committed no reversible error and that the only
argument meriting further discussion is whether the corporate veil
should be pierced to hold Middleton and Gardes personally liable
for LASC’s judgment debt.
A. STANDARD OF REVIEW
The decision to disregard a corporate entity “depends upon the
trial court’s findings of fact.”3 We have noted that “[r]esolution
of the alter ego issue is heavily fact-specific and, as such, is
peculiarly within the province of the trial court.”4 As such, we
apply a clearly erroneous standard of review.5
B. APPLICABLE LAW
As a general rule, corporations are distinct legal entities,
separate from the individuals who own them, as a result of which
3 Talen’s Landing, Inc. v. M/V Venture, II, 656 F.2d 1157, 1160 (5th Cir. 1981). 4 United States v. Jon-T Chems., Inc., 768 F.2d 686, 694 (5th Cir. 1985). 5 Id.
8 the shareholders are not liable for the debts of the corporation.6
This generality is grounded in the theory that insulation of
shareholders from personal liability promotes business and industry
by allowing investors to use the corporate form to make investments
while shielding their personal wealth from business risks.7 Only
in exceptional circumstances may a creditor of the corporation
reach a shareholder by piercing the corporate veil and thereby
render the individual liable for the corporation’s debts or
obligations.8 One such exception is when the corporation is deemed
the “alter ego” of the shareholder. This usually involves
situations in which the shareholder has practiced fraud or deceit
on a third party by acting through the corporation.9 The corporate
veil may be pierced in the absence of fraud, though, when the
shareholders disregard the corporate entity to such an extent that
the corporation ceases to be distinguishable from its
shareholders;10 but when fraud or deceit is lacking, “other
circumstances must be so strong as to clearly indicate that the
6 LSA-R.S. 12:93(B); Riggins v. Dixie Shoring Co. Inc., 590 So.2d 1164, 1167 (La. 1991). 7 Riggins, 590 So.2d at 1167-68. 8 Id. at 1168. 9 Riggins, 590 So.2d at 1168; American Bank of Welch v. Smith Aviation, Inc., 433 So.2d 750, 752 (La.App. 3d Cir. 1983). 10 Riggins, 590 So.2d at 1168.
9 corporation and shareholder[s] operated as one.”11
Courts consider a number of factors in determining whether to
pierce the corporate veil, including (1) commingling of corporate
and shareholder funds; (2) failure to follow statutory formalities
for incorporating and transacting corporate affairs;
(3) undercapitalization; (4) failure to provide separate bank
accounts and bookkeeping records; and (5) failure to hold regular
shareholder and director meetings.12 No one factor carries the most
weight; the “totality of the circumstances is determinative.”13
C. PIERCING THE CORPORATE VEIL
KBR insists that here the corporate veil should be pierced, as
Gardes and Middleton both committed fraud and failed to follow
corporate formalities. It argues that the district court
erroneously reversed its original determination that LASC’s
corporate veil should be pierced because the court harbored the
erroneous belief that a corporate veil could not be pierced absent
a finding of fraud. KBR correctly points out that, even when no
fraudulent conduct has occurred, the corporate veil can be pierced
for failure to observe corporate formalities. Relying on the
11 Cahn Elec. Appliance Co., Inc. v. Harper, 430 So.2d 143, 145 (La.App. 2d Cir. 1983; Kingsman Enters. v. Bakerfield Elec. Co., 339 So.2d 1280, 1284 (La.App. 1st Cir. 1976). 12 Riggins, 590 So.2d at 1168 (citing Smith-Hearron v. Frazier, Inc., 352 So.2d 263 (La.App. 2d Cir. 1977); Kingsman, 339 So.2d 1280). 13 Riggins, 590 So.2d at 1169.
10 factors listed above, KBR urges that the corporate veil should be
pierced because there was evidence of commingling, undercapitali-
zation, and failure to observe corporate formalities.
Specifically, KBR notes that regular shareholders and
directors meetings were not held; and that LASC’s minutes reveal
that the corporation held only annual meetings and had failed to do
even that since 1991. Additionally, KBR points out that the
corporation commingled funds by transferring money back and forth
between LASC and L.A. Smoothie Franchise, Inc. (a company founded
by Gardes and Middleton for the development of LASC franchises)
whenever either needed money. KBR notes further that the court
found that the Woodward payment constituted commingling of funds.
Finally, KBR urges that LASC was undercapitalized, observing that
it was unable to make its initial capital contribution to the
Venture in December 1992 and that Venture funds were used to pay
some costs of construction of LASC’s City Park store and rent for
LASC’s Severn Street store.
The Defendants counter that they did not disregard the
corporate entity. They acknowledge that commingling, lack of
written minutes of meetings, and borrowing funds from L.A. Smoothie
Franchise, Inc. are asserted by KBR, but insist that these
incidents are insufficient to entitle KBR to pierce the corporate
veil. Instead, argue the Defendants, the evidence indicates that
LASC was at all times operated as a corporation. The Defendants
maintain that, as LASC (1) was incorporated and maintained its
11 corporate status with the state; (2) filed corporate tax returns;
(3) maintained banking and accounting records for a small business
corporation; and (4) maintained by-laws and produced minutes of
meetings, the district court did not err in declining to pierce
LASC’s corporate veil.
As a preliminary matter, we disagree with KBR’s contention
that the reason the district court refused to pierce the corporate
veil was its improper belief that the corporate form cannot be
disregarded absent fraud. Although the district court did state
that “[a]s the Court has now found that no legal fraud was proved,
KBR is not entitled to pierce the corporate veil and hold Gardes
and Middleton personally liable for the damages it has sustained,”
this language is not tantamount to a declaration by the district
court that the corporate veil cannot be pierced absent fraud;
rather, it reflects the court’s conclusion that in the absence of
fraud the remaining circumstances of this case do not merit
piercing the corporate veil.
As we agree with the district court’s conclusion that there
was no fraud, we analyze the evidence of corporate behavior to
determine whether Middleton and Gardes disregarded the corporate
form to such an extent that they cannot hide behind the corporate
name.14 To begin with, we here have two business corporations, one
14 Chaney v. Godfrey, 535 So.2d 918, 919, 921 (La.App. 2d Cir. 1988)(In this suit against the corporation and its four shareholders for breach of an alleged contract, “[s]ince the plaintiffs do not assert that the individual shareholders committed
12 on each side ——— KBR and LASC —— all of whose shareholders were
fully aware that the business transaction they sought to confect
was to be a joint venture of their respective corporations. After
reviewing the Agreement, the Assignment for Assumption of Lease,
and other documents and correspondence in the record, we conclude
that sufficient indicia of “corporateness” existed to support the
district court’s determination not to pierce the corporate veil.
The Louisiana Supreme Court opinion in Riggins v. Dixie
Shoring Company15 is instructive. There, the court reversed the
state court of appeal’s determination that the state trial court
was justified in concluding that the corporate form should be
disregarded and the major shareholder held liable. The Louisiana
Supreme Court noted several factors considered by the state trial
court in support of its decision to pierce the corporate veil:
“1) employees being paid in cash with no records maintained of
this; 2) checks from customers of the business that were made out
to O.P. and Reginald Bajoie [majority shareholder and his son]
individually instead of to the corporation; 3) no corporate minutes
kept; 4) property belonging to O.P. Bajoie individually was used by
fraud, they have a heavy burden of proving that the shareholders disregarded the corporate entity to such an extent that it ceased to be distinguishable from themselves.”); Welch, 433 So.2d at 755 (“In the absence of fraud on the part of the Smiths [defendants], plaintiff had a heavy burden of proving that they disregarded the corporate entity to such an extent that it ceased to be distinguishable from themselves.”) 15 590 So.2d 1164 (1991).
13 the corporation without compensation to O.P.; 4) over $100,000
disappeared without explanation between the end of 1986 and the
filing of the bankruptcy petition; 6) some of the same equipment
used by the corporation . . . being used by the successor business
. . .; 7) disbursements made to employees without complete
documentation; 8) failure to show that the cash received by cashing
the checks made out to the Bajoies individually was deposited into
the corporate accounts; and 9) inexact testimony . . . about how
cash was handled.”16
The state trial court also considered facts which militated
against piercing the corporate veil. These included: “1) for many
years the corporation operated under the corporate name; 2) the
corporation maintained checking accounts and filed the appropriate
tax returns under the corporate name; 3) the corporation showed
profits and paid federal income taxes; 4) the plaintiff testified
that he understood that he was dealing with the corporate entity
and not O.P. and Reginald individually; 5) O.P. held informal
meetings with Reginald about business operations which amounted to
a form of Board of Directors meetings; 6) the corporation was
properly incorporated under the laws of Louisiana; 7) the
corporation had gross receipts of $280,403 in 1985 and $251,963 in
1986; 8) corporate checking accounts were maintained from which
significant corporate disbursements were made; and 9) substantial
16 Id. at 1166-67.
14 sums of money were maintained in the corporate checking
accounts . . . .”17
In ruling that the corporate veil should not have been
pierced, the Louisiana Supreme Court relied on a number of factors,
including, but not limited to, the following points. First, there
was no evidence that Bajoie used the corporate form to perpetrate
fraud. Second, even though some corporate formalities —— like
Board of Directors meetings —— were not followed, most formalities,
such as maintaining corporate bank accounts and filing corporate
tax returns, had been followed. Furthermore, when corporate
formalities such as board meetings were not followed, the
shareholders “still ran the corporation basically on a corporate
footing; for example, they regularly met informally about business
operations which, especially given that this was a small, closely
held corporation, sufficed to satisfy the spirit of the
requirement.”18 Third, contracts were routinely entered into in the
name of the corporation, including those with the plaintiffs, who
understood and believed they were contracting with the corporation.
Fourth, the court noted that the record did not support the alleged
diversion of corporate assets prior to filing the bankruptcy
petition. Finally, the Louisiana Supreme Court declared that the
uncompensated use of Bajoie’s tools and land by the corporation, as
17 Id. at 1167. 18 Id. at 1169.
15 well as the failure to keep corporate minutes or maintain a cash
journal, were not sufficient derelictions to support piercing the
corporate veil when viewed in light of the totality of the
circumstances.
Applying Riggins to the totality of the circumstances of the
instant case, we conclude that the district court did not commit
clear error in refusing to pierce the corporate veil. When the
time came to formalize this business deal, the Agreement plainly
reflected that two corporations were the only parties forming the
joint venture. The Agreement was signed by Middleton and Kirschman
in their respective corporate capacities. Moreover, Kirschman
signed individually for the express but limited purposes of
sections 2.8(f) [confidentiality and noncompetition] and 4.1 [KBR’s
initial contribution], and Middleton and Gardes signed individually
for purposes of section 4.2 [LASC’s initial contribution] only.
As for the conduct of business after the Venture had been
formed, LASC entered an Assignment and Assumption of Lease
Agreement with the Venture in December 1992. In this transaction,
Middleton, the assignor, signed the document in his capacity as
LASC President; Middleton and Kirschman both signed for the
Venture, the assignee, in their respective corporate capacities
with KBR and LASC; and Middleton, Gardes, and Kirschman each signed
individually as guarantors of the lease. Kirschman cannot be heard
to complain that LASC failed to act in its corporate capacity when
both he and Middleton, as corporate officers, signed an agreement
16 with its lessor, The Pickwick Club, assigning LASC’s lease to the
Venture. Moreover, Kirschman, as a leasing agent with Latter &
Blum, had represented The Pickwick Club in finding a lessee for the
building. Later, as Pickwick’s agent, Kirschman addressed a
facsimile transmission to LASC regarding lease compliance. And
additional documents in the record reflect correspondence between
two corporate entities.19
When addressing the observation of corporate formalities,
commentators have generally recognized that adherence must be
substantial, but that 100 percent observation is not required.20
We also recognize that this was a small business formed and
operated by closely-held corporations that were owned by three
individuals who had dealt with one another in the past; and that in
such circumstances parties tend to follow fewer formalities
without, however, eschewing corporateness altogether. Neither does
Louisiana corporate law require perfection;21 maintaining
19 We recognize that there are also documents addressed to Middleton and Gardes solely as Venture representatives (not LASC representatives), referring to them as “Stan” and “Al”, and signed by Kirschman on behalf of KBR. See, Plaintiff’s Exhibit 18; Defendant’s Exhibit 34h(13). It is important to note, however, that it was Kirschman who assumed a more informal tone in this correspondence rather than Middleton or Gardes. 20 Riggins, 592 So.2d 1282, 1284 (La. 1992)(Dennis J., concurring in the denial of rehearing)(citing H. HENN & J. ALEXANDER, LAWS OF CORPORATIONS § 146, at 347 (3d ed. 1983)). 21 See e.g., Chaney, 535 So.2d at 921-22 (circumstances were insufficient to clearly indicate that shareholders and corporation acted as one despite evidence that shareholders often informally met to discuss business without sending notice of a meeting,
17 formalities is not sacrosanct but is merely an indicia of reliance,
absent fraud.
Both KBR and LASC were fully aware that this was to be a
business venture entered into by their respective corporations.
Absent a conclusion of either fraud or alter ego, Kirschman cannot
bypass the corporation and satisfy LASC’s obligation from the
assets of Middleton and Gardes. Instead, he may recover damages
only from the corporation; if that pocket proves to be empty, so be
it.
III
CONCLUSION
After a thorough review of the record, we conclude that, in
the Venture, LASC simply was not the “alter ego” of its
shareholders and that the Defendants did not disregard the
corporate entity to such an extent that it was not —— or ceased to
be —— distinguishable from its shareholders. The district court
did not commit clear error when on reconsideration it determined
that there was no fraud and that the corporate veil should not be
pierced. Accordingly, we
AFFIRM.
minutes were not usually kept, and resolutions were reduced to writing only when required by financial institutions).