Corporate Transactions

by Chris Swiecicki

What is “Lifting the Corporate Veil in Company Law?

Founders set up LLCs and other corporations to protect themselves from personal legal liability. The personal assets of members of an LLC are separate from their business assets. However, courts sometimes end the limited liability protection for owners, directors, and shareholders, an action called the lifting the corporate veil or piercing the corporate veil. 

“Veil” refers to the protection from legal liability provided by LLCs and corporations.  When a court lifts the corporate veil, it removes the shareholders’ protection from legal liability. Their personal assets will be included in any orders to repay creditors and other litigants.

Owners, directors, and shareholders need to do all they can to protect themselves from a court piercing the corporate veil—and the personal consequences that follow.

When Do Courts Lift the Corporate Veil?

Courts use caution when considering lifting the corporate veil because the principle of limited liability is a key part of corporate law. However, in cases where there is straightforward evidence of an egregious act of misconduct, courts are willing to pierce the corporate veil and impose personal liability. The misconduct may include fraud, wrongdoing, or abuse of the corporate form. In Missouri and in most other states, three factors must be present for a judge to pierce the corporate veil:

1. The owner dominated finance, policy, and business practices around a transaction and the corporate entity did not have a “separate mind.”
2. The owner’s control was used to defraud, violate a statute or other legal duty, or commit a dishonest or unjust act that hurt the plaintiff.
3. The control is believed to have caused the injury or loss.

A Missouri appeals court reaffirmed the three requirements for lifting the corporate veil in a 2014 case, Hibbs v. Berger.

Can Minority Members Ask Courts to Pierce the Corporate Veil?

The Hibbs ruling is also known for the court’s decision on whether minority members may file claims against majority owners. Plaintiff Steve Hibbs claimed that Brian Berger, his former employer, owed him money. Hibbs owned 5% of one of Berger’s businesses. When the company started having money problems, Hibbs stopped getting paid.

The Missouri Court of Appeals ruled Hibbs, a minority member of an LLC, had a right to pierce the corporate veil. Then, the court considered whether the case met the three requirements for removing the protection offered by an LLC. The court decided there was not enough evidence to pierce the corporate veil.

Examples of Courts Piercing the Corporate Veil

Two high-profile examples of a court piercing the corporate veil took place in Florida:

• In Ocala Breeders’ Sales v. Hialeah, Inc., the court lifted the corporate veil to investigate reports of the corporate officers of Hialeah, Inc., unlawfully running a subsidiary. The look behind the corporate veil revealed the subsidiary was no more than an instrument of the parent company. Hialeah, Inc., did not have enough capital and thus could not meet its obligations.
• In Broward Marine, Inc. v. S/V Zeus, the court lifted the veil of a yacht company to reveal the dominant shareholder’s evasive moves to avoid paying the plaintiff the money he owed him. The court found the defendant transferred all the company’s assets to another business he owned and hid the transaction. A judge ruled the dominant shareholder and his other company both were liable for the debt.

Florida courts followed the same guidelines for piercing the corporate veil as Missouri courts do.

Bad Business Practices Leading to Lifting the Corporate Veil

Courts are more likely to strip protection from legal liability–pierce the corporate veil–of companies guilty of one or more of these bad business practices:

• Commingling funds. When members of an LLC do not keep their own money separate from their business funds, they risk losing protection from legal liability. In the view of the courts, a business owner who does not treat their business as a separate entity does not qualify for limited liability protection.
• Sharing assets. Owners of LLCs who own more than one business need to keep separate financial records and lists of assets for each business. For example, if they list an expensive piece of equipment as an asset for one business, they cannot list the same equipment on their other business’s Schedule C.
• Illegal activities. If a corporation is used as a vehicle to defraud creditors, shareholders, or other third parties, a court may disregard the corporate form and hold the individuals responsible for the corporation’s actions. This can occur when the corporation is used to conceal illegal activities or to evade legal obligations.
• Lack of corporate formalities or recordkeeping. Corporations must follow certain formalities such as holding regular meetings and tracking finances. They also must keep a clear separation between the corporation and its owners.
• Undercapitalization. The courts consider whether a business is undercapitalized when a creditor or other litigator asks for lifting of the corporate veil. The court wants to know whether the business has enough money to run. If the court decides the LLC or other business entity is undercapitalized, it is more likely to pierce the corporate veil.

How to Avoid Piercing of the Corporate Veil and Personal Legal Liability

If you ever face piercing the corporate veil, you will have a better chance of convincing a court you keep your business and personal assets separate by adhering to best practices:

• Follow formalities for your business structure. Corporations need to have annual meetings, file reports, and more. LLCs and LLPs need to file reports to the state, have operating agreements, and keep records of votes on big decisions.
• Save business documents for at least seven years. When you do this, you can prove you run your business following the law.
• Have separate business and personal accounts at the bank and for other accounts.
• Capitalize your business to the extent you can always pay your bills, employees, and contractors.
• Use your business name on everything including contracts, signage, business cards, and other official documents.

Corporate lawyers have advice specific for maintaining the veil for different industries and fields.  Whether you are starting a business or tweaking an existing corporate structure, a conversation with an experienced corporate attorney is a valuable use of your time. Swiecicki and Muskett, LLC, advises business owners and corporate leaders based on decades of legal experience. Contact us today if you have any questions about piercing the corporate veil!

 

by Chris Swiecicki

What is a “Poison Pill” in Corporate Law?

When a larger company tried to take over the company owning the St. Louis Post-Dispatch in 2022, corporate lawyers showed Lee Enterprises how to fight back. They crafted a poison pill defense, or shareholders rights plan, to kill the unsolicited offer from Alden Global Capital. The defense worked, and Lee still owns the Post-Dispatch and 22 other papers.

Corporate lawyers often recommend poison pills for defense against corporate raiders.  Sometimes the acquirer backs off. Other times, the targeted company and the acquirer reach a favorable agreement.

How Do Poison Pills, Shareholder Rights Plans, Work?

Poison pills reduce the appeal of a takeover by either making the deal too expensive for the bidder or by creating negative side-effects of a takeover.

As corporate raiders begin buying up shares, corporate lawyers work closely with the targeted company to determine the specifics of the poison pill and when to launch it. For example, a  board may stipulate that a shareholders rights plan take effect when the acquiring entity gains 20% of the company’s shares.

Most shareholders rights plans include a stipulation that they can be changed or negated by the board. Thus, the board is forcing the acquirer to negotiate directly with them, which will have a positive position for bargaining.

Corporate lawyers use a variety of ways to launch poison pills including:

1. Preferred stock plan: A company issues a dividend of preferred stock to shareholders. These shareholders may use special voting rights when a company tries to takeover by buying a large quantity of shares.
2. Flip-in: Many companies include a provision in their charter or bylaws establishing a threshold for buying stock. Before the acquiring entity nears the ceiling, usually between 20 and 50%, the targeted company starts selling stock at a discount to its existing shareholders. This dilution of the company’s stock may prevent the hostile takeover.
3. Flip-over: When a company employed a flip-in poison pill and was not able to avoid a hostile takeover, there is another defense mechanism to try: A flip-over poison pill.  The shareholders of the targeted company buy up stock at a discount. In doing so, they dilute the shares of the acquiring company’s existing shareholders. This is only possible if a section of the bylaws spells out the legality of the maneuver.
4. Back-end plan (also known as a note purchase rights plan): A back-end plan gives shareholders of the targeted company the opportunity to exchange their stock for either cash or other securities at a higher value if the acquiring company gains a majority of the company stock. This strategy may diminish the acquiring company’s interest in purchasing the existing shareholders’ stock.
5. Golden handcuffs: Corporate lawyers also may recommend a golden handcuffs poison pill. Many executives have lucrative deals rewarding them when they hit goals and/or stay with the company for a certain period. The “handcuffs” often include deferred compensation and employee stock options. A golden handcuffs poison pill defense removes the vesting and performance requirements. Then, the executives may cash out and leave the company. This often makes the target less desirable to the acquirer who need the executives to lead the company after they take over.

Pros and Cons of Poison Pill Defense Strategies

The ultimate success of a poison pill defense strategy reveals itself years down the road. Boards will consider whether the goals of both companies were met and whether they are still being met when analyzing the success of the shareholders rights plan.

For many companies, the poison pill is a negotiation tactic that succeeds in either 1) preventing a hostile takeover or 2) laying the foundation for a favorable merger. While developing the shareholder rights plan, or poison pill, the company finds a way to dictate the terms of the takeover. The poison pill’s benefits may include:

• The targeted company identifies potential acquisitions.
• Higher premiums for shareholders.
• Slowing the speed of a corporate raid.

In the short term, a poison pill can hurt the valuation of many shares. The decrease in value will affect the company’s constituencies in different ways:

• Shareholders may receive a financial loss when the value of their shares declines.
• Corporate executives who also own part of the company may or may not lose their position, power, or money during a takeover.
• Lower and mid-level employees may be laid off.

Corporate Lawyers Guide Companies Threatened by a Takeover

If another company is positioning itself to get majority ownership in your company, contact the Swiecicki-Muskett law firm. Managing partner Christopher Swiecicki will guide you in developing a poison pill, or another strategy, to lead your company through a hostile takeover proactively and cost-effectively.

Christopher developed his expertise in corporate law as both in-house and outside legal counsel. Today, he provides senior-level counsel to C-suite executives, in-house legal teams, and business owners. He is on the faculty of Washington University in St. Louis School of Law where he teaches business acquisitions (M&A) courses.

Contact the Swiecicki-Muskett law firm at 636-778-0209 or email Chris@SwiecickiLaw.com.

  

by Chris Swiecicki

How to Find a Corporate Tax Lawyer

Creating a tax strategy takes teamwork among legal, finance, and accounting professionals. Many companies trust an independent corporate tax lawyer as an advisor to the tax strategy team. When you are ready to add a corporate tax lawyer to your team, how do you find one? The search starts the old-fashioned way and ends with a list of interview questions. 

Ask for a Referral to a Corporate Tax Lawyer

This is a case when “Googling it” is not a good first step. You will not see many listings for “corporate tax lawyer.” You probably will have better success by asking your professional network if they will refer you to a corporate tax lawyer. Inquire with your banker and accountant, and the lawyers you work with on other matters. Most of us trust recommendations from respected colleagues, which is why this is the best way to find a lawyer you will trust from day one. 

If you do not get a referral from someone you know, check with the bar associations in your area; for Missouri, those include the Federal Bar Association and the Eighth Circuit Bar Association, the bar for the St. Louis area. (You can also learn about our own Taxation Law capabilities here at Swiecicki & Muskett.) 

Check Their Credentials for Practicing Taxation Law

The practice of taxation law requires a minimum of a Juris Doctor degree, known as a J.D. The attorney also must be licensed by the state bar. Many corporate tax lawyers expand their expertise and earn a Master of Laws in Taxation degree, known as an L.L.M.. Some are certified public accountants and others have served in corporate finance positions.

Christopher Swiecicki, founder and managing attorney at Swiecicki & Muskett, L.L.C., practices taxation law with the insight of decades of experience in law, finance, and accounting. During his career he has:

 

• Earned a J.D. in 1990 and an L.L.M. in 2005, both from the Washington University School of Law, one of the top law schools in the nation.
• Taught a course in Business Acquisitions as an adjunct professor at the Washington University School of Law since 2011. 
• Worked as a tax accountant at one of the Big Four accounting firms.
• Served as inside tax counsel to a Fortune 500 Company.
• Worked as inside tax counsel to a regional financial institution.
• Served as a chief financial officer and general counsel for a $40 million private company. 
• Been recognized as an expert in the field by the Association of Corporate Counsel and the American Bar Association. 

Today, Christopher Swiecicki provides personalized service to business owners and executives at major corporations. He keeps his client roster small enough to respond quickly to every client. When he meets with clients, he has in-depth knowledge of their needs. (To begin a conversation, you can find his contact information here.)

Ask If the Corporate Tax Lawyer Has Applicable Experience

A corporate tax lawyer might have impressive credentials but lack experience related to your situation. Ask them about it before signing a contract with them. In some cases, you may need to meet with them to explain your situation. If you learn they are not experienced in the area you need help with, ask them for a referral to another corporate tax lawyer. 

Learn What the Corporate Tax Attorney Will Do for You

When hiring a corporate tax attorney, find out what they will do for you. Christopher Swiecicki has decades of experience advising companies on the federal tax-related aspects of acquisitions and dispositions, mergers and financial structures and products, and corporate governance. If you are seeking counsel in one of these areas, contact Swiecicki to discuss your situation and see if there is a good fit.

In other situations, consider asking the following questions, or variations of them, depending upon your business:

 

1. What is your experience with a business like ours?
2. How do you see our business interests intersecting with tax law?
3. How will you apply your knowledge of taxation law to help us manage our business functions more effectively?
4. Will you help us decide whether to set up a C-Corp or an LLC?
5. What skills and resources do you have to help our company manage tax exposure and risk?
6. How does your team stay current on IRS rulings and government programs affecting business taxes?
7. Will you advise us on the tax ramifications of current operational and business decisions?
8. Do you provide counsel related to e-commerce and cloud-based services?
9. Do you have experience litigating cases before the IRS?

 

At Swiecicki & Muskett, we serve businesses in many industries with varied structures and sizes. We are constantly gaining new insights, thanks to the diversity of our clientele.  

When you are ready to increase profits with a sophisticated tax strategy, contact us. We will serve you with the strength of our experience combined with constant attention to changes in taxation law. Contact Christopher Swiecicki at 636-778-0209 or email Chris@SwiecickiLaw.com.

by Chris Swiecicki

Understanding Sandbagging in M&A Transactions

In the context of buying a business, a “sandbagging” Buyer is one who is (or becomes) aware that a specific representation or warranty made by the Seller is false—but instead of telling the Seller this fact, the Buyer completes the transaction. The Buyer then seeks post-closing damages against the Seller for the breach.

Sandbagging is a frequent occurrence in acquisitions. It happens so often that transactional planners have made a “sandbagging playbook” that tells people how to handle the issue, depending on which side of the deal they’re on and whether the state law governing the agreement is “pro-sandbagging” or “anti-sandbagging.” 

Competing Interests When it Comes to Sandbagging Clauses

More importantly, the Buyer and Seller in a deal have different competing interests, and so each has their ideas on handling the sandbagging clause.

So, while there are many different ways to prepare for sandbagging, most strategies boil down to three essential elements:

1. Including a clause in the acquisition agreement that says the Buyer can seek a claim even if the Buyer knew ahead of time that the Seller’s representations and warranties were false (i.e., sandbagging is permitted)..
2. Including a clause in the acquisition agreement that says the Buyer can’t seek compensation for a breach of the Seller’s representations and warranties if the Buyer knew the representations and warranties were false ahead of time (i.e., sandbagging is explicitly forbidden).
3. Saying nothing about the issue. In this case, the contract defaults to whatever state law says.

When the Buyer wants a sandbagging clause, and the Seller wants an anti-sanding clause, a typical compromise is to leave both clauses out of the purchase agreement. However, in certain states, if the agreement makes no mention of a sandbagging clause, sandbagging is permitted. So from the Seller’s perspective, mentioning the clause is only sometimes considered an equal compromise. 

As seen in Arwood v. AW Site Services, LLC In the Court of Chancery of Delaware, the state respects contracting parties’ right to enter into good and bad contracts. The Delaware Supreme Court has yet to decide if a party can win a settlement for a broken promise if both parties knew some of the promises weren’t true at the time of signing.

Sandbagging in the Context of Due Diligence

Due diligence is expensive, so parties to contracts in mergers and acquisitions often try to ensure a Buyer doesn’t have to check every detail of a Seller’s business. 

Pro-Sandbagging

A pro-sandbagging clause enables a buyer to pursue compensation for a violation of a representation or warranty even if the Buyer had previous knowledge that the statement was untrue. The right to a remedy, for instance, is not affected by any knowledge acquired (or capable of being acquired) before or after the execution and delivery of the agreement or the closing date with respect to the accuracy or inaccuracy of such representation [or] warranty. 

In the Buyer’s eyes, a pro-sandbagging clause helps assure that it will benefit from its bargain. Based on the Seller’s promises and warranties, the Buyer assumed that its target had a particular worth. Buyers claim that if the statements are untrue, they overpaid and should receive compensation. Additionally, buyers contend that pro-sandbagging agreements give the parties more assurance. They eliminate obstacles to recovery, for instance, a protracted and expensive argument over the Buyer’s prior knowledge during the indemnification process.

Anti-Sandbagging

An anti-sandbagging clause would prevent a buyer from pursuing reimbursement in cases where the Buyer knew (or, depending on the clause’s scope, had cause to know) that a representation was untrue before closing. The contract can provide, for instance, that the Seller is not responsible for “any Losses originating from or attributable to any inaccuracy in or warranty in this agreement if the party claiming indemnification for such Losses had Knowledge of such breach before Closing.” 

The parties may restrict the scope of the agreement to knowledge received by a particular group of people or to knowledge obtained before a particular date.

These days, anti-sandbagging clauses are rare. However, sellers contend that these clauses may encourage collaboration between the sale parties in specific situations. If, for instance, an executive or owner plans to stay with the acquiring company after the acquisition, the persistent danger that the Buyer may sandbag the Seller may result in conflict and distraction. Sellers might also contend that they should be allowed to fix any problems the Buyer learns about before closing.

Key Takeaways

By getting the Seller’s promises, the Buyer puts some risks on the Seller. As a practical matter of business, a Buyer doesn’t have to check and make a provision for every aspect of the company’s finances because it knows it can take legal action against the Seller if the claims turn out to be false. For example, false or misleading statements about the company’s financial health or expectations of future performance. 

A Seller can’t go back on the promises it made because the Buyer’s due diligence didn’t find out they were false. Since the Seller promised in the contract that the Buyer could depend on certain statements, the Seller can’t say that the Buyer was wrong to trust the Seller’s own binding words.

Two General Rules Governing Sandbagging

In general, courts have established two separate rules—the so-called “Modern Rule” and the “Traditional Rule”— In the absence of a sandbagging clause in the M&A agreement, parties to M&A transactions and their counsel should be aware of how various states handle a buyer’s indemnity rights.

The Modern Rule

The modern rule refers to a legal principle that guides the interpretation and application of law in contemporary society. It is based on the principle that laws should evolve and adapt to changing circumstances and new situations. In other words, the modern rule emphasizes the need for a flexible and dynamic approach to law rather than a strict and rigid interpretation of outdated legal principles.

According to “Modern Rule” courts, the Buyer had the right to rely on the representations and warranties because they were negotiated contractual duties. Delaware and, generally speaking, New York are two states that adhere to the Modern Rule (as well as Illinois, Florida, Connecticut, and Indiana). 

The Modern Rule is a “pro-sandbagging” rule and is thus in the best interest of the Buyer. Because purchasers are typically not required to demonstrate reliance in those jurisdictions to pursue an indemnity claim for a seller’s breach of a representation or warranty, buyers are likely to prefer the controlling law of an M&A agreement to be a state that adheres to the Modern Rule.

The Traditional Rule

According to the Traditional Rule, a buyer’s indemnification claim requires that it be proven that they relied on the representation or warranty in some way. 

Most states have adopted this approach, which calls on purchasers to demonstrate that they relied on the representation or warranty that the Seller broke. 

The Traditional Rule is seller-friendly since it prohibits “sandbagging.” Because a buyer would have to demonstrate that they relied on the Seller’s false representation or warranty to succeed in a claim for breach of representation or warranty against the Seller, a seller will likely prefer that a state that adheres to the Traditional Rule serve as the governing law of an M&A agreement. 

The Bottom Line

Some people who disagree with modern rules think sandbagging is bad economics because it makes bargaining more like a punishment. Others believe that sandbagging is unfair or questionable from an ethical point of view. Even though it might be unsettling to let a Buyer wait until after closing to bring a breach claim against the Seller that it knew about before closing, the risk of this kind of litigation can be managed just like any other risk in the deal that the parties make.

A rule that supports sandbagging backs up the idea that representations and warranties are an essential way to share risks. 

When the parties to a contract choose not to (or don’t) divide the risk of sandbagging, the Buyer can rest assured that, as part of the deal, the Seller has implicitly promised to be honest in what it says. This view of “reliance”—that is, it requires nothing more than relying on the express warranty as part of the deal between the parties—reflects the common belief that an action for breach of an express warranty is no longer based on tort but mainly on the contract. 

In other words, the fact that the Buyer questioned whether the Seller would honor their promises should not free the Seller from his obligations when it agrees to do what it said it would do. Reliance, whether a good idea or not, is not a part of breaking a contract.

Practice Pointer

During the due diligence, you should keep in mind the Seller’s promises and any facts you find that goes against the promises. It is best to seek legal advice before entering into any contract. 

Contact Swiecicki & Muskett, LLC for practical solutions to your business and legal issues.