Business law brief a case

Case Brief: Kinney Shoe v. Polan 939 F.2d 209 (1991) Introduction: The importance of the doctrine of piercing the corporate veil was adequately illustrated in the case of Kinney Shoe v Polan. The doctrine refers to a remedy which permits going beyond the corporate veneer of the corporation and attaching liability to its members. Although courts are reluctant to award the corporate veil remedy it will do so in an appropriate case. For instance in Kinney Shoe v Polan, the appellate court felt that it was necessary to pierce the corporate veil in order to provide compensation for Kinney shoe. By piercing the corporate veil, the plaintiff did not bear the risks of dealing with a dummy corporation, and this is as it should be.
In such a case the corporation had no assets, was merely a shelf company and was indistinguishable from its sole shareholder. Moreover, the defendant corporation, although formed according to legal protocol had conducted its business by foregoing corporate formalities such as passing resolutions, filing annual statements and paying annual fees so that the act of the company was no different from the act of the shareholder, Polan. The risk of forgoing corporate formalities eliminates the limited liability protections associated with corporate status.
In the final analysis, it is perfectly ethical to form a corporation for the purpose of avoiding personal liability. However, the doctrine of piercing the corporate veil functions to ensure that personal liability will arise if and when there is unity of conduct between the owner and the company such that the acts of the company are the acts of its members. Piercing the corporate veil also ensures that the company will not forego corporate formalities and expect to have the benefits associated with corporate personality. In this way the grounds upon which a corporate veil can be pierced makes is entirely reasonable for a corporation to be formed expressly for the purpose of escaping personal liability. Subject to the doctrine of piercing the corporate veil, there is nothing wrong will allowing the formation of a corporation for limited liability purposes.
Fact Summary:
The defendant, Polan incorporated two companies. They were Industrial Realty Company and Polan Inductries Inc. Sometime in November 1984 Polan entered into an agreement with Kinney She for a sublease of a building. In doing so, Polan utilized his two companies so that Industries Reality subleased the subject building to Polan Industries Inc. Polan indorsed the relevant documents on behalf of both of his companies. Industrial had not engaged in any corporate activities and apart from the sublease, it did not have any assets, bank accounts or income. Polan submitted the first rental instalment personally, but no other payments were made. (Kinney Shoe v Polan, 1991)
Kinney brought an action against Polan in the United States District Court for the Southern District of West Virginia for recovery of the money due under the sublease with Industrial Realty. Although Polan was the only shareholder of Industrial Realty, the district court ruled that Polan was not liable in his personal capacity. Kinney appeal the district court’s ruling to the United States Court of Appeals for the 9th Circuit. (Kinney Shoe v Polan, 1991)
Issues and Ruling
The United States Court of Appeals for the 9th Circuit overturned the district’s court’s ruling. In doing so the appellate court set out the requirements that must be satisfied before the veil of the corporation can be pierced. The first hurdle for the plaintiff is discharging the burden of proof. In other words, anyone claiming that the corporate veil should be pierced must prove that the ends of justice require it. In determining whether the ends of justice require it the court will typically apply a two-tier test. This two-tier test involves the following two issues:
“First, is the unity of interest and ownership such that the separate personalities of the corporation and the individual shareholder no longer exist. and second, would an equitable result occur if the acts are treated as those of the corporation alone.” (Kinney Shoe v Polan, 1991)
The appellate court went onto state that the court will take all of the facts and circumstances into account when applying the two-tier test. The appellate court also held that there is quite often a third test that can be applied in an appropriate case. The third test was such that it placed responsibility on the party contracting with a corporation. If in such a case the contracting party could have discovered by virtue of an investigation that the corporation was bereft of assets then he is taken to have assumed the risk of liability. This test had been applied by the district court and relied upon to discharge Polan of any personal liability. (Kinney Shoe v Polan, 1991)
The Court’s Reasoning
The appellate court doubted that the third leg of the test could be applied to a contracting party who was not a bank or lending institution. Even if it could be applied in the present case it would not operate to discharge Polan of personal liability. This was so because Polan’s Industrial Realty company was no more than a shell. Polan’s liability was limited to his shares in the company. That company had no assets and was for all intents and purposes a dummy corporation set up solely for the purpose of escaping liability. As such it was not be equitable to allow Polan to use the company to escape liability. It therefore followed that the ends of justice required that the corporate veil should be pierced.
Kinney Shoe v. Polan 939 F.2d 209 (1991)