(MCT) CHARLESTON — With Freedom Industries going through bankruptcy proceedings and all litigation stayed, some lawsuits have brought a question to light.
Can the company’s individual shareholders, members or parent companies be held liable?
There’s a strict set of tests to determine this, called “piercing the corporate veil” in the shareholder case and “enterprise liability” in the parent company realm. Attorneys say these tests are very difficult to pass.
A complaint filed Jan. 20 in U.S. Bankruptcy Court has highlighted this topic.
The complaint listed Chemstream Holdings, Rosebud Mining Company, Gary Southern and J. Clifford Forrest as defendants — marking one of the first instances where Chemstream, Rosebud and Forrest’s names appeared on a lawsuit.
However, the adversary proceeding was dismissed the next day without prejudice, which means it can be re-filed once the bankruptcy judge gives the green light for all lawsuits to move forward.
Many of the previous lawsuits have listed only Freedom Industries and West Virginia American Water Co. as defendants.
Southern’s name has appeared at least once before in a Jan. 13 federal lawsuit. This lawsuit alleged Southern was responsible because of his “personal role in directing operations at the facility … and his ownership interest in the facility which he sold to Freedom Industries.”
Another previous lawsuit listed Dennis Farrell as a defendant.
Freedom Industries filed for Chapter 11 bankruptcy Jan. 17, causing all litigation involving the company to be in “time out.” Attorneys can file a motion to lift the stay but so far, no such motion has been filed.
In last week’s hearing on first-day motions, attorneys for West Virginia American Water and Freedom Industries reached an agreement for what’s known as debtor-in-possession financing while Freedom reorganizes under Chapter 11 bankruptcy code.
In this agreement, Freedom would get a $3 million cash infusion from Mountaineer Funding with the potential for an extra $1 million later.
Mountaineer Funding is owned by Forrest, who also owns Chemstream Holdings, Freedom’s parent company. Mountaineer Funding was incorporated Friday, the same day Freedom filed for Chapter 11 bankruptcy protection.
Joshua Fershee, a professor at West Virginia University College of Law, said when determining if corporate members can be held liable, courts look at two basic things.
One, he said, is the unity of interest and ownership between the corporation and shareholders.
The second is an inequitable result, which he said courts would look at the possibility of a fraud or injustice.
“Not being able to get paid isn’t the injustice we’re talking about,” he said. “It has to be something greater than that.”
Fershee said sometimes this tactic can be used if companies don’t seem like they will be able to satisfy the obligation.
“For example, if a bread company hits me with a truck and I suffer $2 million in damages and they have $500,000 in the bank, you may look for someone else,” Fershee said. “Then the liability question is should someone else be on the hook to recover?”
Fershee said veil piercing has been criticized as arbitrary. He said typically, this is not done in large public companies.
One of the reasons is how many shareholders are involved in larger public companies. He said the unity of interest test becomes stronger here.
“If there is one bad actor, that doesn’t mean all shareholders should be liable,” he said. “Then the liability question is should someone else be on the hook to recover?”
Generally, the LLC shield is a hard one to break and attorneys have a lot of tests to pass.
Fershee said West Virginia courts have listed 19 factors to consider in determining whether a corporation has a unity of interest, which he said is hard to determine in this particular case.
One example is a commingling of funds. If shareholders or members treat their corporate account like their personal account, that would be a problem under this part, Fershee said.
There also are other tests such as the basic corporate structure, meetings of the companies’ board of directors and annual shareholder meetings.
When it comes to unity of interest, Fershee said there could be a problem if the sole owner of a parent company would be the sole owner of the lower company.
If that did happen, attorneys could assert the companies operate as a single enterprise to satisfy the debt of a lower company under enterprise liability. However, Fershee said plaintiffs wouldn’t be able to seize the owner’s personal assets.
And sole ownership itself isn’t enough to create liability, Fershee notes. If the owner follows all the rules, it’s harder to prove a unity of interest, he said.
Fershee noted not much is known yet about Forrest’s ownership in Chemstream and whether the parent company has other holdings.
He said for enterprise liability, the main question is going to be whether Freedom is a separate and distinct entity.
So far, Fershee says based on current information, he doesn’t see enough connections to support enterprise liability or veil piercing.
“Absent of other information, I don’t know. It’s a long shot in my view based on the info that I have so far,” Fershee noted. “But there’s going to be a lot that comes to light over the next three to six months. As of right now, it seems like a long shot for either one.”
For proving liability of a company’s president, Fershee said attorneys would have to prove the president is liable for behaviors in that position.
“If there are behaviors he conducted on his own, he certainly could be corporately liable. There’s a strong shield for employees,” Fershee noted.
Fershee said if litigation does get the green light, he believes the court will be fair.
“I think they’ll get a fair shake from the court,” Fershee said. “The court of public opinion, maybe not. But the court of law, I have faith the court will look at the law and determine what is supposed to be.”
Contact writer Andrea Lannom at Andrea.Lan…@dailymailwv.com or 304-348-5148. Follow her at www.twitter.com/AndreaLannom.
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