Pennsylvania Supreme Court Recognizes Both Enterprise Liability And Reverse-Veil Piercing As Viable Theories for Holding Affiliates Liable for Debts

In a July 21, 2021 decision, the Supreme Court of Pennsylvania examined whether Pennsylvania recognizes the doctrine variously referred to as the “single-entity,” “enterprise,” or “horizontal liability” theory.  Under that doctrine, “affiliated or sister corporations-corporations with common ownership, engaged in a unitary commercial endeavor- [may] be held liable for each other’s debts or judgments.”  The court concluded that “a narrow form of what we will refer to as ‘enterprise liability’ may be available under circumstances,” but that those circumstances were not present in the case before it.

Ryan Mortimer was seriously and permanently injured when an intoxicated driver struck her car.  The intoxicated driver had been served liquor at the Famous Mexican Restaurant.  The restaurant was located on real property owned by McCool Properties, LLC (“Properties”).  The restaurant had a contractual arrangement with 340 Associates, LLC (“Associates”) under which the restaurant was allowed to use a liquor license owned by Associates in its operations.  Andy and Chris McCool owned Associates.  Andy, Chris, and Raymond McCool owned Properties.

Mortimer obtained a judgment against the restaurant and Associates in a “dram shop action.”  However, the judgment debtors had no insurance and no assets of any consequence other than the liquor license.  Consequently, Mortimer filed suit against Properties, Andy McCool, Chris McCool, and the estate of Raymond McCool, who had died by the time the second suit was filed, to hold them liable for the debts of the restaurant and Associates.

The trial court dismissed Mortimer’s claims against Raymond’s estate, reasoning that he could not be liable for Associates’ debts because he had no ownership interest in Associates.  After trial, the trial court ruled against Mortimer on her claims against Properties, Andy McCool, and Chris McCool as well.  The trial court concluded that the enterprise liability theory had not been recognized in Pennsylvania and that, even if it had been, Associates and Properties were not under common ownership because Raymond McCool owned an interest in Properties, but not Associates, and Properties and Associates were under different management.  On appeal to the intermediate Superior Court, the Superior Court affirmed on the grounds that the enterprise liability theory had not been recognized in Pennsylvania.

The Supreme Court began its analysis by discussing the circumstances under which the “corporate veil” may be pierced under established Pennsylvania law to hold owners liable for corporate debts.  Noting that incorporation encourages investment by enabling corporate owners to limit their liability to their investment in the entity, the Supreme Court said that “limiting liability through incorporation is not a bug of corporate law, but its defining feature.”  Accordingly, “Any court should start from the general rule that the corporate entity should be recognized and upheld, unless specific, unusual circumstances call for an exception.”  The corporate form may be disregarded “whenever justice or public policy demand, such as when the corporate form has been used to defeat public convenience, justify wrong, protect fraud, or defend crime.”

The Supreme Court then looked to the law of other states in which the enterprise liability theory has been recognized, stating that “In at least ten states, courts clearly embrace the enterprise liability approach.”  After surveying cases from those states, the Court said that “What we take from these cases is that…most jurisdictions that recognize an enterprise liability variant also retain a requirement of wrongdoing and resultant injustice no less stringent than that which applies in any [veil] piercing cases.”  The Court concluded that “We must determine whether enterprise liability can be squared with, and serve as a salutary complement to, the principles that have shaped our own case law on veil-piercing—and, if so, what form it should take.”

The Court said that “We may validate the prospect of a viable claim for enterprise liability while underscoring that the fundamental concern for its use only in cases of great injustice and inequity must remain the lodestar of piercing jurisprudence.”  In that regard, the Court said that “enterprise liability in its most logical form requires an alter ego component, and it is that at least substantial common ownership ensures.”  Enterprise liability “depends upon the actions (or omissions) of the common owner to exploit limited liability while failing to observe the separation between the corporations.”  “Consequently, enterprise liability in any tenable from must run up from the debtor to the common owner, and from there down to the targeted sister corporation(s).”  Therefore, “enterprise piercing is aptly described as triangular.”

The need to trace liability down from the common owner down to the targeted sister corporation to complete the triangle brought the Court to the subject of “reverse-piercing.”  Noting that it had neither adopted nor rejected reverse-piercing previously, the Court said that “To rule out reverse-piercing as a viable doctrine would be tantamount to saying either that it is not possible for a corporation’s owner to use that corporation as a shield against personal liability by the creative movement of assets or liabilities between himself and the corporation, or that equity cannot reach such an event even when it happens.”  It concluded that “Pennsylvania courts’ equitable powers should not be so constricted.”

Bringing together the concepts or piercing and reverse-piecing, that Court said:

Piercing law exists because it long has been recognized that an individual or corporation may abuse the corporate form directly, or vertically, by treating the corporation as a liability-free repository to protect funds from judgment during times of trouble, and in fairer conditions like a piggy bank for personal (or parent corporation) benefit.  And it would be naïve to say that sister corporations in a larger enterprise with common owners cannot be used to similar effect.

In seeking to set the parameters for enterprise liability, the Court noted that “Pennsylvania has resisted the temptation to formalize the inquiry with an ever-increasing number of predefined factors embodying the many considerations that might aid in determining whether the corporate form has been abused and we do not propose to change course now.”  Because “simplicity is to be preferred,” the Court adopted the two-pronged test advocated by Professor Franklin A. Gevurtz.  Under that test, first, “there must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist” and, second, “there must be some fraud, wrong, or injustice.”  The “fraud or injustice element,” the Court said, “tells the court when to pierce.”  The first “control element tells it against whom.”

The first element, the Court said, “requires at least substantially common ownership.”  In the case before it, the Court said that since Raymond McCool had no ownership in Associates but a one-third ownership interest in Properties, his estate “would suffer tremendously by imposing liability upon…Properties” for Associates’ debt.  Such a result would be contrary to established Pennsylvania veil-piercing law that piercing may occur only “when the rights of innocent parties are not prejudiced thereby.”  Moreover, as the trial court had found that Andy McCool and Chris McCool had “maintained an appropriate separation between their personal interest and…Associates’ corporate affairs and coffers” and the only path to Properties’ assets would be pierce the veil of Associates to them and then reverse-pierce from them down to Properties, “the triangle won’t close” and “Properties is insulated by the gap.” Accordingly, the Supreme Court affirmed the denial of relief to Mortimer by the lower courts.

In conclusion, that Supreme Court said that “it remains for the lower courts in future cases to consider [enterprise liability’s] application consistently with the approach described above, in harmony with prior case law, mindful of the salutary benefits of limited liability, and with an eye towards the interests of judgment.”  Time will tell whether those lower courts will think that the Supreme Court achieved the simplicity that it professed to prefer.