Filed November 24, 1998.
Appeal from the District Court, Mower County, File No. C2-96-395.
Hubert H. Humphrey, III, Attorney General, Janette K. Brimmer, Assistant Attorney General, (for appellant)
Jeffrey G. Stephenson, (for respondent Woodvale Management Services)
Bryan J. Baudler, (for respondents Baldus)
Considered and decided by Toussaint, Chief Judge, Anderson, Judge, and Thoreen, Judge.
This opinion will be unpublished and may not be cited except as provided by Minn. Stat. § 480A.08, subd. 3 (1996).
Appellant State of Minnesota Department of Human Services (DHS), creditor of a defunct corporation, challenges the district court's refusal to pierce the corporate veil and hold respondents, its parent corporation, and its shareholders, liable for the debt. Because we see no basis for piercing the corporate veil, we affirm.
Originally, respondents Walter and Janet Baldus were the sole officers, directors, and shareholders of Woodvale III, Inc., an entity that operated an intermediate care facility for the mentally retarded. Woodvale III was reimbursed for most of its costs from Medical Assistance (Medicare and Medicaid) funds.
The Balduses formed Woodvale Management Services, Inc. (WMSI) to be the umbrella parent corporation of Woodvale III and other Woodvale corporations engaged in the same or similar work and transferred their Woodvale III stock to WMSI. WMSI provided management services to the Woodvale entities and engaged in large-scale purchasing on their behalf. The WMSI board of directors included, in addition to the Balduses, an attorney, an accountant, and an insurance agent. WMSI held regular board meetings of which it kept minutes; the board was an active decision-maker and observed corporate formalities.
During times relevant to this litigation, the Balduses owned and operated a sole proprietorship, Baldus Properties. Several Woodvale facilities, including Woodvale III, leased their buildings from Baldus Properties, an arrangement that reflected the preference of the former Minnesota Department of Public Welfare (predecessor of DHS) for having facilities and buildings separately owned. The Balduses procured personal loans to obtain these properties.
In 1992, the Mower County Department of Human Services instigated the closing of Woodvale III by transferring patients to other facilities. Woodvale III, however, continued to incur expenses for its remaining patients until it completely ceased operations. The decline in operating expenses was not commensurate with the decline in revenue as the number of patients dropped, so Woodvale III was in very poor financial condition when it closed.
Woodvale III, along with other providers of care to the disabled, was a member of the Association of Residential Resources in Minnesota (ARRM). Disputes between DHS and ARRM as to what reimbursements were allowed led to ARRM suing DHS. ARRM members, among them Woodvale III, agreed to be bound by any settlement agreements. The matter was settled, and the amount due DHS from Woodvale III was set at $214,622.
Because Woodvale III had ceased operations well before the settlement agreements, it had no funds with which to pay the settlement. DHS therefore sued WMSI, as shareholder and parent corporation of Woodvale III, and the Balduses, as officers, directors, and shareholders of Woodvale III and shareholders of WMSI, arguing that they were liable by "piercing the corporate veil." The court declined to pierce the corporate veil to find either WMSI or the Balduses liable, and dismissed the DHS claims against them. DHS appeals.
DECISION 1. DHS Claim against WMSI
The question of whether a corporation is an instrumentality or alter ego of another corporation is primarily a fact question. United States v. Advance Mach. Co ., 547 F. Supp. 1085, 1093 (D.Minn. 1982) (citing National Bond Fin. Co. v. General Motors, 341 F.2d 1022, 1023 (8th Cir. 1965) (noting clearly erroneous test applies)). Therefore, this court will not reverse the district court unless its findings are clearly erroneous. Minn.R.Civ.P. 52.01.
DHS alleges that WMSI was an alter ego of Woodvale III and is therefore liable for its debt.
Generally, absent fraud or bad faith, a corporation will not be held liable for the acts of its subsidiaries. There is a presumption of separateness the plaintiff must overcome to establish liability by showing that the parent is employing the subsidiary to perpetrate a fraud and that this was the proximate cause of the plaintiff's injury. * * * The main point is that, although corporations are related, there can be no piercing of the veil without a showing of improper conduct.
Association of Mill Elevator Mut. Ins. Co. v. Barzen Int'l, Inc. , 553 N.W.2d 446, 449 (Minn.App. 1996) (quoting 1 Charles R. P. Keating Gail O'Gradney, Fletcher Cyclopedia of the Law of Private Corporations § 43, at 729 (rev. ed. 1990) (footnotes omitted)), review denied (Minn. Nov. 20, 1996). Although Minnesota case law has not tailored the factors relevant to piercing the corporate veil to the relationship between a parent corporation and a subsidiary, those factors have been held to apply in the parent-subsidiary corporate context. Id.
The factors are set forth in Victoria Elevator Co. v. Meriden Grain Co. , 283 N.W.2d 509, 512 (Minn. 1979) (holding number of factors, although not all, must be present). The factors include:
insufficient capitalization for purposes of corporate undertaking, failure to observe corporate formalities, nonpayment of dividends, insolvency of debtor corporation at time of transaction in question, siphoning of funds by dominant shareholder, nonfunctioning of other officers and directors, absence of corporate records, and existence of corporation as merely facade for individual dealings.
Id. There must also be an element of injustice or fundamental unfairness before a court will pierce the corporate veil. Barzen , 553 N.W.2d at 449-50.
In Barzen , as here, the unsecured creditors of a defunct subsidiary argued that the corporate veil should be pierced and the parent held liable for the subsidiary's debt. The trial court's decision to pierce the corporate veil was based on findings that the subsidiary was insufficiently capitalized, that it was insolvent when it incurred the debts giving rise to the action, and that the functioning of the subsidiary's officers was inhibited. Id. This court reversed, basing its decision partly on the trial court findings that the subsidiary corporation observed corporate formalities, kept its own corporate records, did not operate as a facade for the parent, was not the parent's alter ego or mere instrumentality, and that the parent did not siphon funds or receive dividends from the subsidiary. Id. This court also refuted the grounds for the trial court's decision, noting that the subsidiary's capitalization originally was sufficient, that "[t]he presence of insolvency before a corporate closing * * * is too common to give the factor much weight * * *," and that the increase in the parent's control of the subsidiary was a reasonable reaction to the failing condition of the subsidiary and did not constitute domination of the subsidiary's corporate functions. Id. "In conclusion, the facts do not rebut the presumption of corporate separateness in this case." Id. Barzen has many similarities to this case, and the differences that exist further support the district court's refusal to pierce the corporate veil. Here, as in Barzen , the trial court found that Woodvale III and the other Woodvale entities "were, in fact, operated as separate corporations, observing all of the requisite and statutory corporate formalities." The court specifically noted that it credited the testimony indicating that corporate dividends were not paid but reinvested in the corporation and that there was no evidence that WMSI siphoned funds from Woodvale III. It is undisputed that Woodvale III was adequately capitalized. Woodvale III was insolvent when the settlement agreements went into effect, but not during the transactions that gave rise to them; moreover, as the court observed, "it is the State that directly caused the insolvency of Woodvale III by closing the facility." There is no indication of fraud: WMSI provided management services to Woodvale III, and Woodvale III provided services to its patients.
"[D]ue regard shall be given to * * * the trial court to judge the credibility of the witnesses." Minn.R.Civ.P. 52.01.
Barzen also reversed the trial court's finding of injustice or fundamental unfairness to unsecured creditors in the parent's use of the funds from liquidating the subsidiary to pay down a bank's secured line of credit, holding that the bank, as a secured creditor, had priority to the unsecured creditors and that the parent's actions were both legal and not unfair. 553 N.W.2d at 450. DHS here argues that it is fundamentally unfair to require taxpayers to pay Woodvale III's settlement agreement debt to DHS, but cites no support for the view that the involvement of public money is de facto justification for piercing the corporate veil. The court found that Woodvale III legitimately believed the expenses for which it sought reimbursement were in fact reimbursable; it also noted that the state closed the facility and changed the reimbursement parameters, causing the financial ruin of Woodvale III. Because the relationship between the corporations is a question of fact, see Advance Mach. Co. , 547 F. Supp. at 1093, deference is due the district court's credibility determinations. Minn.R.Civ.P. 52.01. The court's conclusion that "the facts of this case simply do not rise to the level of injustice or fundamental unfairness required to disregard the corporate form" is not clearly erroneous.
2. The Balduses
DHS argues that Woodvale III was an alter ego of the Balduses, its sole officers, shareholders, and directors, and that the Balduses are therefore liable for Woodvale III's debts. Consideration of each of the Victoria Elevator factors demonstrates that the trial court did not abuse its discretion in refusing to pierce the corporate veil to find them liable.
(a) Sufficiency of Capitalization
It is undisputed that Walter Baldus paid $3,000 for the stock of Woodvale III at its inception. DHS argues that this is evidence of insufficient capitalization, but does not refute the argument that, when Woodvale III was capitalized, there was no indication that the amount would prove insufficient.
(b) Corporate Formalities and Corporate Records
The parties agree that corporate formalities were observed and adequate records maintained.
(c) Nonpayment of Dividends
It is undisputed that Woodvale III did not pay dividends, but testimony showed that all funds were put back into the corporations. Nonpayment of dividends is not improper if all funds are put back into the corporation. Snyder Elec. Co. v. Fleming , 305 N.W.2d 863, 868 (Minn. 1981). An independent accountant for Woodvale III and WMSI testified that the corporations used the money they received to pay debts and salaries.
(d) Insolvency at Time of Transaction
It is undisputed that Woodvale III was insolvent at the time of the settlement agreements; it had ceased operating almost two years earlier. Testimony showed that its funds had been used to pay off creditors. See Barzen , 553 N.W.2d at 450 ("The presence of insolvency before a corporate closing * * * is too common to give the factor much weight * * *.").
(e) Siphoning of Funds by Dominant Shareholder
The independent accountant testified:
In my meetings with the directors of WMSI or whichever corporation was involved at the time, the discussions were always about those issues. They were about how do we pay off the debts, how do we replace our assets, and how do we compensate the people that work for us so we can take care of the people we are responsible for. I was never involved in any conversations with the board members that had any tone of "How do we get money to Balduses?" There were no discussions about that, and frankly, it wasn't an issue that the board ever discussed.
He also testified that the Balduses ultimately lost money through their involvement with WMSI and Woodvale III.
(f) Existence of Corporation as Facade for Individual Dealings
There was no evidence that the Balduses conducted any business for which Woodvale III was a facade. Their ownership of the land and buildings by Baldus Properties was not concealed; testimony indicated that the rents charged to the corporation were reasonable. The accountant provided unrefuted evidence that the rise in rent near the end of Woodvale III's operation was a legitimate response to the risk the Balduses ran in running a single-purpose facility.
DHS relies on three federal cases involving nursing homes, United States v. Normandy House Nursing Home, Inc. , 428 F. Supp. 421, 424 (D.Mass. 1977), Woodland Nursing Home Corp. v. Harris , 514 F. Supp. 110, 114 (S.D.N.Y. 1981), aff'd mem. , 697 F.2d 302 (2d Cir. 1981), and United States v. Thomas , 515 F. Supp. 1351, 1357 (W.D.Tex. 1981). As a threshold matter, none of these cases is dispositive in this court. Moreover, the cases are distinguishable. In Normandy House , the court suspected that the nursing home's assets were sold to avoid returning overpayments; in Woodland , a partnership that received overpayments dissolved and reconstituted itself into a corporation, and in Thomas , the corporation's assets were dissipated for the shareholder's benefit prior to the satisfaction of a previously incurred Medicare debt. DHS's reliance on these decisions is misplaced.
Minnesota law and the facts on the record both support the trial court's decision; there was no abuse of discretion in its refusal to pierce the corporate veil.