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July 25, 2014

Doing Business with Corporate Entities: Lessons to Learn From a Deal Gone Bad

At its core, each business’s goal is usually the same – generating profits. This is true whether a business manufactures auto parts, provides medical services, or stages a traveling circus. Accordingly, a primary objective of each business is the collection of money owed; any business that fails to prioritize realization of its accounts receivable soon will find that it is no longer in business. Thus, it can be instructive to review one company’s errors and its failed attempts to collect a debt. While the company undoubtedly learned from its mistakes, other businesses would be wise to review its situation and learn those same lessons without experiencing the corresponding loss. 

Howell Contractors (“Howell”), a Kentucky contracting company, entered into a contract in 2005 with Westview, an LLC organized under Ohio law, to provide services in the building of a residential subdivision in southern Ohio. Several years and one housing collapse later, Howell still was owed roughly $180,000 from Westview for services rendered. After unsuccessful attempts to collect payment, Howell turned to the court system. 

Howell filed suit in Kentucky, seeking a judgment against not only Westview, but also the individual owners of that LLC. In other words, Howell was attempting to “pierce the corporate veil” – impose the company’s debts on its owners. Howell’s case recently came before the Kentucky Court of Appeals (the “Court”) in Howell Contractors, Inc. v. Berling, and that Court found that while Howell was entitled to a judgment against Westview, it could not collect from Westview’s individual owners. This left Howell with a $180,000 judgment against a company, Westview, which may have limited assets. At the end of the day, Howell may be out not only the $180,000 but, regardless of whether it actually ever collects on the judgment, it is certainly out the significant legal expense of attempting to collect the $180,000 via the court system. Three lessons can be learned from Howell’s ordeal:

  1. Know Who You’re Doing Business With: While this lesson is important for any number of reasons already known to successful businesses, the Court highlighted one additional reason most executives probably haven’t considered. When deciding whether to pierce Westview’s veil, the Court decided this issue under the law of Ohio, not Kentucky, because Westview was organized in Ohio. Because different states have different laws and different tests as to when it is appropriate to pierce the veil, companies could achieve varying degrees of success imposing company liabilities on individual members depending on the debtor’s state of incorporation. 
  2. Think About Seeking Personal Guaranties: While the home state of a potential business partner should be included in the calculus of deciding whether to begin a relationship, sometimes potential business partners are limited. Perhaps there is only one manufacturer that makes a particular type of widget, and the company needs that widget to make its product. In this scenario, and innumerable others, the market won’t allow for one to select a partner from a favorable state after weighing the pros and cons of each – one must simply do business with the partner that’s available. That doesn’t mean there aren’t alternative protections available, however. Consider seeking a personal guaranty from the potential business partner’s principals. When an individual personally guaranties a particular liability, he is essentially co-signing for the debt, promising to pay the debt of the company should the company fail to appropriately satisfy it. Thus, if the corporate business partner does not meet its obligation, one could successfully pursue the individual without first having to litigate the complex veil-piercing question. If Howell had received joint and several guaranties from Westview’s principals, it stood a better chance of collecting its $180,000. It is important to note, however, that to be effective, a guaranty must meet certain legal requirements which vary by state (for Kentucky’s requirements, see KRS § 371.065).
  3. Don’t Throw Good Money After Bad: While the first two lessons are things a business could do before entering into a business relationship to protect its interests down the road, this final lesson is something to remember if the deal still turns ugly. Those that remember this lesson will mitigate their losses and live to fight another day. Howell would have been wise to recall this principal of sunk costs once it realized Westview wasn’t going to pay but before engaging in costly litigation in an attempt to pierce the LLC’s veil. If there was any doubt before, the Court clarified that, in Ohio and Kentucky at least, a corporate entity’s mere failure to pay its debt is not grounds to pierce the entity’s veil. To determine whether pursuing litigation in a particular circumstance is a waste of resources or a sound tactical decision, it is always wise to discuss the strengths and weaknesses of one’s case with counsel. In this situation, however, Howell would have been better served saving the money it spent seeking to pierce the veil.

While it is too late for Howell to apply these lessons in its relationship with Westview, other companies can take them into consideration in the course of their own business. Those that take these lessons to heart will, at the end of the day, be more likely to enjoy the fruits of their labor and accomplish a common goal of all businesses – getting paid.

© 2013 Dinsmore & Shohl LLP. All rights reserved.

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About this Author

Partner

David Treacy concentrates his practice in complex corporate and commercial litigation in the state and federal trial and appellate courts as well as before state administrative agencies. His litigation experience on behalf of businesses and individuals encompasses a wide variety of issues in corporate and commercial law, including shareholder, membership and partnership disputes, contract and non-compete issues, warranty disputes, business torts, commercial leases, real estate litigation, construction litigation, mechanics liens, insurance coverage, and litigation involving the...

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Associate

Patrick Schach is a member of the Litigation Department. Prior to joining the firm, Patrick worked for Judge Gregory Van Tatenhove for the United States District Court, Eastern District of Kentucky.

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