May 25, 2020

New Jersey Court Dismisses Claims Against Shareholders of Defunct Corporation

New Jersey‘s Appellate Division recently upheld the corporate form to shield shareholders from liability, even when the corporation was defunct. GS Partners, LLC v. VenutoDocket A-4176-12T4 (App. Div. April 28, 2014) involved a claim by a franchisee of Hollywood Tanning Systems, Inc. (the "Company"). In April 2007, several months after the plaintiff acquired his franchise, Hollywood Tanning sold most of its assets, including the franchise business, for $40 million in cash plus some non-cash consideration, including some preferred stock in the acquiring company and contingent earn-out rights. Hollywood Tanning used some of the cash to pay off its creditors but the plaintiff was not a creditor at the time. In June 2007, the remaining cash was distributed to the five Hollywood Tanning shareholders. By September 2008 Hollywood Tanning was insolvent and had ceased doing business, but the Company was never formally dissolved.

The plaintiff filed suit against the Company and two shareholders that were alleged to have made misrepresentations about the franchise. The trial court dismissed the allegations against the individuals on the grounds that their actions were on behalf of the corporation. The plaintiff ultimately obtained a default judgment in the amount of $959,359 against Hollywood Tanning. After obtaining post-judgment discovery in another lawsuit against the Company, the plaintiff brought a new action against the five shareholders, claiming that the June 2007 distributions(i) violated the New Jersey Uniform Fraudulent Transfer Act (UFTA), N.J.S.A. 25:2-31, (ii) constituted an improper distribution of corporate assets under N.J.S.A. 14A:6-12(1)(c), and (iii) had unjustly enriched the shareholders at the expense of those who had valid claims against the Company. The trial court allowed the plaintiff to file an amended complaint in January 2012 but thereafter dismissed all of the claims.

On appeal, the Appellate Division reversed and remanded. The first part of its decision is of less concern for present purposes: the court ruled that the trial court erred in dismissing the fraudulent transfer claims under the four-year statute of limitations because the amended complaint related back to a date within the limitations period. More instructive were the appeals court’s reasons for dismissing the remaining claims against the shareholders.

First, the court noted that the asserted statutory basis for liability—N.J.S.A. 14A:6-12(1)(c)—did not apply. That statute pertained to the liability of corporate "directors who vote for, or concur in" certain corporate actions, including "the distribution of assets to shareholders during or after dissolution of the corporation without paying, or adequately providing for, all known debts, obligations and liabilities of the corporation" (emphasis in original). Slip op. at 12. Given that Hollywood Tanning had never formally dissolved and still existed, the court held that the statutory predicate for liability (a distribution during or after a dissolution) did not exist. The court rejected the plaintiff’s argument that the Company had been "constructively dissolved" when it became insolvent. The appeals court noted that after the distributions, the preferred stock and the contingent earn-out constituted valuable company assets, and Hollywood Tanning continued to collect receivables until August 2008. Indeed, the distributions occurred 15 months before the Company ceased operations and became insolvent.

Second, the court dismissed the claim of unjust enrichment against the shareholders, holding that "New Jersey does not recognize unjust enrichment as an independent cause of action in tort." Slip op. at 13. Even if there were a valid claim, it could not be asserted against the shareholders absent some allegation that would allow the court to "pierce the corporate veil" and disregard the corporate entity. The Appellate Division ruled that the plaintiff had produced no evidence that Hollywood Tanning was a sham corporation whose existence should be cast aside.

GS Partners shows that New Jersey courts will uphold the limited liability protections of the corporate form, even when the equities might militate in favor of imposing shareholder liability.

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About this Author

Vincent Gentile, Commercial Litigation Lawyer, Drinker Biddle

Vincent E. Gentile litigates a broad range of civil and commercial matters from trial through appeal. He has represented major corporate clients in complex, multiparty cases and individuals and small businesses in both state and federal courts.

Vince concentrates his practice on financial litigation including defense of accountants and auditors, and on shareholder disputes involving closely held corporations, including shareholder "oppression" cases and appraisal actions. He successfully tried and defended an appeal on one of the early seminal...