In a recent breach of contract case and fraud case arising out of a commercial lease for a doggy day care facility in Nashville (Dog House Investments, LLC v. Teal Properties, Inc.), the Court of Appeals of Tennessee discussed several areas of Tennessee law including: (1) The law related to piercing the corporate veil; (2) the law of breach of contract in commercial lease cases; (3) fraud; and, (4) the award of punitive damages in commercial disputes. For Tennessee lawyers who handle breach of contract cases and piercing the veil cases, the opinion is a worthwhile read.
Here are the facts of the case:
• An individual named Jerry Teal (“Teal”) owned a commercial building in Nashville, Tennessee
• Although Jerry Teal owned the building, he leased it through a corporation of which he was the sole owner (“Corporation”)
• The tenant (“Tenant”) which signed the lease with Corporation for the building was an LLC
• The lease agreement between Tenant and Corporation required Corporation to make all repairs to the building
• The May 2010 flood in Nashville caused substantial flooding and damage to the building
• Tenant immediately notified Teal of the damage
• Because it was critical to Tenant’s business that the water removal and repairs be done quickly, Tenant began handling the water removal and repairs with the knowledge and consent of Teal
• Teal informed Tenant that the building was covered by insurance
• Teal engaged in a series of conduct that unquestionably led Tenant to believe that Teal would submit a claim to the insurance company for repairs made by Tenant and that Tenant would be reimbursed
• Tenant paid for $39,000 in repairs and submitted documentation to Teal so that he could submit a claim to the insurance company
• Teal submitted a claim to the insurance company and Corporation received over $40,000 from it
• Teal never paid Tenant any money and concealed that the insurance company had paid Corporation anything
• The insurance money paid to Corporation was used by Teal for his individual purposes
The trial court, the Chancery Court for Davidson County, Tennessee, held that Corporation was liable for breach of contract and fraud. The trial court awarded compensatory damages in an amount about equal to that expended by Tenant for remediation and repair of the building. The trial court also awarded Tenant $10,000 in punitive damages, held that the corporate veil of Corporation should be pierced, and held that Teal should be held individually liable. The trial court’s decision was affirmed by the Court of Appeals of Tennessee.
On appeal, Teal argued that punitive damages were not warranted. The appeals court agreed that Corporation’s breach of contract was not so egregious as to justify an award of punitive damages. It found, however, that the trial court was justified in awarding punitive damages for fraud because Teal’s actions in deceiving Tenant were “knowing and intentional.”
In piercing the corporate veil cases in Tennessee, courts will apply a number of factors to determine whether the corporate veil should be pierced. Among those factors are whether the corporation was grossly under capitalized; the sole ownership of the corporation by one person; the use of the corporation as an instrumentality for an individual or another business entity; and whether assets of the corporation were diverted. (These are just a few of the eleven factors that Tennessee law recognizes).
In the case of Teal and Corporation, the factors which swayed the trial court to pierce the veil and impose personal liability were that Teal owned the property, but leased it through Corporation and that the insurance proceeds were paid to Corporation, but then diverted for Teal’s personal use. Even if the building had been owned by Corporation, if the insurance proceeds had been diverted directly to Teal, in my opinion, it is quite likely, if not almost certain, that the trial court would have still pierced the veil on Teal.
I think very few Tennessee courts, if any, would allow a sole shareholder who deposited funds into a corporation’s account, knowing that they were essentially someone else’s funds (as in this case), to escape personal liability even if the funds were commingled and indirectly diverted from the account of the corporation for otherwise legitimate expenses of the corporation. This case is a prime example of how useful the piercing the corporate veil theory is to keep the laws which provide limited personal liability to shareholders, officers and LLC members from going too far.