In Youree v. Recovery House of East Tennessee LLC, a case involving a breach of a lease contract signed by a limited liability company, a Tennessee trial court ruled that the Plaintiff could pierce the corporate veil to hold two LLCs related to the LLC which breached the lease liable for its debts. The Supreme Court of Tennessee reversed the trial court’s decision. Its reasoning contains no less than a directive that the factors set forth years ago in the Allen case, the “Allen factors,” will no longer be outcome determinative, as they have been in many cases since Allen. Instead of proving the existence of some or all of the Allen factors, the Supreme Court held that, to prove a piercing the veil claim, a plaintiff must establish the elements required by a 1979 Tennessee case, Continental Bankers.
The facts alleged by the Plaintiff in Youree to support its piercing the veil claim were:
- Plaintiff leased a commercial property in Davidson County to an LLC named RSN
- RSN breached the contract by failing to pay rent
- Plaintiff filed suit against RSN, and obtained a judgment for $56,000
- Plaintiff then filed a second suit against what it alleged were LLCs “affiliated” with or “related” to RSN — RHET and RHT
- Plaintiff described RHET and RHT as “functional alter egos” of RSN
- For its bases that RHET and RHT were alter egos, Plaintiff alleged a number of facts consistent with the “Allen factors” including that RSN’s facility (for which it failed to pay rent) was used to operate a call center to refer patients to RHET’s facility in Anderson County; that RSN operated a website that marketed RHET’s facility; that RSN, RHET and RHT used the same corporate office; that RSN, RHET and RHT used the same employees; and that RSN, RHET and RHT had overlapping ownership
The LLCs the Plaintiff sued in the second suit, RHET and RHT, failed to respond to the Complaint against them, and the trial court granted a default judgment against them. On appeal, the Supreme Court ruled that, if the Plaintiff’s Complaint failed to allege facts sufficient to support a piercing the veil claim against RHET and RHT, then the default judgment should not have been entered and should be set aside.
Before focusing on the facts alleged by the Plaintiff, the Supreme Court first acknowledged that the law in Tennessee on piecing the veil was inconsistent and confusing, and clarified it by holding that the factors set forth in Continental Bankers, not the ones set forth in Allen, were determinative in piercing the corporate veil cases. Moreover, it held that will be the rule whether the case involves a claim that the corporate veil should be pierced to hold an individual liable for the obligations of an entity, such as a corporation or LLC, or whether, as in the case before it, a plaintiff is attempting to pierce the veil of one entity to hold other entities liable.
The eleven Allen factors have been applied by Tennessee courts to determine liability for piercing the veil for years, in many cases, and without any analysis of whether the plaintiffs in those cases have satisfied any of the directives which were the basis of the decision in Continental Bankers. The Supreme Court held that the Allen factors may be applied to determine whether the elements that a plaintiff must prove under the Continental Bankers criteria have been met, but that the Continental Bankers’ factors are determinative.
Here are the factors that a plaintiff must prove under Continental Bankers to prevail on piercing the veil claim:
- That the defendants controlled, not only the finances of the entity, but its policies and business practices so that the entity had no separate existence of its own;
- That control was used to commit a fraud or a wrong, to violate the law, or to commit a dishonest or an unjust act; and
- That the control proximately caused the loss for which the plaintiff has sued.
In the case before it, the Supreme Court held that the facts pled by the Plaintiff did not meet the third element of the Continental Bankers’ factors. While the Plaintiff pled facts, such as the common ownership of RSN, RHET and RHT, and that they used the same office, which met Allen factors, there were no allegations which established that these facts proximately caused the injury to the Plaintiff.
The Youree opinion should be welcomed by Tennessee commercial lawyers even thought it will, in many cases, make proving a piercing the claim harder or not possible. Too many piercing the veil cases in Tennessee have proceeded on the plaintiffs relying on the Allen factors when, even though many of those factors may have been present, there was no connection between their existence and the injury to the plaintiffs in those cases.