HARLOW V. FIBRON CORP., 1983-NMCA-117,
100 N.M. 379, 671 P.2d 40 (Ct. App. 1983)
W. V. HARLOW, JR., JOHN G. O'BRIEN,
WALES H. MADDEN, JR.,
JOHN M. ADAMS, and ADAMS AND McGAHEY, a General
Partnership, Individually and as members of a
joint venture known as NORTH BLOOMINGTON
PIPELINE PROJECT,
Plaintiffs-Appellants,
vs.
THE FIBRON CORPORATION, KINETICS, INC., MIDWEST EQUIPMENT
CO., MID-TEX CONSTRUCTION CO., and JAMES W. BROCK,
Defendants-Appellees.
COURT OF APPEALS OF NEW MEXICO
1983-NMCA-117, 100 N.M. 379, 671 P.2d 40
Appeal from the District Court of Eddy
County, John B. Walker, District Judge
Petition for Writ of Certiorari Denied
October 20, 1983
Richard E. Olson, Paul M. Bohannon, David
L. Spoede, Hinkle, Cox, Eaton, Coffield & Hensley, Roswell, New Mexico,
Attorneys for Plaintiffs-Appellants.
R.D. Mann, Bob F. Turner, William P.
Lynch, Atwood, Malone, Mann & Cooter, P.A., Roswell, New Mexico, Attorneys
for Defendants-Appellees.
WOOD, J., wrote the opinion. WE CONCUR: C.
FINCHER NEAL, Judge, WILLIAM W. BIVINS, Judge
{1} Harlow (Harlow and the
other plaintiffs) purchased defective pipe from Kinetics (Kinetics, Inc., a New
Mexico corporation); Harlow obtained a damage judgment against Kinetics. This
appeal involves Harlow's efforts to collect that judgment from Midwest (Midwest
Equipment Company, a Texas corporation), from Mid-Tex (Mid-Tex Construction
Company, also a Texas corporation), and Brock, individually. Harlow sought (A)
to hold Midwest, Mid-Tex and Brock liable to pay the Harlow judgment by
piercing the corporate veil, and (B) to hold Brock liable to pay the Harlow
judgment on the basis of Brock's alleged fraud. The trial court ruled against
Harlow on both
{*381} contentions;
Harlow appeals. We state (1) the background, and discuss (2) piercing the
corporate veil, and (3) proof of fraud.
{2} In September of 1972,
James Brock incorporated Kinetics for the purpose of marketing and
manufacturing fiberglass pipe in its plant in Artesia, New Mexico. Brock was a
controlling shareholder in Midwest and Mid-Tex. Midwest was in the business of
furnishing oil field roustabout services, and Mid-Tex was engaged in operating
heavy equipment and dirt moving. Other than the transfer of funds, discussed
later, the three companies were not related and did not have common customers.
Brock was, however, on the board of directors of all three corporations.
{3} Along with Brock, the
shareholders in Kinetics were Messrs. Connie Hester and Robert Evans.
Twenty-five thousand shares of $1 par value stock were issued. Additional
start-up money was procured by a $56,000.00 SBA loan for which Brock was
personally liable. Fiberglass pipe production commenced, and continued for
approximately three years, at which time the company began experiencing serious
financial difficulties.
{4} The operating expenses of
Kinetics were initially financed by the First National Bank in Midland, Texas.
By late 1975 or early 1976, the Midland Bank ceased financing Kinetics.
Inventories swelled and production ceased. The undisputed evidence is that from
this point on, Midwest, Mid-Tex, and Brock, personally, began channeling large
sums of money into Kinetics to help Kinetics pay its creditors. Since Brock was
president of all three businesses, and they all shared a common accountant, the
initial transfers were apparently carried out on a casual basis. Only later did
Kinetics issue promissory notes evidencing its indebtedness to Midwest and
Mid-Tex. This was done primarily to facilitate bad debt write-offs and was not
contemporaneous with the transfer of the funds.
{5} Eventually all of
Kinetics' accounts were carried on the Midwest and Mid-Tex books. All financial
transactions of Kinetics were carried out through the Texas offices of Midwest
and Mid-Tex. The two Texas companies paid virtually all of Kinetics' debts,
from rental and utility payments to carrying Kinetics' employees on their own
bankroll.
{6} Kinetics began delivery
of pipe to Harlow in late 1973 or early 1974. In July of 1978, Harlow obtained
a judgment against Kinetics in an Oklahoma state court for damages resulting
from the marketing and manufacture by Kinetics of defective pipe. Harlow then
filed suit in the United States District Court for the Western District of
Oklahoma, seeking full faith and credit on the Oklahoma judgment. Default
judgment was entered against Kinetics in the federal court in November 1978 in
the amount of $327,885.81. This judgment was subsequently registered in the
United States District Court for the District of New Mexico.
{7} In December of 1978,
unbeknownst to Harlow, the entire assets of Kinetics were sold to the Fibron
Corporation. It is undisputed that Fibron was not made aware of the existence
of the Harlow judgment prior to closing this sale. In June of 1979, Harlow
filed suit in the District Court of Eddy County seeking judgment against Fibron
for violation of our bulk transfers provisions.
See NMSA 1978, §§
55-6-101 to
55-6-110. It is undisputed that there was noncompliance with these
provisions. A fire subsequently destroyed the entire assets of Fibron,
including those purchased from Kinetics. Harlow, by amendment, joined Brock,
Midwest and Mid-Tex as defendants, and asserted claims to pierce the corporate
veil and in fraud against Brock. Summary judgment was entered against Fibron in
June of 1981, and at the same time the sale of Kinetics to Fibron was set aside
as violative of the bulk transfers provisions.
Piercing the Corporate Veil
{8} Harlow claims that
Midwest, Mid-Tex and Brock are alter egos of Kinetics and should be liable for
the judgment owed by Kinetics. Inasmuch as this is an incomplete
{*382} statement of the requisites for
piercing the corporate veil, we state those requisites.
{10} There are three
requisites for obtaining this equitable relief. C. Krendl and J. Krendl,
Piercing
the Corporate Veil: Focusing The Inquiry, 55 Denver L.J. 1 (1978). Krendl
and Krendl, at page 15, identify those requisites as instrumentality, improper
purpose and proximate causation.
{11} The
"instrumentality" requisite is described by Krendl and Krendl:
[A] plaintiff must prove that the subsidiary or other subservient
corporation was operated not in legitimate fashion to serve the valid goals and
purposes of that corporation but that it functioned under the domination and
control and for the purposes of some dominant party.
Id. at 16. New Mexico decisions refer to the
"instrumentality" or "domination" requisite as the alter
ego doctrine. Cruttenden v. Mantura, 97 N.M. 432, 640 P.2d 932 (1982); Scott
Graphics, Inc. v. Mahaney, 89 N.M. 208, 549 P.2d 623 (Ct. App.1976). We use
the term "alter ego doctrine" hereinafter.
{12} Krendl and Krendl state:
"The heart of most corporate veil cases, explicitly or implicitly, is that
a corporation has been used for such an improper purpose that equity will
permit its corporate form to be disregarded."
Id. at 28. Krendl and
Krendl go on to classify five situations in which improper activities arise.
Because of the broadness of these classifications, and the extent of their
explanation, these classifications are not helpful in this case.
See
Krendl and Krendl, pages 28-42. Although not specifically identified as a
requisite,
Scott Graphics recognized the "improper purpose"
requisite in its discussion of the facts.
{13} It is unnecessary to
elaborate on the proximate causation requisite in this case.
{14} Cruttenden v. Mantura
sets forth guidelines for determining if the alter ego doctrine is applicable.
See
also Krendl and Krendl, pages 16-17. Harlow reviews the guidelines against
his view of the facts and asserts that the alter ego doctrine applies and,
therefore, the veil should be pierced. A substantial portion of the briefs is
devoted to applying the "facts" to the
Cruttenden guidelines.
This argument also includes an attack on the trial court's findings as being
unsupported by evidence, as being improper statements of law and as being legal
conclusions. We need not review the evidence and findings directed to the alter
ego doctrine because Harlow's argument is that if the alter ego doctrine
applies, then the veil should be pierced. The argument is incorrect.
{15} Krendl and Krendl state:
If it is found that the subsidiary has been a mere
instrumentality with respect to a particular transaction, the next question * *
* is whether the parent's domination or control has been used for fraud or
other improper purpose. * * * Therefore, in fairness to the parent and to
support the policy of limited liability [of corporations], improper purpose
must be established before the parent or other dominant party can be found
liable.
{16} Requiring an improper
purpose is not inconsistent with
Cruttenden v. Mantura; Cruttenden ruled
the alter ego doctrine was not applicable, it did not reach the question of
improper purpose. However, an improper purpose is necessary.
See Scott
Graphics.
{17} Assuming, but not
deciding, that the alter ego doctrine is applicable to the facts of this case,
the dispositive question is whether the three defendants used Kinetics for an
improper purpose.
{*382} C. Improper
Purpose
{18} The trial court found:
Plaintiffs' inability to collect their judgment against
Kinetics * * * was not the result of any improper, inequitable, unfair,
illegal, unjust or fraudulent act or actions on the part of Defendants Brock,
individually, Midwest or Mid-Tex.
This finding is supported by substantial evidence. The three
defendants advanced over $1,000,000.00 to Kinetics, or on Kinetics' behalf.
This money was not used to further the affairs of the defendants, but to keep
Kinetics operating and to pay creditors of Kinetics, including the Midland
Bank. The three defendants were supplying money to a losing business, not
taking money or other assets from Kinetics. Brock testified that money was put
into Kinetics because "I had [a] real good feeling * * * about Kinetics
making it."
{19} Hill v. Dearmin, 44
Colo. App. 123, 609 P.2d 127, 128 (1980), states:
It would frustrate the purposes of the corporate law to
expose directors, officers, and shareholders to personal liability for the
obligations of a corporation when they, in their individual capacities,
contribute funds to, or on behalf of, a corporation for the purpose of
assisting the corporation to meet its financial obligations, and not for the
purposes of perpetrating a fraud or promoting their personal affairs.
D. Specific Arguments of Harlow
{20} Harlow contends that the
trial court's finding of no improper purpose is inconsistent with other
findings or inconsistent with undisputed evidence, and that it would be
improper to decide the piercing issue on the basis of the finding quoted in C,
above. In this section, we identify and answer the specific arguments.
{21} 1. Brock was responsible
for the incorporation of Kinetics and Kinetics was undercapitalized, starting
off with an indebtedness of $100,000.00. Harlow asserted at oral argument that
the undercapitalization, in itself, requires us to hold there was an improper
purpose. Undercapitalization is a factor to be considered in determining
whether the alter ego doctrine applies,
see Cruttenden v. Mantura, and
is also a factor to be considered in determining whether there was an improper
purpose,
see Krendl and Krendl, page 37. However, it is only one factor
to be considered.
See Associated Vendors, Inc. v. Oakland Meat Co., 26
Cal. Rptr. 806, 201 Cal. App.2d 825 (1962). Here there was evidence of a
legitimate business purpose, separate from the business of the three
defendants. There was evidence of the operation of Kinetics as an independent
business manufacturing and selling pipe without financial participation from
the three defendants until the Midland Bank refused further financing, and
evidence that the three defendants undertook their financial assistance with
the view that Kinetics would eventually "make it". Under the
evidence, undercapitalization does not require us to hold there was an improper
purpose or that equity requires imposition of liability on the three
defendants.
{22} 2. The trial court found
that at the time Harlow obtained his judgment in Oklahoma in 1978, the judgment
was uncollectable. The trial court found that the lien of the Midland Bank on
equipment and inventory was greater than the market value of the assets,
equipment and inventory of Kinetics. Harlow contends this finding is incorrect
because of the sales price in December 1978, when Kinetics was sold to Fibron.
Harlow relies on evidence that Kinetics owed the bank $580,000.00 at the time
of the sale, and that Fibron valued Kinetics' assets at $650,000.00. This
argument disregards evidence that the value of Kinetics was less than what
Fibron paid, that more could be obtained for Kinetics as a going business.
According to Brock, if the Bank had foreclosed and there was a forced sale,
"[n]o one wants fiberglass wrapping machines and hand tools, that nature.
And you'd have just probably had to sell it for junk scrap." The finding
is supported by substantial evidence.
{23} 3. The sale of Kinetics'
assets to Fibron was without notice to Harlow and
{*384}
was in violation of our bulk sales provisions. Harlow argues that the sale,
without notice to Harlow, was the equivalent of commercial fraud. The trial
court allowed Harlow full rights of execution against the assets transferred to
Fibron. Harlow argues this right of execution did not negate the asserted fraud
because of the delay from protracted litigation. The answer is that the value
of the assets, inventory and equipment was enhanced after the sale. In
addition, Harlow's position as a creditor was enhanced because the Midland
Bank's lien was subordinated in the sale, and after the sale was set aside,
Harlow had priority over the Bank's lien. "But for the fire in March,
1981, Plaintiffs would have recovered more from the assets of Kinetics, Inc.,
than they would have if there had been no agreement to sell to Fibron."
Harlow did not recover more because of the fire; it only recovered insurance
proceeds. No one contends the fire was arson. In light of the findings, which
have substantial evidentiary support, a conclusion of fraud upon Harlow is not
required.
{24} 4. In February 1979,
after the sale to Fibron and before the sale was set aside as to Harlow,
Kinetics borrowed $90,000.00 from the Midland Bank. Harlow contends that, as a
minimum, the three defendants should be liable to Harlow for this amount. The
trial court disagreed, finding that the loan was obtained on the basis of
Brock's individual credit and was repaid by Mid-Tex. "There was never any
assets of Kinetics, Inc. involved in such transaction, and there never was a
lien against Kinetics, Inc.'s assets as a result of said loan. Plaintiffs were
not in any way damaged by the execution of this note * * *." Substantial
evidence supports the finding. This transaction, under the trial court's
findings, shows neither an improper purpose nor any injury to Harlow.
{25} 5. Harlow contends that
the money advanced to Kinetics by the three defendants was improperly
considered as loans, and should have been considered capital contributions.
Harlow asserts the advances were treated as loans in order for the three
defendants to obtain tax advantages. Thus, Harlow contends the money was
advanced for an improper purpose. There is evidence from which the trial court
could properly find the advances were in fact loans; any tax advantage
resulting from the unpaid loans would thus not show improper purpose.
{26} 6. Implicit in all of
Harlow's arguments is the view that the trial court should have resolved
disputed facts in favor of Harlow and should have pierced the corporate veil,
and that this Court should require such a result. This misstates the appellate
function; we review for trial court error. The trial court could properly find
no improper purpose and could agree with the accountant that there is no
benefit "by throwing a million dollars down the drain."
{27} These arguments do not
demonstrate that the trial court erred in finding no improper purpose, nor do
they require this Court to direct such a result.
{28} Bruck did not disclose
the Harlow judgment to Fibron in connection with the sale of Kinetics' assets
to Fibron. Harlow claimed that this nondisclosure was a fraud by Brock on
Harlow.
{29} The trial court
dismissed the fraud claim against Brock at the close of Harlow's case-in-chief.
NMSA 1978, Civ.P.R. 41(b) (Repl. Pamp.1980). The basis of the dismissal was
that fraud had not been established by clear and convincing evidence.
{30} We are not concerned
here with a false representation by nondisclosure or with the claim of an
injury to Harlow by the nondisclosure. Fraud requires a false representation
with intent to deceive, and this must be established by clear and convincing
evidence.
Sauter v. St. Michael's College, 70 N.M. 380,
374 P.2d 134
(1962);
Rodriguez v. Horton, 95 N.M. 356,
622 P.2d 261 (Ct. App.1980).
{31} Brock testified that he
did not disclose the Harlow judgment to Fibron because his attorneys told him
there was no judgment, that it would be reversed on
{*385}
appeal. There is evidence that on the day of closing the Fibron sale, both
Brock's attorney and the Bank's attorney represented there were no undisclosed
judgments, liens or lawsuits that might be claims against the assets of
Kinetics. This testimony, if it is to be considered, was sufficient for the
trial court to rule that intent to deceive was not established by clear and
convincing evidence.
{32} Harlow contends this
evidence should not be considered. "Brock surely thinks that the Court is
completely credulous if he expects it to believe that he did not know the
import of the Oklahoma proceedings."
{33} The credibility of the
above-cited testimony was for the trial court; it is not our function to
determine the weight to be given this evidence.
Duke City Lumber Company,
Inc. v. Terrell, 88 N.M. 299,
540 P.2d 229 (1975);
Rodriguez v. Horton.
The trial court could properly consider the evidence referred to above.
{34} The judgment of the
trial court is affirmed. Plaintiffs are to bear their appellate costs.
WE CONCUR: C. FINCHER NEAL, Judge, WILLIAM W. BIVINS, Judge