One of the enduring benefits of the corporate form is the treatment of corporations as separate “people,” distinct from their owners when questions of legal rights, responsibilities and liabilities arise. This separation extends not just to individual investors and shareholders, but in most circumstances to the corporate directors and officers who decide what their corporation does. Common law courts and federal and provincial corporation statutes define the exceptions – usually based on what are called “piercing the corporate veil” between the company and its controlling minds, or by deciding that those controllers run the corporation as an “alter ego” rather than as a distinct legal person. In recent months, two cases in Ontario have given courts the opportunities to review and reaffirm these traditional approaches.
General applicability of Corporate Veil Analyses
Business laws are based on corporations’ separate identities. For example, the Canada Business Corporation Act states: “A corporation has the capacity and, subject to this Act, the rights, powers and privileges of a natural person” (CBCA s. 15(1)). Accordingly, courts traditionally pierce the “corporate veil” in only three sets of circumstances:
The corporation was established not as a separate legal person to conduct legal business but as the mechanism for the human incorporator(s) to undertake illegal or fraudulent activity.
“Directing mind” of the corporation – often an owner/ operator or at least dominant shareholder and/or board chairman and chief executive officer – operates it as an “alter ego” to effectuate personal schemes; or
The corporation becomes inextricably tied up in fraud, deceit, dishonesty or want of authority by directors, officers and/or the employees.
Since courts respond to lawsuits and determine in each case whether to pierce the veil, the lines between piercing and non-piercing aren’t clear, and tend to wobble with each major round of litigation. The 2019 cases from Ontario reflect this point.
Causing Your Company to Exceed its Legal Rights Doesn’t Trigger Piercing
In May 2019, the Court of Appeal for Ontario reversed a Superior Court ruling that had pierced a corporate veil to find the owner/operator of a small business personally liable for penalties to an aggrieved tenant. This decision reaffirms that veils aren’t pierced just because a company exceeded its rights, if no fraudulent or criminal activity occurred. The case is Pita Royale Inc. (Aroma Taste of the Middle East) v. Buckingham Properties Inc.:
William Mendelbaum owns and operates Buckingham Properties, Inc. Buckingham leased commercial property (formerly occupied by a restaurant) to Pita Royale, Inc., owned and operated by Jcyk Josefsberg. The tenant bought a number of the restaurant fixtures and equipment, renovated the premises, and then operated the Aroma Taste of Middle East restaurant in the space. The tenant fell behind on its rent, and Buckingham eventually terminated the lease and evicted the tenant. Buckingham also changed the locks, effectively blocking the now-ex-tenant from recovering any of the restaurant’s fixtures or chattels. Buckingham then released the premises, which reopened as another restaurant.
Pita Royale sued Buckingham and owner/operator Mendelbaum, for improper termination of the lease and distraint (seizure for payment of a debt) of the blocked property, seeking a total of $950,000 in compensatory and punitive damages. Defendants contested, and initially sought nearly $11,000 for unpaid rent and improvements. After trial, the Superior Court of Justice for Ontario ruled for the plaintiffs, awarding $68,190.74 in compensatory and punitive damages, minus an offset of $1,294 owed on the rent and improvements. The trial judge also pierced the corporate veil between Buckingham and Mendelbaum, and found Mendelbaum jointly and severally liable with his company because he had personally conducted all the business activities that led to the case.
The defendants appealed the amount of damages, and Mendelbaum’s personal liability. The Ontario Court of Appeal reviewed the calculations of damages and expenses, reducing the damages for conversion to $18,539.71, leaving punitive damages unchanged, and eliminating Mendelbaum’s personal liability. The three judge panel reviewed precedential cases in Ontario that address the corporate veil, and refused to do so in this case because:
The lease and business dealings were between the plaintiff and defendant corporations, not personally between the owners.
Mendelbaum did not commit any wrongdoings outside the scope of Buckingham’s corporate actions (which did exceed the company’s contractual rights); there was no indication of fraud, deceit, dishonesty or criminal activity.
There was no evidence that Buckingham had been incorporated as a sham, or operated to shield fraudulent or improper conduct.
This decision confirms the three traditional bases for piercing the corporate veil, and decides that none were present in the case.
Creating and Operating a Company as the Vehicle for Wrongdoing Justifies Piercing
In June 2019, the Ontario Superior Court of Justice issued its decision in another case, and applied the analysis suggested above to pierce the defendant corporation’s veil to reach its owner. The case is 6071376 Canada, Inc. v. 3966305 Canada, Inc. & Mahmood Khedmatgozar:
Mahmood Khedmatgozar (MK) had a plan to develop certain commercial property in Gatineau, Quebec (“the Hull Project”). He attracted three investors from California, who invested $233,600 to buy a 40% interest in the project and 40% of its net value upon sale; they incorporated 6071376 Canada, Inc. to hold their interest. Separately, MK had attracted three other investors who had each purchased 5% interests in the project. Once he had raised sufficient money to fund a mortgage, he purchased the Hull Property for $2.64 million and vested title in a company he formed for that purpose, 3966305 Canada, Inc. There is discussion in the court’s opinion of various irregularities in MK’s dealings in purchasing and holding the property, and in disclosing and recording conditions applicable to the Californian investors and their company.
In 2006, MK sold the Hull property and paid off the three 5% owners. He never informed the Californians of the sale, or paid them any of the sales proceeds. MK directed the net proceeds of the sale to buy a second property (“the Wellington Property”), which he sold six years later for $4.67 million. In 2014, after failed negotiations, 6071376 Canada, Inc. sued 3966305 Canada and MK for 40% of the proceeds of the sale of the Hull Project property, and other appropriate relief. The Superior Court calculated the net value of the 40% share to be $515,600, and also awarded $200,000 in punitive damages based on MK’s “blame worthiness” and the need to protect these plaintiffs and deter future wrongdoing. The court also found MK to be personally liable, jointly and severally with 3966305 Canada, for these amounts. The court discussed the judicial hesitance to pierce corporate veils, but found that MK had been the controlling mind of the company at all times, and had it as his alter ego, in order to misappropriate the plaintiff’s funds for his personal purposes.
In this case, the court found that at least one of the traditional bases for piercing the corporate veil was met.
Conclusion – Legitimate Operations Should Forestall Piercing
These cases reaffirm courts’ traditional approaches to the sanctity of corporate personhood, and the limited reasons courts apply to go behind the corporate veil to reach wrongdoers. Of course, the best way to avoid personal liability is to avoid wrongdoing altogether.
Where Can I Go For More Information?
6071376 Canada, Inc. v. 3966305 Canada, Inc. et al., 2019 ONSC 3947 (CanLII)
About the Author
Jon F. Elliott Esq., MPP, JD, is the author of over a dozen books and many articles, and has worked in public agencies, non-profit groups, and private businesses. He has an engineering degree from Princeton and his public policy graduate degree (MPP) and law degree (JD) are from the University of California, Berkeley. For over 20 years he has been the primary author of STP’s Directors’ and Officers’ Liability publication, analyzing and explaining common law, statutory and regulatory provisions in the U.S. For more than 10 years, he has also contributed extensively regarding Canadian requirements. See www.stpub.com for a full bio of Jon Elliott.
You may contact Mr. Elliott directly at: email@example.com