Clark Farms is an Iowa corporation with K.W. Clark as its president, secretary, and treasurer. Clark owns and operates two other entities, Casey Clark Farm and White Pines Farm. Woodruff is a commercial industrial construction company. In 2009, Woodruff contracted with the city of Leon, Iowa, to act as general contractor during the construction of a wastewater treatment facility. In April 2010, Woodruff contracted with Clark Farms for lagoon sludge removal. Clark Farms began work, then in 2011 abandoned the project when Clark determined he had underbid the contract, leaving the work incomplete. In July 2012, Woodruff brought a breach of contract action against Clark Farms. In September 2014, Woodruff obtained a judgment against Clark Farms for \($410,066.83\) plus interest. Clark Farms failed to pay the judgment. In June 2015, Woodruff brought suit to pierce the corporate veil of Clark Farms and recover personally from Clark and impose a constructive trust and equitable lien on all assets of Clark Farms. In a deposition that July, Clark stated Clark Farms still existed but was not bidding any projects and no longer had any employees aside from the bookkeeper. By the time of trial, Clark Farms had no employees. In 2017, the court denied Woodruff’s request to pierce the corporate veil. Woodruff appealed.
JUDGE BOWER Woodruff seeks to have us pierce the corporate veil on Clark Farms, and hold Clark personally liable for the judgment against Clark Farms.
The corporate veil is central to the concept of a corporation—separation between the corporate entity and the stockholders, limiting their personal liability to the extent of their investment. “But the corporate device cannot in all cases insulate the owners from personal liability.” Where the corporation is “a mere shell, serving no legitimate business purpose, and used primarily as an intermediary to perpetuate fraud or promote injustice[,]” the corporate veil may be pierced.
Plaintiffs must prove exceptional circumstances exist to warrant piercing the corporate veil. Woodruff makes several claims but primarily asserts Clark Farms was undercapitalized. Other factors claimed include failure to follow corporate formalities, failure to keep separate books, commingled finances with Clark, and that the corporation is a sham.
A. UNDERCAPITALIZATION Undercapitalization occurs when the business’s capitalization is insufficient to support the business considering its nature and the risks. When determining if a corporation is undercapitalized, we first examine the adequacy of the capital at the time of formation. We agree with the district court that Woodruff did not provide sufficient evidence to show undercapitalization at the time of the corporation’s creation in 2001. The company had assets and was profitable. Nor did Woodruff provide sufficient evidence to show Clark Farms was undercapitalized at the time it entered the contract with Woodruff.
However, the corporation’s initial adequate capitalization is not determinative of adequate capitalization for the remainder of the corporation’s existence. A corporation may later become undercapitalized for any number of reasons. Exceptions permitting examination of capitalization after formation might include a change in nature of the business, an inadequately-capitalized expansion, capital transfers to the controlling shareholder which renders the initial adequacy irrelevant, or losses resulting from fraudulent manipulation of the corporation. These exceptions allow courts to disregard the corporate veil where the shareholder purposely underfunds the business, while maintaining protections for a shareholder whose business has suffered legitimate financial reversals.
No evidence presented indicates a change in the nature of the work done by Clark Farms, or an inadequately-capitalized expansion. Whether Clark made capital transfers to himself which rendered the initial adequacy irrelevant is unclear from the record. It is unclear whether Clark Farms is undercapitalized based on the records provided. What is clear to us is that the corporation was not so obviously and purposely undercapitalized by Clark so as to merit disregarding the corporate entity on its own. Despite the loan, testimony indicates Clark Farms continues to own equipment of value Woodruff may request a lien on. We find Woodruff has not proven Clark Farms to be undercapitalized.
B. COMMINGLED FINANCES Commingling of funds occurs when the same account is used to deposit fees and pay for expenses for both personal and business use. Activities such as using corporate funds for personal purposes, mixing corporate and personal accounts, and commingling assets are factors weighed under this element.
Testimony from both Clark and his bookkeeper, Karen Halverson, indicate the bank account for Clark Farms was used by Clark for personal purposes and his sole proprietorships. Clark testified, and the corporate ledgers and bank statements produced show, money and revenues from Clark Farms, Casey Clark Farms, and White Pines Farms all came into an account under Clark Farms. Bills for each entity were paid out of the Clark Farms bank account, using Clark Farms checks. The funds and expenses were identified and allocated to each entity per Clark’s instructions to his bookkeeper, with book transfers via occasional reconciliation entries. Likewise, the ledger for Casey Clark Farms shows deposits for Clark Farms were deposited into Casey Clark Farms’s account, expenses paid, and money transferred on paper. The bills paid and the notes held for all the entities were tracked together. At any given time, the Clark Farms bank account and the Casey Clark Farms account each held assets for Clark Farms, Casey Clark Farms, White Pines Farms, and Clark personally, with only an internal bookkeeping transfer done periodically.
Halverson testified in deposition that Clark would often write a check on the Clark Farms account to pay for things for Casey Clark Farms or for himself personally, and the bookkeeper would then transfer the amount to an account receivable under Clark’s name in the Clark Farms books. She explained, “It’s just the way he did his business.” Halverson would determine which entity should pay which invoice based on the type of expense. Clark would also deposit moneys owed to Casey Clark Farms directly into the Clark Farms account to go toward a receivable from personal funds. Halverson had to maintain a special file to track the transfers between Clark’s personal and corporate accounts. According to Halverson, at the end of 2013, Clark owed Clark Farms \($665,422.\) She testified that a signed promissory note exists in corporation records regarding Clark paying back any expenses paid for him or that would be in the receivable account, but that no dollar amount was specified. She also clearly testified that Clark owed money to Clark Farms, that Clark Farms did not owe Clark.
While we concluded above that Clark Farms owed the money to Clark based on the tax returns, we note Clark Farms’ bookkeeper was uncertain which direction money was flowing between Clark and Clark Farms. Even Clark did not appear to know whether he owed money or was owed money, changing his story from his deposition through his trial testimony. Moreover, Clark clearly testified at trial he would not make any effort to pay back any debt he did owe Clark Farms “Because the corporation is owned by me.” This indicates he did not see the corporation as a separate entity from himself and did not view personal debts to the corporation as real.
Separate finances are not merely the existence of an account with the corporation’s name on it. Although the moneys may have been tracked, Clark clearly used the accounts for Clark Farms and Casey Clark Farms interchangeably, with no regard for which company should be providing money for expenses or benefitting from deposits. Clark Farms assets were kept under the name Clark Farms, but also under Casey Clark Farms. Not all assets or debts kept under the name Clark Farms were assets or liabilities of Clark Farms. We find Clark Farms finances were commingled with Clark’s personal and sole proprietorship finances.
C. SEPARATE BOOKS Despite the commingling of assets and funds, the corporate books may still be maintained separately. We examine evidence including the records of capital transfers in and out of the company beyond a log book entry, promissory notes, interest charged, recording personal purchases or sales on corporate books, personal use of corporate assets, and failure to document corporate activities.
Both Clark and Halverson testified regarding the effort to identify and track the revenues and expenses relating to Clark Farms in the commingled accounts.
However, nothing indicates any effort was made to track the loans and corresponding interest payments to personal or corporate loans, with Clark admitting both were tracked on the Clark Farms books. No specific records were kept tracking loans between Clark Farms and Clark and his sole proprietorships. It does not appear any promissory note was executed for loans from Clark to Clark Farms. According to Halverson, Clark executed a single, ongoing promissory note with no specific loan amount or date to cover all loans to him from Clark Farms. No note exists for loans from Clark to Clark Farms. Halverson entered periodic reconciliation entries into the Clark Farms books without further explanation to transfer moneys to Clark’s other entities.
Based on the evidence presented, we find the Clark Farms books inadequately distinguished, tracked, and recorded Clark Farms corporate activities as a separate and distinct entity from Clark.
D. CORPORATE FORMALITIES NOT FOLLOWED Clark Farms was incorporated as a domestic profit corporation under Iowa Code chapter 490 in 1997.
The 1997 corporation was administratively dissolved by the Secretary of State as of August 3, 1998, due to failure to file a biennial report. Clark did not apply to reinstate that corporation, but instead refiled for incorporation. While it was dissolved from 1998 to 2001, Clark Farms continued operations as if it were active.
We find a new Clark Farms was incorporated in 2001. Clark filed the new articles of incorporation more than three years after the dissolution, on August 27, 2001, creating a new corporation carrying the same name as his prior corporation. No bylaws, corporate minutes book, or shareholder ledger were produced for the 2001 Clark Farms. Shares of the 1997 corporation were issued at the initial meeting in 1997, and Clark appears to have considered those shares as shares of the reincorporated company in 2001. Similarly, bylaws were adopted in 1997, but not officially readopted by the 2001 corporation. No transfer of assets occurred between the two corporations. Clark testified no documentation of shareholder meetings following 2001 existed—at most interoffice correspondence and meetings with the bank, which Clark considered to be corporate meetings but which did not need written documentation.
The Secretary of State administratively dissolved the new Clark Farms three times for failure to submit the biennial report—in 2006, 2012, and 2014. Clark Farms used the statutory procedure to apply for reinstatement each time (in 2006, 2013, and 2016), which was granted. Woodruff uses these dissolutions to allege corporate formalities were not followed. However, the reinstatement statute specifically provides that a reinstatement takes effect as of the date of the dissolution “as if the administrative dissolution had never occurred.”
Following the 2001 incorporation, Clark appears to have treated Clark Farms in substantially the same way as his sole proprietorships. The only corporate formalities observed following reincorporation appear to be the filing of the biennial report, which was only done sporadically (but included a listing of the current registered agent and officers and directors), and the filing of taxes. Failure to follow corporate formalities, though one of the recognized factors, “does not necessarily justify piercing the corporate veil.” While the lack of corporate formalities in this instance is not sufficient on its own to disregard the corporate entity, it lends weight to other factors supporting Woodruff’s request.
E. MERE SHAM Woodruff claims Clark Farms was a sham corporation but treats the factor as a summary of claims regarding corporate formalities, separate books, and separate finances. While the other factors may indicate a sham corporation, a corporation can be found to be a sham even if the other factors are not met. A sham is “a false pretense[;] … something that is not what it seems; a counterfeit.” A corporation is a sham when it has no business or corporate purpose. A sham corporation must be an “instrumentality of, or conduit for” the owner to justify piercing the corporate veil. The district court correctly examined whether Clark Farms was a mere instrumentality of or conduit for Clark. The evidence clearly shows Clark Farms was a real, if failing, business. We agree with the district court the corporate entity was not a sham.
Clark Farms successfully conducted business for a number of years, employing workers and completing contracts. That business began to struggle prior to 2010, and that struggle is not sufficient to pierce the corporate veil. However, Clark egregiously used the corporate bank account for non-corporate purposes, writing as many checks for his other businesses and for himself as for Clark Farms using the corporate account. The only corporate formalities that appear to have been followed after the 2001 incorporation are the filing of taxes, occasional biennial reports, and the officers named on those filings. Clark’s and Halverson’s testimony demonstrate the corporate books were not entirely separate from Clark’s other finances. Clark’s testimony and actions indicate he did not consider the business or its finances to be a separate entity from himself and his other businesses. For these reasons, we determine the corporate veil should be pierced. Therefore, we reverse the district court.
CRITICAL THINKING:
What reasons did the court offer to support its conclusion? What do you think about the quality of those reasons?
ETHICAL DECISION MAKING:
What values are in conflict when courts are asked to permit the piercing of the corporate veil?