Perpetual Real Estate Services, Inc. v. Michaelson Properties, Inc.

• Decision Date: 08 September 1992
• Docket Number: Nos. 92-1004,92-1014,s. 92-1004
• Citation: 974 F.2d 545
• Parties: PERPETUAL REAL ESTATE SERVICES, INCORPORATED, Plaintiff-Appellee, v. MICHAELSON PROPERTIES, INCORPORATED; Aaron I. Michaelson, Defendants-Appellants. PERPETUAL REAL ESTATE SERVICES, INCORPORATED, Plaintiff-Appellant, v. MICHAELSON PROPERTIES, INCORPORATED; Aaron I. Michaelson, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 545

974 F.2d 545

61 USLW 2178

PERPETUAL REAL ESTATE SERVICES, INCORPORATED, Plaintiff-Appellee, v. MICHAELSON PROPERTIES, INCORPORATED; Aaron I. Michaelson,

Defendants-Appellants.

PERPETUAL REAL ESTATE SERVICES, INCORPORATED, Plaintiff-Appellant, v. MICHAELSON PROPERTIES, INCORPORATED; Aaron I. Michaelson,

Defendants-Appellees.

Nos. 92-1004, 92-1014.

United States Court of Appeals, Fourth Circuit.

Argued July 7, 1992.

Decided Sept. 8, 1992.

Paul Martin Wolff, Williams & Connolly, Washington, D.C., argued (J. Alan Galbraith and William M. Wiltshire, on brief), for defendants-appellants.

William Dennis Cross, Morrison & Hecker, Kansas City, Mo., argued (William E. Hanna, Morrison & Hecker, Kansas City, Mo., Michael E. Tucci, Morrison & Hecker, Washington, D.C., David L. Lingerfelt, Robert J. Lowe, Jr., Lowe & Lingerfelt, Alexandria, Va., Michael A. Schlanger, Philip J. Harvey, Christine M. Nicolaides, Kent J. Morton, Shaw, Pittman, Potts & Trowbridge, Washington, D.C.), for plaintiff-appellee.

Before WILKINSON, NIEMEYER, and LUTTIG, Circuit Judges.

OPINION

WILKINSON, Circuit Judge:

In this case plaintiff has sought to pierce the corporate veil of its former business partner, Michaelson Properties, Inc. (MPI), and to hold MPI's sole shareholder, Aaron Michaelson, personally responsible for MPI's contractual liability. The jury returned a verdict in plaintiff's favor, and the district court upheld the jury's decision to pierce MPI's corporate veil. We reverse. The jury instructions in this case misstated the applicable standard under Virginia law, and the jury verdict improperly stripped Michaelson of the limited liability to which his business partner had agreed in the course of their negotiations. Virginia law will not permit the corporate veil to be pierced in this case, and we remand for entry of judgment in Michaelson's favor.

I.

In August 1981, defendant Aaron Michaelson formed Michaelson Properties, Inc., for the purpose of entering into joint real estate ventures. MPI was incorporated under the laws of the state of Illinois with initial paid-in capital of $1,000. Michaelson was the president and sole shareholder.

MPI subsequently entered into two joint ventures with Perpetual Real Estate Services, Inc. (PRES), the plaintiff in this case, involving the conversion of apartment buildings into condominiums. The first was formed in October 1981, and was known as Bethesda Apartment Associates (BAA). Under the BAA partnership agreement, each partner was to contribute $100,000 to a working capital fund, and MPI was to put up a $1 million letter of credit. Michaelson and his wife, Barbara, agreed to personally indemnify PRES against any loss on MPI's letter of credit. The BAA partnership sold the last condominium unit in 1983, and distributed about $600,000 in profits to each partner in 1985.

The second partnership, known as Arlington Apartment Associates (AAA), was formed in November 1983. Under the AAA partnership agreement, both PRES and MPI contributed $50,000 in capital, and each agreed to share pro rata in satisfying any liabilities of the partnership. The partnership also borrowed $24 million from Perpetual Savings Bank, PRES's parent corporation, but only after Aaron and Barbara Michaelson agreed to personally guarantee repayment of $750,000 of the loan. When an additional $2.1 million was needed to complete the project, MPI could not come up with the money so PRES loaned MPI $1.05 million, again after PRES secured a personal guarantee of repayment from the Michaelsons.

During 1985 and 1986, the AAA partnership made various distributions of the profits from the condominium units. Prior to each distribution, the partners made the determination, as required by the partnership agreement, that they were leaving sufficient assets to permit the partnership to meet its anticipated expenses. Three distributions were made to PRES and MPI, totalling approximately $456,000 to each partner. MPI then authorized distributions of its profits to its sole shareholder, Aaron Michaelson.

In 1987, more than a year after the last of these distributions, several condominium purchasers filed suit against AAA, asserting breach of warranty claims in the amount of $5.5 million. Shortly before the case went to trial, counsel for AAA entered into settlement negotiations. The case was ultimately settled for $950,000. PRES paid the full amount on behalf of the partnership; MPI made no contribution toward the settlement since its profits had been distributed years earlier.

PRES then filed this diversity action against Michaelson and MPI. The complaint sought indemnity from MPI pursuant to the AAA partnership agreement and asserted that Michaelson had received unlawful distributions from MPI. PRES also asserted two theories for holding Michaelson personally responsible for MPI's debt: (1) that Michaelson had made an oral promise during settlement negotiations to answer for MPI's debt; and (2) that MPI was Michaelson's "alter ego or mere instrumentality" and that MPI's corporate veil should be pierced. Both parties--and the district court--agreed that Virginia law controls.

The district court entered summary judgment on the contractual indemnity claim against MPI. The remaining counts proceeded to trial. At the close of the evidence, Michaelson moved for a directed verdict. On the unlawful distribution count, Michaelson argued that the applicable statute of limitations had expired. The district court agreed, and entered judgment in Michaelson's favor. ¹ On the "veil piercing" count, Michaelson argued that PRES had failed to justify disregarding the corporate form under Virginia law--that PRES had failed as a matter of law to prove that Michaelson had used MPI as a "device or sham" to "disguise wrongs, obscure fraud, or conceal crime," as required by Cheatle v. Rudd's Swimming Pool Supply Co., 234 Va. 207, 360 S.E.2d 828, 831 (1987). The court denied this motion, and submitted both the veil piercing and oral promise counts to the jury.

The jury subsequently returned a verdict in favor of PRES on the veil piercing count, but decided in Michaelson's favor on the oral promise count. Michaelson filed a motion for jnov, which was rejected by the district court. 775 F.Supp. 893 (E.D.Va.1991). Michaelson appeals.

II.

Michaelson makes two principal arguments on this appeal. He first argues that the district court's jury instruction on veil piercing misstated the standard applicable under Virginia law. Second, he argues that under the appropriate standard he is entitled to judgment as a matter of law. We will address these arguments in turn.

A.

Virginia courts have long recognized the basic proposition that a corporation is a legal entity separate and distinct from its shareholders. See Beale v. Kappa Alpha Order, 192 Va. 382, 64 S.E.2d 789, 796 (1951); Cheatle, 360 S.E.2d at 831. A fundamental purpose of incorporation is to "enable a group of persons to limit their liability in a joint venture to the extent of their contributions to the capital stock." Beale, 64 S.E.2d at 796. This concept of limited liability "supports a vital economic policy," Cheatle, 360 S.E.2d at 831, a policy on which "large undertakings are rested, vast enterprises are launched, and huge sums of capital attracted." Anderson v. Abbott, 321 U.S. 349, 362, 64 S.Ct. 531, 537, 88 L.Ed. 793 (1944).

Virginia courts have assiduously defended this "vital economic policy," lifting the veil of immunity only in "extraordinary" cases. Beale, 64 S.E.2d at 797; Cheatle, 360 S.E.2d at 831. Under Virginia law, plaintiff bears the burden of convincing the court to disregard the corporate form, and must first establish that "the corporate entity was the alter ego, alias, stooge, or dummy of the individuals sought to be charged personally." Cheatle, 360 S.E.2d at 831. This element may be established by evidence that the defendant exercised "undue domination and control" over the corporation, Beale, 64 S.E.2d at 797, and the jury instruction in this case fairly described this aspect of the test. Under this element of the test, the court properly permitted the jury to consider such factors as whether Michaelson "observe[d] corporate formalities," whether he kept "corporate records," whether he paid dividends, and whether there were "other officers and directors."

The Supreme Court of Virginia has specifically held, however, that proof that some person "may dominate or control" the corporation, or "may treat it as a mere department, instrumentality, agency, etc." is not enough to pierce the veil. Beale, 64 S.E.2d at 798. In Virginia, "something more is required to induce the court to disregard the entity of a corporation." Id. at 797. Hence, plaintiff must also establish "that the corporation was a device or sham used to disguise wrongs, obscure fraud, or conceal crime." Cheatle, 360 S.E.2d at 831. See also Garrett v. Ancarrow Marine, Inc., 211 Va. 755, 180 S.E.2d 668, 670 (1971); Lewis Trucking Corp. v. Commonwealth, 207 Va. 23, 147 S.E.2d 747, 753 (1966); Beale, 64 S.E.2d at 797-98.

The stringency of the Virginia standard is illustrated by the facts of Cheatle. In that case plaintiff Rudd's Swimming Pool Supply Co. (Supply) brought suit against its successor corporation, Rudd's Swimming Pool Management & Service Co. (Management), to recover on two promissory notes from Management. Management's shareholders (including the Cheatles), however, reorganized into a new corporation (Regency Pool Corporation), deliberately rendering Management incapable of paying on its notes to Supply. 360 S.E.2d at 830-31. Supply obtained a default judgment against Management and convinced the trial court to impose personal liability against the Cheatles. On appeal, the Virginia Supreme Court emphasized that the reorganization from Management to Regency impacted solely upon Management's obligations to Supply, and did not "warrant the extraordinary action" of imposing individual...