White v. Winchester Land Development Corp.

• Decision Date: 08 June 1979
• Citation: 584 S.W.2d 56
• Parties: 27 UCC Rep.Serv. 158 C. Thomas WHITE and Adelyn S. White, Individually and d/b/a The White House, Inc., and Julianna M. White's Administrator, Appellants, v. WINCHESTER LAND DEVELOPMENT CORPORATION, the Winchester Bank, and The White House, Inc., Appellees.
• Court: Kentucky Court of Appeals

Page 56

584 S.W.2d 56

27 UCC Rep.Serv. 158

C. Thomas WHITE and Adelyn S. White, Individually and d/b/a

The White House, Inc., and Julianna M. White's Administrator, Appellants, v. WINCHESTER LAND DEVELOPMENT CORPORATION, the Winchester

Bank, and The White House, Inc., Appellees.

Court of Appeals of Kentucky.

June 8, 1979.

As Modified June 29, 1979.

Janet R. White, White, McCann & Stewart, Winchester, for appellant, Julianna M. White's Administrator.

John Paul Moore, Rick J. Thomas, Winchester, for C. Thomas White and Adelyn S. White, Individually and d/b/a The White House.

Henry L. Rosenthal, Jr., Winchester, for appellee, The Winchester Bank.

Edsel T. Jones, Winchester, for appellee, Winchester Land Development Corp.

Before MARTIN, C. J., and REYNOLDS and WINTERSHEIMER, JJ.

MARTIN, Chief Judge.

Charles T. and Adelyn S. White appeal from a decision of the circuit court holding that certain stock pledged as security on appellants' personal loan could be sold by the appellee bank to discharge the indebtedness on subsequent loans executed by appellants in the name of their corporation. The rather unusual facts of this appeal present several significant questions as to the extent of individual liability on corporate loans.

On February 2, 1973, Charles T. and Adelyn White jointly executed a $15,000.00 personal note to The Winchester Bank. To secure this note, Charles' mother, Julianna M. White, executed a pledge agreement ¹ and delivered 670 shares of Allied Stores Corporation common stock to the bank. The loan ledger of The Winchester Bank, filed as an exhibit, shows that the note on February 2 increased the indebtedness of the borrower, Charles T. White, to $22,932.00. This indebtedness was gradually reduced, and after an increase on April 11, the loan ledger indicated a balance of zero by June 8.

Appellants incorporated their card and gift shop as The White House, Inc. on May 23. On June 6, Charles T. White signed a note in the amount of $20,000.00 to The Winchester Bank in his capacity as president of the corporation. On July 1, 1974, Adelyn White, the Secretary-Treasurer of The White House, Inc., signed a third note. This note was signed on behalf of the corporation in the amount of $19,630.36. Based upon requests for admissions filed in the trial court, these two notes, less payments, represented the indebtedness of The White House, Inc. to The Winchester Bank in the amount of $18,350.02 prior to this law suit. In 1975, The White House, Inc. became insolvent.

The crucial problem in this case centers upon whether the 670 shares of stock pledged by Julianna White on the appellants' personal note may be considered continuing security for the notes made in the name of The White House, Inc. Those shares of stock were originally issued by the Allied Stores Corp. to Charles R. White and Julianna White as joint tenants with the right of survivorship. Charles R. White died on November 26, 1972, and Julianna M. White died on October 10, 1974. Thus, a claim is now being made by the bank for the stock certificate upon the grounds that the stock is security for the corporate loans. Julianna's surviving heirs, on the other hand, contend that the stock was released as security upon the appellants' payment of the indebtedness on the original loan.

The trial court held that the second and third notes were mere renewals of the original notes, denying the Whites' motion for summary judgment on the issue and ordering them to pay the bank the amount of $15,000.00, "the amount of the original loan to the individuals which the pledge secured." ² The trial court thus granted summary judgment in favor of the appellees.

We are of the opinion that the decision below is erroneous. In reaching that result, we must consider the following questions.

1. Did the appellants sign the second and third notes in an individual or corporate capacity?

2. If the notes were signed in a corporate capacity, should the appellants nevertheless be held personally liable on the notes on the theory that the principal, The White House, Inc., was a mere sham?

3. If The White House, Inc. was not a sham corporation, were there sufficient indicia of intent to evidence a novation by the bank such that the earlier pledge was released? Alternatively, did the loan by the bank to The White House, Inc. constitute a mere renewal so that the earlier pledge remained in effect.

I.

In addressing the first issue, we note at the outset that Charles T. White, the maker of the second note, and Adelyn White, the maker of the third one, signed those notes as follows:

KRS 355.3-403(3), in effect since July 1, 1960, provides that "(e)xcept as otherwise established the name of an organization preceded or followed by the name and office of an authorized individual is a signature made in a representative capacity." ³ The significance of the fact that the Whites' signatures were made in a representative capacity is that after the identity of the principal (here, The White House, Inc.) is disclosed, the agent is not liable for his own authorized acts. This fundamental tenet of the law of agency was upheld in Potter v. Cheney, Ky., 290 S.W.2d 44 (1956), and was recently followed in American Collectors Exchange v. Auter, Smalley, and Stengle, Inc., Ky.App., 566 S.W.2d 759 (1978). The record shows that on May 31, 1973, The White House, Inc. adopted a resolution to the effect that the President and Secretary-Treasurer of the Corporation were authorized to effect loans at any time for this corporation from The Winchester Bank, ". . . and to sign any notes . . . of this corporation." Further, that resolution states that a certified copy thereof was delivered to the bank. Hence, the bank had notice of the agency relationship and the resolution which authorized the Whites, in their official capacities, to make notes. To this extent the principal, The White House, Inc., was liable on the notes and the agents, the Whites, were not.

As we noted, however, merely finding that appellants signed these later notes in a corporate rather than an individual capacity does not dispose of this appeal. If The White House, Inc. is a "sham" corporation, as contended by appellees, the corporation could be held simply an "alter ego" of appellants. ⁴ Under that theory, appellants could be held liable on the later notes regardless of the fact that they signed them in a corporate capacity.

II.

The second issue presented on this appeal deals with appellees' contention that The White House, Inc. is a mere sham designed to defraud its creditors. Thus, it is argued, the corporate veil should be pierced and the Whites found to be personally liable for the obligations of the corporation upon the basis that the corporation is an "alter ego" of the Whites. Appellees regard Zanone v. Standard Oil Co., Ky., 322 S.W.2d 710 (1959), as controlling.

In the Zanone case, it was established that the corporation was a family device organized to take over the business of a partnership without any cessation of activity. Many of the assets of the partnership were transferred to the corporation without consideration. According to one of the partners who became the president of the corporation, the sole purpose of the incorporation was " 'to search about for some means to be able to do business and not be entangled with the past.' " The holding, then, was based upon direct and uncontroverted evidence that the corporation was merely a fraudulent device which operated to do indirectly what the partnership could not do directly, Viz, to defraud its creditors. ⁵ To the extent that the record in this case is utterly devoid of such evidence, we find the Zanone case to be clearly distinguishable on its facts from the instant case, and hence not controlling. However, despite the fact that a corporation is usually recognized as an entity which is distinct from its shareholders, officers, and directors, there are "specific, unusual circumstances" that will prevent the rule of limited liability from applying. Zubik v. Zubik, 384 F.2d 267, 273 (3d Cir. 1967).

Three basic "theories" have been utilized to hold the shareholders of a corporation responsible for corporate liabilities. See Campbell, Limited Liability for Corporate Shareholders: Myth or Matter-of-Fact, 63 Ky.L.J. 23, 33 (1975). These have been labeled (1) the instrumentality theory; (2) the alter ego theory; and (3) the equity formulation. Because the bank seeks to rely upon all of these theories if indeed they are distinct they bear some examination. ⁶

Under the instrumentality theory three elements must be established in order to warrant a piercing of the corporate veil: (1) that the corporation was a mere instrumentality of the shareholder; (2) that the shareholder exercised control over the corporation in such a way as to defraud or to harm the plaintiff; and (3) that a refusal to disregard the corporate entity would subject the plaintiff to unjust loss. The courts adopting this test have been virtually unanimous in requiring that these three elements co-exist before the corporate veil will be pierced. See Campbell, supra at 33.

In this case it cannot be doubted that the Whites exercised a great deal of control over the corporation insofar as they were the sole shareholders. However, mere ownership and control of a corporation by the persons sought to be held liable is not alone a sufficient basis for denial of entity treatment. Poyner v. Lear Siegler, Inc., 542 F.2d 955, 958 (6th Cir. 1976). As to the second element, our courts have placed a great emphasis upon fraudulent organization and have denied entity treatment upon that basis. See Poyner, supra at 958, and the authorities cited therein. The record before us is utterly devoid of the essential elements of fraud, I. e., material representation, falsity, scienter, reliance, deception, and injury. See Sanford Construction Co. v. S & H Contractors, Inc., Ky., 443 S.W.2d 227 (1969), and Scott v....