Second Department Applies De Facto Merger Doctrine and Veil Piercing in Recent Appeal
Introduction and Background
On January 29, 2020, the Second Department affirmed a Suffolk County Commercial Division decision applying both the de facto merger doctrine and the veil piercing doctrine. Each doctrine often plays an important role in determining whether plaintiffs in business disputes can recover from certain entities and their owners who are not signatories to operative agreements. The Second Department’s analysis in reviewing a decision by Justice Elizabeth Hazlitt Emerson of the Commercial Division provides a helpful review of these concepts.
The case, Bonanni v. Horizons Investors Corp.,,[i] centers around an entity, formed in 2001, that provided magnetic resonance imaging services to local hospitals. The original entity, named MRI Enterprises, LLC (“MRI LLC” or the “LLC”), was founded by four investors: Plaintiff Luciano Bonanni (through MRI, Inc.) and Defendants Benito Fernandez (through Horizons Investors Corp. (“Horizons”)), Solomon Kalish (through Adex Management Corp.) and Dr. Allan Hausknecht.[ii] Fernandez/Horizons owned 40% of the entity, while the remaining investors each held a 20% stake. Separately, MRI LLC established Defendant Comprehensive Imaging of New York, PLLC (“CINY”), which was 99% owned by Dr. Hausknecht, and 1% by another physician.[iii]
From inception until April 2005, MRI LLC was managed by Bonanni. However, in April of 2005, a dispute arose between the members of the LLC regarding the selection of MRI scanners for a client hospital. Following this dispute, Bonanni was excluded from the management of MRI LLC. In addition, even though the other investors never acquired Bonanni’s interest in MRI LLC, from April 2005 forward, Bonanni was no longer included in the LLC’s distributions.[iv]
In July 2005, Bonanni brought suit on behalf of himself and the LLC, asserting claims for breach of contract and conversion, and seeking an accounting. In addition, derivative causes of action were asserted for misappropriation of corporate opportunities and looting, waste, and misappropriation. After a bench trial, Justice Emerson of the Commercial Division found in favor of Bonanni, ordering Defendants to pay damages, and ordering an accounting of payments made by or for both the LLC and CINY.[v]
Defendants CINY and Hausknecht appealed, contending that Bonanni was not entitled to an accounting from CINY, because Bonanni never held an ownership interest in CINY.[vi] Defendant Fernandez also appealed, asserting that he should not have been held personally liable for the damages awarded against Horizons.[vii]
The Second Department’s Opinion
- An Accounting of CINY Was Appropriate Under the De Facto Merger Doctrine
The first issue addressed by the Court was whether Bonanni was entitled to an accounting of payments to CINY, even though Bonanni never held an interest in CINY. As an initial matter, the Second Department explained that “[g]enerally, a corporation which acquires the assets of another is not liable for the torts of its predecessor.”[viii] However, an exception to that general rule exists where “there was a consolidation or merger of seller and purchaser [or] the purchaser corporation was a mere continuation of the seller corporation.” Indeed, that exception specifically applies when a “transaction [is] structured as a purchase of assets[,] a de facto merger.”[ix] Thus, ordinarily, Bonanni would not be entitled to an accounting of CINY payments, unless the court determined that a de facto merger between MRI LLC and CINY occurred.
Under New York law, the hallmarks of a de facto merger are: “continuity of ownership; cessation of ordinary business and dissolution of the [predecessor] as soon as possible; assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and, continuity of management, personnel, physical location, assets, and general business operation.”[x] Importantly, “[w]here the acquired corporation is ‘shorn of its assets’ and becomes a ‘shell,’ legal dissolution is not required to support a finding of de facto merger.”[xi]
Applying these factors to the relationship between CINY and MRI LLC, the Appellate Division determined that a de facto merger between the two entities did occur, thereby entitling Bonanni to an accounting. Specifically, the court determined that “in early 2012, MRI LLC’s assets and employees were transferred to CINY, MRI LLC’s business ceased, and CINY provided the services to the client hospital that MRI LLC had previously performed.”[xii] Furthermore, “[t]he equipment, assets, business operation, management, and some of the personnel remained unchanged.” The court also observed that MRI LLC had engaged in transactions with CINY that were “indicative of self-dealing,” namely the transfer of an MRI scanner to CINY at substantially below market value. On these facts, the Second Department affirmed the Commercial Division’s determination, that “there was a de facto merger between MRI LLC and CINY,” and thus that Bonanni was entitled to an accounting.[xiii]
- Defendant Fernandez Was Properly Held Personally Liable Under the Veil Piercing Doctrine
The Second Department also addressed whether Fernandez, owner of Horizons, was properly held personally liable for the damages owed to Bonanni and MRI LLC. As the court explained, the ordinary rule is that “a corporation exists independently of its owners, who are not personally liable for its obligations, and that individuals may incorporate for the express purpose of limiting their liability.”[xiv] However, New York law recognizes a veil piercing doctrine whereby an owner can be held personally liable if a plaintiff can show: “(1) the owners exercised complete domination of the corporation in respect to the transaction attacked; and (2) that such domination was used to commit a fraud or wrong against the plaintiff which resulted in plaintiff’s injury.”[xv] In answering these questions, courts consider the following factors: “whether there was a failure to adhere to corporate formalities, inadequate capitalization, commingling of assets, and use of corporate funds for personal use.”[xvi]
Applying these factors to Fernandez, the Second Department ruled that there was evidence in the record that Fernandez was “trying to manipulate the books” to hide transactions, including the liquidation of an account from which Bonanni was excluded when funds were distributed to other LLC members. Additionally, the Court noted that the seizure of Bonanni’s interest in MRI Enterprises without process or payment also amounted to a “failure to adhere to corporate formalities.”[xvii] Thus, the Court found that “the record as a whole supports the Supreme Court’s conclusion that despite the fact that Fernandez did not control a majority of MRI LLC’s stock, he ‘exercised complete domination of [MRI LLC]’ and did so in a manner that resulted in ‘a fraud or wrong against [MRI Inc.]’ and that resulted in [MRI Inc.’s] injury.”[xviii]
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The Appellate Division’s decision in Bonanni illustrated how the de facto merger and veil piercing doctrines can be utilized to expand the scope of parties who are subject to liability in a commercial case.
[i] 2020 NY Slip Op 00563 (App. Div. 2d Dep’t 2020).
[ii] Consistent with the Court’s opinion, this blog post will refer to Bonanni and MRI Inc. interchangeably.
[iii] CINY was a necessary entity because New York law prohibits non-physicians from splitting fees for medical services with non-physicians.
[iv] See Bonanni, 2020 NY Slip Op 00563, at *2-4.
[v] Id. at *4-5.
[vi] Id. at *6-7.
[vii] Id. at *12.
[viii] Id. at *7 (quoting Shea v. Salvation Army, 169 A.D.3d 1081, 1082 (2d Dep’t 2019)).
[x] Id. (quoting Fitzgerald v. Fahnestock & Co., 286 A.D.2d 573, 574 (2d Dep’t 2001)).
[xi] Id. at *7-8 (internal citations omitted).
[xii] Id. at *8.
[xiii] Id. at *8.
[xiv] Id. at *12 (quoting Sky-Track Tech. Co. Ltd. v. HSS Dev., Inc., 167 A.D.3d 964 (2d Dep’t 2018)).
[xv] Id. at *12-13.
[xvi] Id. (internal citations omitted).
[xvii] Id. at *14