VICARIOUS LIABILITY-PIERCING THE CORPORATE VEIL-ALTER EGO-SANCTIONS

July 13th, 2018 by Rieders Travis in Business and Corporations

Case Involving Vicarious Liability, Piercing the Corporate Veil and Alter Ego Sanctions

Clientron v. Devon IT, Inc., No. 16-3432, E.D. Pa. No. 2-13-cv-05634 (3d Cir. July 5, 2018) Greenaway, Jr., C.J.  In this unusual case, Appellant Clientron Corp. is actually the prevailing party below and holds a judgment against Appellee Devon IT, Inc. worth over $7 million. Clientron claims, however, that it is unable to recover because Devon IT is insolvent. Before the District Court and now also on appeal, Clientron has argued that Devon IT’s corporate veil should be pierced, and that the two shareholders who own Devon IT as tenants by the entirety, Appellees John Bennett and Nance DiRocco, should be held personally liable for the entire judgment. Although the District Court declined to disregard Devon IT’s corporate form on the merits, it held Bennett—but not DiRocco—personally liable for a portion of the judgment as a sanction for egregious discovery misconduct. According to Clientron, this decision to sanction only Bennett was insufficient because he, like Devon IT, is judgment-proof. Clientron contends that it can recover only if DiRocco is held personally liable for the judgment as well. As we will explain below, we hold that, irrespective of whether the imposed sanction was sufficient to cure the prejudice suffered by Clientron, the District Court committed legal error in piercing Devon IT’s veil as a sanction to reach Bennett but not DiRocco, and in holding Bennett personally liable for only part of the judgment. We will therefore vacate the District Court’s order sanctioning Bennett and remand so that the District Court may impose a new sanction.

The evidence must ultimately show that the corporation was “nothing more than a sham used to disguise [the shareholders’] use of its assets for [their] own benefit in fraud of its creditors.” Blatstein, 192 F.3d at 100 (quoting Kaplan, 19 F.3d at 1521).

Clientron next argues that even if it failed to meet its burden on the merits of the Pennsylvania alter ego claim, the District Court should have pierced the veil as to both Bennett and DiRocco as a discovery sanction. It contends that both Bennett and DiRocco should be held personally liable because DiRocco’s personal conduct was sanctionable, and because there is no legal basis for distinguishing between shareholders when piercing the corporate veil.

We are forced to conclude that the court’s veil piercing remedy was grounded in federal law. Our task here on appeal, then, is to determine whether Rule 37 authorizes the fashioning of such a remedy. We conclude that it does not and will therefore vacate the District Court’s sanctioning order.

Distinguishing between shareholders for alter ego purposes is especially problematic where, as here, the corporation is owned jointly by two tenants by the entirety. Applying Pennsylvania law, we have previously stated that tenancies by the entirety are “based on the legal fiction that husband and wife are one person.” In re Brannon, 476 F.3d 170, 173 (3d Cir. 2007). The ownership form’s “essential characteristic” is that each spouse holds “the whole or the entirety,” and not a “share, moiety or divisible part.” Id. (quoting In re Gallagher’s Estate, 43 A.2d 132, 133 (Pa. 1945)). The only ways the tenancy may be severed, “other than by the death of one of the spouses, are ‘a joint conveyance of the state, divorce, or mutual agreement,’” id. (quoting Clingerman v. Sadowski, 519 A.2d 378, 381 (Pa. 1986)), none of which is at issue in this case. And as long as the tenancy remains intact, “[i]t is presumed that each tenant by the entirety may, without specific consent, act individually on behalf of both.” Id. Taking all of these considerations together, a conclusion that a corporation was the alter ego of one shareholder tenant by the entirety, but not the other, is legally untenable in Pennsylvania.

Again, here, having already concluded that Devon IT was not Bennett and DiRocco’s alter ego as a matter of Pennsylvania law, the District Court proceeded to pierce the corporate veil anyway. And it did so in a manner that, as explained above, Pennsylvania law would not have allowed: it distinguished between two tenants by the entirety and pierced with respect to only part of the judgment.

We will accordingly vacate the court’s order holding Bennett liable for the $737,018 in damages from the breach of contract claim and the $44,320 monetary sanction. Because the authority to impose sanctions for discovery violations committed in the district courts is generally entrusted to the discretion of those courts in the first instance, we will remand for further proceedings.