On Oct. 17, in Kertesz v. GVC and Korn, the 2nd Circuit ruled that a defendant who seeks indemnification from a corporation suing him for misconduct as an executive doesn’t lose his right to pierce the corporate veil and find other company executives personally liable for that coverage.
The dispute in Kertesz v. GVC and Korn centers on two men and their ex-business organization, General Video Corporation (GVC). Although now defunct, GVC was a Delaware corporation in which Emery Kertesz (plaintiff-appellant) and Justin Korn (defendant-appellee) were the sole shareholders, owning 31.6 percent and 68.4 percent shares, respectively. GVC first brought an action against Kertesz in his capacity as a corporate officer in the Delaware Court of Chancery. Among other things, GVC’s complaint contained claims against Kertesz for alleged breach of fiduciary duties and tortious interference with business relations.
Kertesz successfully defended against the suit and then brought an action against GVC and Korn, seeking indemnification from GVC for the price of his victory: legal fees. As an alternative, on an alter-ego veil-piercing theory, Kertesz argued to the district court that Korn should be held personally liable for GVC’s payments. District Judge George B. Daniels granted Korn’s motion to dismiss and denied Kertesz leave to amend his complaint, holding that Kertesz’s theories of relief were legally (and logically) at odds with one another: “[Kertesz] cannot maintain that he is entitled to corporate indemnification and at the same time seek to challenge the very existence of the corporate structure that he claims legally entitles him to officer/director indemnification.” From the district court’s vantage, by attempting to obtain personal liability from Korn, Kertesz was, impliedly or openly, denying the existence of the corporate form—and yet, that very same corporate form is what would legally entitle Kertesz to relief by way of officer/director indemnification. Judge Daniels wouldn’t let him have it both ways.
But it now seems that Kertesz can have his corporate form and pierce it, too. Whereas the district court had suggested that indemnification and veil-piercing actions are inherently incompatible, the appellate court rejected Judge Daniels’ ruling outright, emphasizing that “it would be perverse to hold that an abuse of the corporate form sufficient to defeat the corporate privilege of limited liability exempts the corporation from the obligation of a corporation to its officers.” Where the district court erred, according to the 2nd Circuit, is that an action to pierce the corporate veil does not deny a corporation’s legal existence, but rather, suggests that a corporation’s owners have disrespected corporate formalities. Veil-piercing claims are, after all, accusations of abuse—courts should not then use the presence of such allegations to reward a corporation (or its putative alter-ego) by relieving it of its duty to indemnify its officers and directors.
Legally, then, the principle articulated by the appellate court is that corporate officers may seek indemnification from a corporation and also hold corporate owners liable for abusing the corporation’s legal form. Factually, however, the importance of context cannot be understated. As the 2nd Circuit noted, alter-ego claims turn on the facts of the owner’s operation of the corporation and its relationship to the alleged victim. Although directors’ and officers’ paths to simultaneous indemnification and veil-piercing may be legally hurdle-free, “in contrast to an innocent outsider, a corporate officer is more likely to have inside knowledge of the corporation’s activities,” and therefore, “it may be more difficult for a majority shareholder to deceive a fellow insider, which in turn may make it more difficult for an insider to prove the overall injustice or unfairness necessary to pursue an alter-ego claim.” Conversely, in factual circumstances ripe for abuse of the corporate form (e.g., small, closely-held corporations), the availability of legal remedies is all the more vital: “a corporate insider may stand to lose more than an outside creditor from a majority shareholder’s fraudulent abuse of the corporation’s limited liability,” the 2nd Circuit wrote.
So where does this go from here? The appellate court suggested that, given the prolonged and complex nature of the Korn-Kertesz controversy, the dispute may be resolved on other grounds, but it declined to comment further, instead vacating the district court’s order dismissing the complaint against Korn and remanding the case to the district court for further proceedings consistent with its opinion. Stay tuned.