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Qugen, Inc. v. Chawla

A3987-09T2 (N.J. Super. App. Div. 2011) (Unpublished)

CORPORATIONS; VEIL PIERCING — A claimant seeking to pierce a corporate veil by alleging that the shareholders committed fraud has to prove the fraud by clear and convincing evidence.

A manufacturer entered into an agreement with a distributor to purchase and then resell merchandise. The distributor was a limited liability company, and the contract was guaranteed by a corporate guarantor. When the distributor failed to pay for the merchandise, the manufacturer sued both the distributor and the corporate guarantor and received an order for summary judgment in its favor. The manufacturer then sought to pierce the corporate veil to impose liability on the principals of the two entities. The lower court found no basis for piercing the veil. The manufacturer appealed, but the Appellate Division affirmed.

The crux of the manufacturer’s claim was that the principals had made material representations in order to induce it to sign the agreement, they undercapitalized the limited liability company, commingled business and personal funds and used business funds for personal purposes, and fraudulently induced the manufacturer to ship the goods based on false promises of payment. The lower court found insufficient evidence to pierce the corporate veil. It found that while the distributor was undercapitalized, it was not due to the principal’s siphoning of assets to avoid paying creditors. The lower court also found that the principals had not use company funds for personal expenses, and that the motel and food expenses were incurred for business trips to promote the companies. Lastly, the lower court determined that the principals had no intent to defraud the manufacturer and made no material misrepresentations. The business’s failure was due to a poor economy and not fraudulent behavior by the principals.

In its appeal, the manufacturer argued that the lower court had applied the wrong standard of proof by requiring it to prove its case by “clear and convincing” evidence as opposed to a “preponderance of the evidence.” The Court disagreed, finding that there was no evidence that the lower court applied the “clear and convincing” standard to the general piercing claim in addition to the fraud claim. However, the Court noted that the lower court would not have erred even had it applied the “clear and convincing” standard to the piercing claim. The Court found that the manufacturer was primarily asserting that the principals of the entities had intentionally defrauded it into selling them merchandise. Since the manufacturer’s claims were based on fraud, they needed to be proven by “clear and convincing” evidence. The Court also noted that, even if it agreed with the manufacturer’s argument that its claim was not dependant on proving fraud, the manufacturer’s claims still failed. Even using the less stringent “preponderance of the evidence” standard of proof, there was no evidence that the principals stripped the entities of assets it would otherwise have had available to pay the manufacturer. Therefore, it was inappropriate to pierce the corporate veil to impose liability on the principals.

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