Question

Thomas Persson and Jon Nokes founded smart inventions, INc., to market household consumer products. The success of their first product, the smart mop, continued with later products, which were sold through infomericals. Persson and nokes were the firm's officers and equal shareholders, with Persson responsible for product development and nokes in charge of day-to-day activities. By 1998, they had become dissatisfied with each other's efforts. Nokes represented the firm as financially "dying," in a grim state,..worse than ever, and offered to buy all of Persson's shares for $1.6million. Persson accepted.. On the day that they signed the agreement to transfer the shares, Smart inventions began marketing a new product the Tap Light. It was an instant success, generating millions of dollars in revenues. In negotiating with Persson, Nokes had intentionally kept the Tap Light a secret. Persson sued Smart Inventions, asserting fraud and other claims   Under what principle might Smart Inventions be liable for Nokes's fraud? Is Smart invention liable in this case?

Answer 1

Smart Inventions might be liable for Nokes's fraud based on the principle of piercing the corporate veil. Based on this principle, courts ignore the corporate structure and expose the shareholders to personal liability in the situations where the corporation is used to perpetrate a fraud or to commit an injustice. Corporate veil is pierced when the corporate privilege is abused for personal benefit. Some of the factors that lead to such situation includes 1) a party is tricked or misled into dealing with the corporation rather than the individual, 2)insufficient capitalization at the time of formation, 3)statutory corporate formalities not followed and 4) personal and corporate interests are commingled and there is no separate identity for the corporation. In this case Nokes has perpetrated fraud by keeping the details regarding the new product Tap Light as a secret during the negotiation with Persson to transfer all the shares to own name. Here Nokes did not follow the statutory corporate formalities which include keeping accurate record and presenting all the information regarding the assets without hiding anything and acting in the best interest of the corporation without giving importance to personal benefits. Hence the court will pierce the corporate veil of Smart invention and find Nokes liable for perpetrating fraud against Persson for personal benefit. Hence only Nokes would be liable here.