Asset Protection Concepts and Strategies by Riser Adkisson LLP

Texas alter ego case demonstrates importance of quality entity planning in asset protection

The law regarding alter ego and whether a corporate veil should be respected is a very confused and difficult area of the law. Every case is very much a facts-and-circumstances analysis, and it is nearly impossible to find anything like bright lines as to where a legitimate corporation ends and a sham corporate form begins. But asset protection planning requires a quality understanding of these issues.

Richards Group, Inc. v. Brock, ___ S.W.____, 2008 WL
2787899 (N.D.Tex., July 18, 2008)

United States District Court, N.D. Texas, Dallas Division.

THE RICHARDS GROUP, INC., Plaintiff,

v.

Jeffrey S. BROCK, et al., Defendants.

Civil Action No. 3:06-CV-0799-D. July 18, 2008.

Scott S. Hershman, Jamie R. Welton, Michelle M. Kostun,
Scott M. Garelick, Lackey Hershman, Dallas, TX, for Plaintiff.

Geoffrey S. Harper, Kiprian E. Mendrygal, Michael T.
Hilgers, Fish and Richardson, Dallas, TX, Norman D. Rollins, McLemore and Rollins,
Nashville, TN, for Defendants.

MEMORANDUM OPINION

SIDNEY A. FITZWATER, Chief Judge.

*1 Plaintiff The Richards Group ("TRG") sues defendants
Jeffrey S. Brock ("Brock") and Brock Music Productions, Inc. ("BMPI") for a
declaration that BMPI and Brock are the alter egos of Brock Music, Inc. ("BMI"),
a company against which TRG is a judgment creditor, that all three are a single
business enterprise, and that BMPI and Brock are jointly and severally liable
for the judgment that TRG has against BMI. TRG also seeks judgment declaring
that various transfers among Brock, BMI, and BMPI were fraudulent and void.
Following a bench trial, and for the reasons that follow,FN1 the court finds in
favor of TRG on its claim that Brock and BMPI are the alter egos of BMI, that
all three are a single business enterprise, and that BMPI and Brock are jointly
and severally liable for the judgment. The court, in its discretion, declines to
grant declaratory relief on TRG's fraudulent transfer claims.

FN1. The court sets out in this memorandum opinion its
findings of fact and conclusions of law. See Fed.R.Civ.P. 52(a).

I

In September 2003 TRG, a national advertising agency, hired
BMI to provide original music ("the composition") for an advertising campaign
that TRG was creating for Travelocity. TRG and BMI entered into a Music
Services/Recording Purchase Agreement with an accompanying Music Rights
Agreement ("Rights Agreement"). In the Rights Agreement, BMI warranted that it
was the sole author of the composition, that the composition was original, and
that the composition would not infringe the copyrights of any other person or
entity. EMI Catalogue Partnership ("EMI") later sued TRG and Travelocity for
copyright infringement arising from their use of the composition in the
Travelocity advertising campaign. BMI did not indemnify TRG, and in September
2004 TRG paid EMI $150,000 to settle the case.

In April 2005 TRG initiated an arbitration proceeding
against BMI for breach of the Rights Agreement. On December 13, 2005 TRG
obtained an award against BMI for over $200,000, covering TRG's settlement with
EMI and its attorney's fees. On December 28, 2005 TRG filed suit in Texas state
court to obtain a judgment enforcing the arbitration award. While the lawsuit
was pending, but before judgment was entered, Brock filed a UCC-1 in his favor
that covered essentially all of BMI's tangible assets. On February 17, 2006-also
during the period that preceded the entry of judgment-Brock incorporated BMPI.
TRG obtained a final default judgment against BMI on February 28, 2006 for
$220,831.40. BMI has yet to pay any part of the judgment.

II

TRG filed the instant lawsuit against Brock and BMPI in
county court in Texas, requesting declaratory relief. Following removal, TRG
filed an amended complaint in which it seeks to collect attorney's fees and
costs under Tex. Civ. Prac. and Rem.Code sec. 37.009 (Vernon 2008). While TRG
implicitly seeks declaratory relief under the Texas Declaratory Judgments Act,
Tex. Civ. Prac. and Rem.Code Ann. sec.sec. 37.001-37.011 (Vernon 2008), "[w]hen a
declaratory judgment action filed in state court is removed to federal court,
that action is in effect converted into one brought under the federal
Declaratory Judgment Act, 28 U.S.C. sec.sec. 2201, 2202." Redwood Resort Props.,
LLC v. Holmes Co., 2007 WL 1266060, at *4 (N.D.Tex. Apr.30, 2007) (Fitzwater,
J.) (citing i2 Techs. US, Inc. v. Lanell, 2002 WL 1461929, at *7 n. 5 (N.D.Tex.
July 2, 2002) (Fish, C.J.)). Therefore, TRG's declaratory judgment claims have
been effectively converted to claims brought under the federal Declaratory
Judgment Act.

*2 The federal Declaratory Judgment Act provides that,
"[i]n a case of actual controversy within its jurisdiction, ... any court of the
United States, upon the filing of an appropriate pleading, may declare the
rights and other legal relations of any interested party seeking such
declaration, whether or not further relief is or could be sought." 28 U.S.C.
sec. 2201. Federal courts have broad discretion to grant or refuse declaratory
judgment. Torch Inc. v. LeBlanc, 947 F.2d 193, 194 (5th Cir.1991). "Since its
inception, the Declaratory Judgment Act has been understood to confer on federal
courts unique and substantial discretion in deciding whether to declare the
rights of litigants." Wilton v. Seven Falls Co., 515 U.S. 277, 286, 115 S.Ct.
2137, 132 L.Ed.2d 214 (1995). The Declaratory Judgment Act is "an authorization,
not a command." Pub. Affairs Assocs., Inc. v. Rickover, 369 U.S. 111, 112, 82
S.Ct. 580, 7 L.Ed.2d 604 (1962). It gives federal courts the competence to
declare rights, but it does not impose a duty to do so. Id.

III

TRG seeks a declaration that BMPI and Brock are the alter
egos of BMI and that all three are a single business enterprise. TRG also
requests that the court declare that BMPI and Brock are jointly and severally
liable for the state court judgment that TRG obtained against BMI.

A

When a suit is removed to federal court based on diversity
jurisdiction, district courts "apply the conflict of laws rule of the state in
which it sits to determine which state's substantive law should be applied."
Alberto v. Diversified Group, Inc., 55 F.3d 201, 203 (5th Cir.1995) (citing
Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 85 L.Ed.
1477 (1941)). Under Texas law, "only the laws of the jurisdiction of
incorporation of a foreign corporation shall govern ... the liability, if any,
of shareholders of the foreign corporation for the debts, liabilities, and
obligations of the foreign corporation for which they are not otherwise liable
by statute or agreement." Tex. Bus. Corp. Act Ann. art. 8.02 (Vernon 2003). TRG
seeks to pierce the corporate veils of BMI and BMPI, both of which are
incorporated in the state of Tennessee. The court therefore applies Tennessee
law in determining whether BMPI and Brock are alter egos of BMI. See, e.g.,
Alberto, 55 F.3d at 204 (holding that, under Texas choice-of-law rules, Delaware
law applied to plaintiffs' piercing claim because they sought to disregard the
corporate form of a company incorporated in Delaware). Moreover, the parties do
not dispute that Tennessee law controls in this respect.

B

"A corporation is presumptively treated as a distinct
entity, separate from its shareholders, officers, and directors." Oceanics
Schools, Inc. v. Barbour, 112 S.W.3d 135, 140 (Tenn.Ct.App.2003). "A
corporation's separate identity may be disregarded or 'pierced,' however, upon a
showing that it is a sham or a dummy or where necessary to accomplish justice."
Id. (some internal quotation marks omitted) (emphasis in original). "The
conditions under which the corporate entity will be disregarded vary according
to the circumstances present in each case and the matter is particularly within
the province of the trial court." Elec. Power Bd. of Chattanooga v. St. Joseph
Valley Structural Steel Corp., 691 S.W.2d 522, 526 (Tenn.1985); see, e.g., Boles
v. Nat'l Dev. Co., 175 S.W.3d 226, 244 (Tenn.Ct.App.2005). "Generally, no one
factor is conclusive in determining whether or not to disregard a corporate
entity; rather, the courts typically rely upon a combination of factors in
deciding such an issue." Oceanics Schools, 112 S.W.3d at 140 (internal quotation
marks omitted) (citing Schlater v. Haynie, 833 S.W.2d 919, 925
(Tenn.Ct.App.1991)). Tennessee courts rely on the factors annunciated in FDIC v.
Allen, 584 F.Supp. 386, 397 (E.D.Tenn.1984), in deciding whether to pierce the
corporate veil. See, e.g., Boles, 175 S.W.3d at 245-46; Oceanics Schools, 112
S.W.3d at 140.

*3 Factors to be considered in determining whether to
disregard the corporate veil include not only whether the entity has been used
to work a fraud or injustice in contravention of public policy, but also: (1)
whether there was a failure to collect paid in capital; (2) whether the
corporation was grossly undercapitalized; (3) the nonissuance of stock
certificates; (4) the sole ownership of stock by one individual; (5) the use of
the same office or business location; (6) the employment of the same employees
or attorneys; (7) the use of the corporation as an instrumentality of business
conduit for an individual or another corporation; (8) the diversion of corporate
assets by or to a stockholder or other entity to the detriment of creditors, or
the manipulation of assets and liabilities in another; (9) the use of the
corporation as a subterfuge in illegal transactions; (10) the formation and use
of the corporation to transfer to it the existing liability of another person or
entity; and (11) the failure to maintain arms length relationships among related
entities.

Allen, 584 F.Supp. at 397. "It is most important to note
that it is not necessary that all of the Allen factors weigh in a plaintiff's
favor in order to justify the piercing of the corporate veil." Boles, 175 S.W.3d
at 246 (citing Oceanics Schools, 112 S.W.3d at 140-41). "Discarding the fiction
of the corporate entity, or piercing the corporate veil, is appropriate when the
corporation is liable for a debt but is without funds to pay the debt, and the
lack of funds is due to some misconduct on the part of the officers and
directors." Id. at 244 (citing Muroll Gesellschaft M.B.H. v. Tenn. Tape, Inc.,
908 S.W.2d 211, 213 (Tenn.Ct.App.1995)). When a creditor of a company attempts
to pierce the company's corporate veil to satisfy its claim against a
shareholder, the creditor must show that the shareholder's control of the
company proximately caused the creditor's inability to collect. See Tenn.
Racquetball Investors, Ltd. v. Bell, 709 S.W.2d 617, 622 (Tenn.Ct.App.1986).
"The party wishing to pierce the corporate veil has the burden of presenting
facts demonstrating that it is entitled to this equitable relief." Oceanics
Schools, 112 S.W.3d at 140.

IV

A

Since BMI's inception in 1979,FN2 Brock has been the sole
shareholder of BMI. Since incorporating BMPI in February 2006, Brock has
remained its sole shareholder. During the existence of both companies, BMI and
BMPI have had the same board of directors, Brock, and his wife Joan. Brock has
also served as Chairman of the Board of both companies. BMI and BMPI also have
the same two officers: Brock, who serves as President, and Joan, who serves as
Secretary. Brock has always directed the daily activities of BMI and BMPI. Joan
has very few duties at either company. As long as both companies have existed,
BMI and BMPI have used the same business office: a recording studio at 2937
Berry Hill Drive, Nashville, Tennessee 37204 ("recording studio"). In their
individual capacities, Brock and Joan own the recording studio. As long as BMPI
has existed, it has used the same business telephone number as has BMI.

FN2. Over the years, BMI occasionally changed names. The
court notes these changes only where relevant to today's decision.

*4 Other than Brock, BMI's sole employee during the
relevant time period was Collin Peterson ("Peterson"), the sole employee of BMPI
besides Brock. Peterson has worked as an engineer for both companies. BMI paid
Peterson's salary until February 28, 2006, when BMI no longer had sufficient
funds to continue doing so. BMPI started paying Peterson's regular salary on
March 1, 2006, in the same amount as BMI paid him. As of December 11, 2007, BMPI
was still paying Peterson's salary. BMI paid Brock's regular salary until
February 28, 2006, when BMI no longer had any money to continue paying it. BMPI
started paying Brock's salary March 1, 2006, in the same amount as his BMI
salary, until the end of June 2006, when Brock stopped receiving salary payments
altogether. February 28, 2006 is the last day that BMI had employees.

Norman Rollins ("Rollins"), Esquire, a tax lawyer, has
represented Brock for the past 30 years; he has also represented BMI and
BMPI.FN3 In the past ten years, he has signed off on all of BMI's and BMPI's tax
returns. Rollins represented Brock and BMPI in the formation of BMPI in February
2006. Rollins assisted Brock in preparing and filing the UCC-1 that encumbered
nearly all of BMI's assets.

FN3. Because the court is finding in favor of TRG, it need
not decide TRG's objection to Rollins' testimony at trial on the basis of Rule
26.

B

The merits of TRG's alter ego claims largely hinge on the
proper characterization of two bank accounts.

1

The first account at issue was at the National Bank of
Commerce, in the name of "Jeffery S[.] Brock DBA Brock Musical Productions" FN4
("357 account").FN5 In June 2005 SunTrust Bank acquired the 357 account, and the
account number remained the same. In March 2006 the 357 account was transferred
to the name of BMPI, but the account number did not change, and it remained at
SunTrust Bank.

FN4. The Bank misspelled Brock's first name, which is
correctly spelled "Jeffrey."

FN5. The account number for this bank account ended with
the numbers "357."

BMI held an account in its own name ("BMI account"), first
at Bank of America, and then at Bank of Nashville, when it was moved there in
October 2003. From 2002 until April 2004, BMI did not use the 357 account,
although the account existed even before 2002. During this period, all invoices
paid to BMI for BMI's professional services were deposited into the BMI account.
In April 2004, however, Brock began to deposit into the 357 account all incoming
checks FN6 payable to BMI for which BMI had rendered professional services.
Brock continued this practice until BMI transferred the 357 account to BMPI in
March 2006.FN7 Brock conducted BMI's affairs this way because he wanted to keep
most of BMI's money in the 357 account and to maintain a low balance in the BMI
account. Although Brock occasionally paid BMI's expenses from the 357 account
during the period from April 2004 and February 2006, he paid the vast majority
of BMI's bills from the BMI account. To facilitate this arrangement, Brock wrote
a check from the 357 account to the BMI account when BMI had bills to pay. This
allowed the BMI account to maintain a relatively low balance.

FN6. These incoming checks were for as much as $50,000.

FN7. Brock deposited incoming BMI checks into the 357
account as late as February 6, 2006, when he deposited over $20,000 of BMI's
money into the 357 account.

Defendants characterize the 357 account, as it was before
March 2006, as a bank account that belonged to BMI. They posit that the 357
account was merely a holding account for BMI. And they assert that the only
monies deposited into the 357 account were BMI's, and that the only funds paid
from the 357 account that accrued to Brock's personal benefit were salary
payments that BMI was obligated to make. Moreover, defendants emphasize that,
from April 2004 to March 2006, BMI paid taxes on the monies deposited into the
357 account.

*5 These facts notwithstanding, the court finds that,
before March 2006, the 357 account was a personal account that Brock owned
individually. Although Brock maintained that the 357 account was not his
personal bank account, he acknowledged that the account was in his name before
it was transferred to BMPI in March 2006. Brock knew how to establish a bank
account in the name of BMI, and BMI in fact had an account in its own name: the
BMI account. Brock also acknowledged at trial that only he, in his individual
capacity, not BMI, had the right to draw on the 357 account.

When asked during his October 26, 2006 deposition about the
initial funding of BMPI, Brock testified that it came from scoring the movie "No
Regrets" for Filmhouse, Inc. ("Filmhouse"). On June 15, 2004 Brock deposited the
$15,000 check from Filmhouse into the 357 account. This was the only check from
Filmhouse compensating BMI for its work on "No Regrets." Throughout his
deposition, Brock repeatedly testified that the "No Regrets" check was held in a
personal bank account with SunTrust Bank.

In Brock's December 12, 2007 deposition, he was asked about
the BMI account with the Bank of Nashville, which had a balance of $6,815.69 at
the end of January 2006:

Q. At this time, roughly January of 2006, does Brock Music
have any other accounts other than this Bank of Nashville account?

A. No.

Q. Is it fair to say, then, that the only funds that Brock
Music had at its disposal at this time was the balance noted in this [BMI]
account statement?

A. As far as I can remember ....

Q. But is it fair to say that, you know, as of January 31,
2006, the only funds that Brock Music, Inc. had at its disposal was the
6,815.69?

A. Yes.

Brock Dec. 12, 2007 Dep. 49:4-23. Brock thus denied that
BMI had another bank account or even had other funds available to it at a time
when BMI was using the 357 account as a "holding account" for all of BMI's
incoming checks. Brock had deposited $11,518.06 of BMI's money into the 357
account on January 26, 2006, and he did not write any checks on the account from
January 13, 2006 until February 3, 2006.FN8

FN8. The court is not able to determine the exact balance
for the 357 account because the bank records that defendants produced do not
establish this. TRG specifically requested this material in requests for
production and a subpoena.

Brock's deposition testimony undermines the contention that
the 357 account was simply a "holding account" for BMI's use. Although Brock
testified at trial that he was mistaken in describing the BMI account as the
only account that BMI owned as of January 2006, the court finds to be more
credible his deposition testimony, which was given closer in time to the events
in question and with less opportunity for revision as Brock became aware of the
potential effect that his testimony might have on the merits of this lawsuit.

Moreover, notations that Brock made on checks written from
the 357 account and deposited in the BMI account corroborate his initial
characterization of the account as a personal one. Of the 20 checks that were
written to transfer money from the 357 account to the BMI account, Brock wrote
the word "loan" on the notation line of 18 of them. Brock acknowledged that he
would not have written the word "loan" on these checks had he not thought that
he was making a loan. He also admitted that BMI would not have needed to loan
money to itself. Thus Brock's notations on these checks confirm that he
understood the 357 account to be a personal account that he individually owned
and controlled, not a BMI-owned account.

*6 That BMI paid taxes on the income represented by checks
deposited into the 357 account is not dispositive in determining the question of
account ownership. Moreover, Rollins-BMI's tax lawyer who prepared BMI's tax
returns during these years-testified at trial that he learned of the holding
account arrangement only three weeks before trial. Thus Rollins' testimony that
he had never seen any red flags related to the finances does not persuade the
court to alter its findings regarding ownership of the 357 account. The court
finds that, until March 1, 2006, when Brock transferred the 357 account into the
name of BMPI, Brock owned the 357 account individually. BMI did not own it.

2

The second account at issue is the bank account that Brock
used for renting out the recording studio ("CC account"). Bank of America
originally held this account in the name of "Creative Caffeine, Jeffrey S[.]
Brock." In late April 2006 Brock transferred the balance of the CC account to
SunTrust Bank, which held the new account in the name of "Jeff or Joan Brock,
D/B/A Creative Caffeine." FN9 Brock has always used the CC account to hold funds
derived from renting the recording studio to third parties. Creative Caffeine is
the name Brock assumes in billing third parties for their use of the studio.
Creative Caffeine's sole business is renting the recording studio. Brock began
the Creative Caffeine business in mid-2004, and he established the CC account
sometime in mid-2005. Before March 2006 Brock had never transferred money from
the CC account to the BMI account or even to the 357 account. Since March 2006,
the CC account has been used for BMPI's benefit, and Brock has made various
online transfers of money from the CC account to the 357 account, which BMPI
then controlled.

FN9. Although the account number changed when the funds
were transferred from Bank of America to SunTrust Bank, the court refers to
these accounts as one account-the CC account-because virtually the entire
balance (less $30) was transferred to the SunTrust account, and the basic
purpose of the new account remained the same, i.e., to hold money generated from
renting the recording studio.

Defendants characterize Creative Caffeine as a division of
BMI, and they characterize the CC account as having been a BMI account until
March 2006. They maintain that, as of March 1, 2006, Creative Caffeine and the
CC account were transferred to BMPI; after March 1, 2006, the CC account was a
BMPI account and Creative Caffeine was a division of BMPI. Defendants point out
that BMI paid taxes on Creative Caffeine income until March 2006, and that,
after March 1, 2006, BMPI began paying taxes on Creative Caffeine's income.

Although "Creative Caffeine" was a name on the CC account,
the account was also in the name of Brock, individually, and later in the name
of Brock and Joan, individually. Brock admitted that he and his wife exercise
control over the CC account, and that the CC account was set up as a personal
account.

Q. So this is just your own personal bank account that you
have put the name Creative Caffeine on.

A. Yes.

Q. It's not different than any personal checking account I
may have.

A. Correct.

Q. And that's where you deposited the money that you
generated from leasing out the recording studio with respect to the invoices we
see here at Exhibit 39.

*7 A. Correct.

Tr. 1:233. Brock repeatedly acknowledged in his December
12, 2007 deposition that the CC account was an "individual account," not an
account of BMPI, even after March 2006. Although he testified that the CC
account existed for the benefit of BMPI after March 2006, Brock acknowledged
that the CC account contained "individual assets that BMPI can freely utilize."
Brock Dec. 12, 2007 Dep. 83:6-7. When asked whether BMPI had any bank accounts
other than the 357 account at SunTrust Bank, Brock responded, "No." FN10
Moreover, when CC supposedly became a division of BMPI on March 1, 2006, nothing
on the account bank statements indicates a change in ownership. In terms of the
basic account information, the CC account bank statement for March 2006 is
exactly the same as the one for February 2006.

FN10. The CC account was with SunTrust Bank from April 2006
onward.

In his October 26, 2006 deposition, Brock spoke of Creative
Caffeine as a personal venture, separate from BMPI:

Q. How long has [Peterson] been employed by BMPI?

A. Since March 1st of 2006.

Q. Does he continue to draw a salary?

A. Not from that company.

Q. Okay. From another company that you own?

A. Yes.

Q. Which company?

A. It's a sole proprietorship, Creative Caffeine.

Brock Oct. 26, 2006 Dep. 19:12-19. Later in the deposition,
Brock testified that Creative Caffeine was a sole proprietorship: "Creative
Caffeine is sole proprietorship. It is owned strictly, solely by me." Id. at
102:11-12. When asked how long Creative Caffeine had been paying for the upkeep
of the equipment in the recording studio, Brock explained, "It started,-it
started loaning money to Brock Music Productions, Inc. probably four months
ago." Id. at 105:18-19. If Creative Caffeine were merely a division of BMPI at
this point, it would not make sense to make "loans" to BMPI. As with the 357
account, that BMI paid taxes on Creative Caffeine income until March 2006, and
that BMPI paid taxes after that, is not dispositive in characterizing the
ownership of the CC account. Moreover, Rollins-BMI and BMPI's tax lawyer who
prepared BMI's and BMPI's tax returns during these years-testified at trial that
he was not aware in preparing these tax returns that Creative Caffeine even had
a separate bank account. The court finds that the CC account was always, and
remains, a personal account of Brock, owned in his individual capacity.

C

On the Allen factor that addresses undercapitalization,
defendants argue that the controlling inquiry is whether the company started
with the statutory minimum amount of capital for incorporating a company:
$1,000. See Newman v. Bartee, 787 S.W.2d 929, 931 (Tenn.Ct.App.1990) ("While
[the company] was organized with capital of $1,000 and did 'go under,' the
evidence is that [the company] was properly formed and capitalized pursuant to
all applicable statutes."). Later decisions of Tennessee courts of appeals,
however, suggest that the statutory minimum capitalization is not controlling.
In Oceanics Schools the court held that the undercapitalization factor supported
piercing, even though the company being pierced was capitalized with $2,000,
more than the statutory minimum. See Oceanics Schools, 112 S.W.3d at 141. In
considering the undercapitalization factor, the court also relied on the fact
that, at the time the plaintiff obtained a judgment against the company being
pierced, the company owed the controlling shareholder over $800,000 based on
personal loans to the company. Id.

*8 In VP Buildings, Inc. v. Polygon Group, Inc., 2002 WL
15634 (Tenn.Ct.App. Jan.8, 2002) (unpublished opinion), the court concluded:
"[The company] was initially capitalized with $500, a gross undercapitalization
considering the nature of the business in which [the company] is engaged." Id.
at *6. Although $500 may not have met the statutory minimum for initial
capitalization, the court did not even mention the statutory requirement, and it
indicated that the undercapitalization factor depended on the industry in which
the company conducted business.

Consistent with Oceanics Schools and VP Buildings, the
Supreme Court of Tennessee held in Electric Power Board of Chattanooga that the
most important factor in deciding to pierce the corporate veil was that, at the
time the plaintiff's claim arose against the company being pierced, the company
owed its parent company $725,000 and was insolvent. Elec. Power Bd., 691 S.W.2d
at 527 ("Of course, all the facts have some effect, but we think it is
particularly significant that at the time of this accident [the subsidiary] owed
[its parent company] $725,000, or more, and was insolvent."). The court also
noted that the subsidiary had an initial capitalization of $12,300. Id. at 525.
It does not matter whether these cases show that the Allen factor concerning
undercapitalization looks beyond the statutory minimum for initial
capitalizations, or whether the decisions create a new piercing factor focusing
on the capitalization at the time the plaintiff's claim arose. Either way, a
company's capitalization at the time the plaintiff's claim arose is an important
factor in the piercing analysis.

TRG's indemnity claim against BMI arose sometime after the
parties entered into the Rights Agreement in September 8, 2003, but before TRG
settled the copyright violation case with EMI on September 24, 2004. Brock
testified that, by the end of 2002, BMI owed him personally $149,187 in unpaid
rent for the use of the recording studio. BMI's back rent liability only grew
over the next few years, reaching an indebtedness of $209,187 by the end of
2005. Moreover, as of September 8, 2003 to September 24, 2004, BMI owed Brock
individually at least $8,000 for a personal loan. During this same period, BMI's
bank account never had a month-end balance that exceeded $87,000. Brock also
testified that the UCC-1 he filed on February 10, 2006 covered essentially all
of BMI's tangible assets, the recording studio equipment, and that the value of
BMI's tangible assets is less than $30,000. Moreover, Brock acknowledged that,
from the moment BMI signed the Rights Agreement, BMI did not have sufficient
resources to fulfill its indemnity obligation.

The court finds that, at the time BMI entered into the
Rights Agreement, and thereafter, it was not only unable to fulfill its
indemnity obligation with TRG, but BMI was very much insolvent and heavily
indebted to Brock, its sole shareholder. These facts support the finding that
BMI's corporate structure must be disregarded. See Elec. Power Bd., 691 S.W.2d
at 527; Oceanics Schools, 112 S.W.3d at 141.

D

*9 BMI diverted large amounts of its money to Brock's
personal bank account-the 357 account-to the detriment of BMI's creditors. BMI
received notice of EMI's copyright lawsuit against TRG, and thus was on notice,
as of March 30, 2004, of its potentially large liability to TRG. The very next
month, on the advice of the attorney who represented BMI in the copyright
matter, BMI began depositing all of its incoming checks into Brock's personal
account, the 357 account. The explicit purpose of using the 357 account for
BMI's incoming checks was to keep the BMI account balance low. BMI continued
this arrangement until the 357 account was transferred to BMPI in March 2006.
Even if Brock did not acquire any personal benefit from placing BMI's funds in
his personal account (the 357 account), and then transferring these funds back
to the BMI account when BMI needed to pay bills, this arrangement demonstrates
that Brock and BMI did not observe BMI's corporate separateness. See, e.g.,
Oceanics Schools, 112 S.W.3d at 141 (relying on failure to observe corporate
formalities in upholding trial court's finding that company's corporate form
should be disregarded).

But Brock in fact personally benefited from placing BMI's
money in the 357 account, even if the only payments made directly to him from
that account were his regular BMI salary payments. That the bulk of BMI's liquid
assets were in Brock's personal account, and not in BMI's account, placed
additional hurdles in the paths of BMI's creditors who were seeking to collect
their debts. Brock's arrangement of holding most of BMI's assets in the 357
account between April 2004 and March 2006 made it more difficult for judgment
creditors of BMI to collect their judgments.

For example, the quick and relatively inexpensive method of
executing a judgment on a company's bank account through garnishment would not
necessarily be available to a judgment creditor of BMI who wanted to reach BMI's
funds in the 357 account. It appears that, under Tennessee law, only a judgment
debtor may be joined as a defendant in suit for garnishment. See Tenn. R. Civ.
P. 69.05; see also Tenn. Indus. Mach. Co. v. Accuride Corp., 139 S.W.3d 290, 294
(Tenn.Ct.App.2004) ("[A] final garnishment judgment may be entered against a
garnishee only where it appears that the garnishee is indebted to the principal
judgment debtor defendant." (internal quotation marks and brackets omitted)).
Thus if a judgment creditor of BMI had served a writ of garnishment on National
Bank of Commerce (or, later, SunTrust Bank), neither garnishee would have been
required to list monies held in the 357 account, because this account was not
set up as a BMI account. While Tennessee courts have not resolved the issue,
other state courts have held "that a bank served with a writ of garnishment may
rely on its deposit agreements when determining to whom it is indebted." E.g.,
Bank One, Tex. N.A. v. Sunbelt Sav., F.S.B., 824 S.W.2d 557, 557 (Tex.1992) (per
curiam); Staley v. Brown, 244 Miss. 825, 146 So.2d 739, 741 (Miss.1962);
Anderson Boneless Beef, Inc. v. Sunshine Health Care Ctr., Inc., 852 P.2d 1340,
1343 (Colo.Ct.App.1993) (holding that bank served with writ of execution cannot
be held liable to judgment creditor unless it handles funds in name of judgment
debtor, and duty of garnishee bank is to find out whether defendant named in
writ of execution has funds on deposit with it, and need not examine affairs of
any person other than the one named in the writ); Flat Iron Mac Assocs. v.
Foley, 90 Md.App. 281, 600 A.2d 1156, 1162 (Md.Ct.Spec.App.1992).

*10 In Bank One the judgment creditor-garnishor discovered
evidence that the judgment debtor-defendant had commingled his personal funds in
a company account, and it pleaded commingling of funds in its garnishment
application. Bank One, 824 S.W.3d at 557-58. But because the company was not
joined as a defendant in the writ of garnishment, the company's bank properly
answered the writ by stating it was not indebted to the judgment debtor because
it did not have any deposits under the name of the judgment debtor. Id. at 558
("A garnishee bank is not indebted to a judgment debtor unless some form of
deposit agreement creates a debtor-creditor relationship between the bank and
the judgment debtor.").

In Anderson Boneless Beef the court held that the
garnishee-bank was not liable to the judgment creditor-garnishor for asserting
in its answer to the writ of garnishment that it did not possess funds of the
judgment debtor-defendant, even though the garnishee-bank held an account of an
entity related to the judgment debtor and in which the related entity deposited
checks made payable to the judgment debtor. Anderson Boneless Beef, 852 P.2d at
1342-44.

In Flat Iron Mac Associates the court held that, upon
service of the writ of garnishment, the garnishee bank was not required to hold
funds of the judgment debtor in an account under a different name, even though
the bank had actual notice that the funds in the other account belonged to the
judgment debtor, and the account owner admitted that the funds in the account
belonged to the judgment debtor. Flat Iron Mac Assocs., 600 A.2d at 1162.

The court's conclusion that BMI's use of the 357 account
diverted corporate assets from BMI to the detriment of BMI's creditors is also
supported by the timing of BMI's actions. Within one month of receiving notice
of a potentially large liability of BMI to TRG, Brock (through BMI) decided to
deposit BMI checks into the 357 account to keep the BMI account balance low.

Moreover, within days of TRG's obtaining a judgment against
BMI, Brock also transferred thousands of dollars of BMI funds to BMPI. At the
beginning of March 2006,FN11 the 357 account was transferred into the name of
BMPI, although the account remained with the same bank, SunTrust Bank, and
retained the same account number. Brock testified at trial, as he did during his
December 12, 2007 deposition, that he depleted the 357 account by paying BMI
debts before transferring the account to BMPI, and that the initial funding of
BMPI came from personal loans.

FN11. There is no persuasive evidence of the exact date
that the account switched to BMPI's control, but BMPI started writing checks
from the 357 account as early as March 15, 2006.

Brock gave a different explanation, however, of the initial
funding of BMPI at his October 26, 2006 deposition, which he gave just months
after the events took place. Brock acknowledged that there was already money in
BMPI when it was started, and that these funds were derived from composing the
score for the movie "No Regrets." BMI performed the work for "No Regrets," and
the only payment received for these services, a $15,000 check, was deposited in
the 357 account on June 15, 2004. Brock testified that there was already
approximately $30,000 in BMPI when it was formed. When asked where this $30,000
was when BMPI was first formed, Brock responded that is was in a personal bank
account. Brock testified that BMPI's initial bank account was with SunTrust, and
that "it already had some personal money in it. So, essentially, I loaned it
money that was already in the account." Brock Oct. 26, 2006 Dep. 21:23-25. Brock
explained:

*11 Q. Okay. You testified that there was this
approximately $30,000 already in the company?

A. Uh-huh.

Q. Which was in your personal bank account?

A. Right.

Q. How did that money get into the newly-created account?

A. I loaned it to it.

Q. From Jeff Brock, in your individual capacity?

A. Yes.

Q. To the company?

A. Uh-huh.

Q. Now, this is money that you testified was already in the
company from this previous movie score?

A. Uh-huh ....

Q. This approximately $30,000 from a previous movie score-

A. Right, that was in a personal account that I loaned then
to BMPI ....

Q. Then Jeff Brock, in your personal capacity, lent
approximately $30,000 to BMPI?

A. Right.

Q. The source of that fund-of those funds was from a
previous movie score-

A. Yes.

Q. -that you had done?

A. And a couple of smaller projects.

Id. at 22:1-15, 23-25, 600 A.2d 1156; 23:1-18. This
description of BMPI's initial funding was given not only at a point closer in
time to the events in question, it was provided at a time when Brock had less
opportunity or motive to revise his testimony as he became aware of the
consequences of his version of the facts. It also accords with the court's
characterization of the 357 account as a personal account of Brock that was used
to hold BMI funds before they were transferred to BMPI. The payments for the
movie score for "No Regrets" and for the handful of smaller projects were BMI
monies that were placed in the 357 account. Brock considered these funds to be
his personal funds, which formed the basis of the "personal loan" to BMPI for
BMPI's initial funding.

The bank records for the 357 account also indicate that the
account was not depleted before the funds were transferred to BMPI. Brock
deposited $20,016.58 into the 357 account on February 6, 2006. From that date
onward, the bank records indicate that, before the account was transferred to
BMPI, only $12,271.55 of checks were written. Although the records of the 357
account produced in this case do not reveal the account's balance at any point
in time, Brock admitted during his trial testimony that he possessed the
documentation that would have established the balance of the 357 account when it
was transferred to BMPI:

Q. Now, you haven't produced any other bank statements or
documentation showing what the balance was in the 357 account at the time that
it switched to BMPI.

A. No.

Q. You haven't provided any such documentation in this
case?

A. No, I have not.

Q. That's certainly documentation that you would have at
your disposal, though?

A. Yes.

Tr. 1:239-40.

Even if the absence of documentary proof of the account
balance were not attributable to defendants' inadequate discovery responses,FN12
they cannot rely on the absence of such records to defeat TRG's claims. Although
Tennessee courts do not shift the burden of proof from the plaintiff in a
piercing claim, they hold that the absence of documentary proof for certain
transactions for which such documentation should exist and should be in the
possession of the defendant does not defeat the plaintiff's claim. See Murroll
Gesellschaft M.B.H., 908 S.W.2d at 214 ("This record is impressive-not from the
facts revealed therein, but from the lack of facts revealed. For example, the
record contains not a single check, invoice or book entry regarding transactions
between the two defendant corporations, nor a single operating statement,
balance sheet or tax return."); VP Buildings, 2002 WL 15634, at *7. After the
plaintiff in VP Buildings filed suit against the defendant corporation, the
corporation borrowed $300,000 against its only asset. Id. at *2. The company's
sole shareholder testified that the $300,000 was used to pay legitimate company
debts, but she provided no documentation regarding how the borrowed money was
spent. Id. She argued that the plaintiff could not prove that she had failed to
apply the $300,000 to legitimate expenses, and she reminded the court that the
plaintiff had the burden of proving facts sufficient to justify piercing. Id. at
*6. The court upheld the trial court's finding that the company was the alter
ego of the sole shareholder, despite documentary proof of the alleged diversion
of the company's assets:

FN12. As noted earlier, see supra note 8, in requests for
production and in a subpoena, TRG specifically requested all bank statements
related to BMI, BMPI, and Brock individually.

*12 [The sole shareholder] cannot rely on the failure of
documentary proof of use of the money ... from the loan on the corporation's
asset, all evidence within her control. This court has considered the inability
to demonstrate a lawful justification for a diversion of funds from one
corporation to another as proof of corporate abuses sufficient to justify
piercing the corporate veil and holding two shareholders personally liable on
the debts of their corporation.

Id. at *7 (internal quotation marks omitted) (quoting
Judd's Inc. v. Muir, 1998 WL 338212, at * 4 (Tenn.Ct.App. June 26, 1998)). This
court therefore finds that, in transferring to BMPI the 357 account (which had
BMI funds in it), Brock caused thousands of dollars of BMI money to be diverted
to BMPI, to the detriment of BMI's creditors.

E

Brock used BMI as an instrumentality to serve his personal
venture, Creative Caffeine. From mid-2004 until December 31, 2006, when Creative
Caffeine rented the recording studio to third parties, BMI has been paying or
accruing an annual rent debt of $57,000.FN13 Moreover, most of the equipment
that customers of Creative Caffeine used when renting the recording studio
belonged to BMI. But all of the money generated from renting the studio to third
parties went directly into Brock's personal bank account, the CC account. No
money was ever remitted to BMI from the CC account, even after the CC account
was supposedly transferred to BMPI. The funds generated from renting the studio
(for which BMI was paying rent) and the equipment (which BMI owned) should have
gone to BMI. Instead, Brock used BMI, and later BMPI, as a tool to advance his
personal venture, Creative Caffeine.

FN13. This is an average based on the two lease agreements.

Brock's placement into the CC account of monies derived
from renting the recording studio can also be viewed as diverting corporate
assets, to the detriment of BMI's creditors. At the very least, it shows Brock's
failure to observe the separateness of BMI and himself. Moreover, Brock offered
no legitimate business explanation for the supposed transfer of the Creative
Caffeine income stream to BMPI in March 2006, when BMI was still obligated to
pay rent and still owned most of the equipment. The transfer of the Creative
Caffeine income stream to BMPI deprived BMI of the profits it would otherwise
have realized from renting the studio, thereby harming BMI's creditors.

The CC account was a Brock personal bank account that
contained funds that should have been remitted to BMI. According to Brock, as of
March 1, 2006 the CC account became the account of BMPI. Although the court
finds that the CC account remained Brock's personal account, the transfer of the
CC bank account to BMPI would have conveyed to BMPI in excess of $5,000 of BMI
funds that were on deposit in the CC account as of February 28, 2006. The bank
records demonstrate that the funds in the CC account were not depleted before
the account was allegedly transferred to BMPI on March 1, 2006. Thus even under
defendants' characterization of the CC account, BMI diverted assets to BMPI, to
the detriment of BMI's creditors.

*13 After the CC account supposedly became a BMPI account,
Brock periodically transferred funds from the CC account to the 357 account,
which was then controlled by BMPI. Based on the court's previous findings that
the CC account remained Brock's personal account, and that the income stream
going into the CC account should have gone to BMI, these transfers constitute a
further diversion of BMI assets and a disregard for the separateness of BMI,
BMPI, and Brock.

F

Brock also exploited his control over BMI to carry out
illegal, fraudulent transfers. Many of the examples cited above of BMI's
diverting corporate assets to the detriment of its creditors can also be viewed
as fraudulent transfers. But because the court has considered them under the
rubric of another Allen factor, in considering the fraudulent transfer factor,
the court will focus exclusively on Brock's filing of the UCC-1 on February 9,
2006. To the extent there is a conflict in law between Texas and Tennessee on
fraudulent transfers, the court applies Tennessee law.FN14

FN14. According to Texas choice-of-law rules, " 'the law of
the state with the most significant relationship to the particular substantive
issue will be applied to resolve that issue.' " De Aguilar v. Boeing Co., 47
F.3d 1404, 1413 (5th Cir.1995) (quoting Duncan v. Cessna Aircraft Co., 665
S.W.2d 414, 421 (Tex.1984)); see Amoco Chem. Co. v. Tex Tin Corp., 925 F.Supp.
1192, 1202 n. 9 (S.D.Tex.1996) (applying "most significant relationship"
choice-of-law test to fraudulent transfer claim). Tennessee has the most
significant relationship to the issue whether the filing of the UCC-1 was
fraudulent. Brock, a Tennessee resident, filed the UCC-1 with the Tennessee
Secretary of State, and the UCC-1 purported to encumber the assets of BMI, a
Tennessee corporation.

A transfer made or obligation incurred by a debtor is
fraudulent as to a creditor whose claim arose before the transfer was made or
the obligation was incurred if the debtor made the transfer or incurred the
obligation without receiving a reasonably equivalent value in exchange for the
transfer or obligation and the debtor was insolvent at that time or the debtor
became insolvent as a result of the transfer or obligation.

Tenn.Code Ann. sec. 66-3-306 (2004). A "transfer" includes
the "creation of a lien or other encumbrance." Tenn.Code Ann. sec. 66-3-302(12)
(2004). "A debtor is insolvent if the sum of the debtor's debts is greater than
all of the debtor's assets, at a fair valuation." Tenn.Code Ann. sec.
66-3-303(a) (2004). "Debts" include claims against the debtor whether or not
they have been reduced to a judgment. Id. at sec. 66-3-302(3) and (5).

By the end of 2005, and within months of the UCC-1 filing,
BMI owed Brock over $200,000 in unpaid rent for the recording studio. TRG also
had a claim against BMI, in the form of an arbitration award, for over $200,000.
BMI's tangible assets were worth no more than $30,000. Less than $15,000 was in
the BMI account at the time of the UCC filing. Thus at the time Brock filed the
UCC-1 on February 9, 2006, BMI was insolvent.

A financing statement such as a UCC-1 does not of itself
create a security interest, but it perfects a security interest. Tenn.Code Ann.
sec. 47-9-310 (2001); see, e.g., AmSouth Bank v. Trailer Source, Inc., 206
S.W.3d 425, 427 (Tenn.Ct.App.2006). And a UCC-1 is effective in perfecting a
security interest only to the extent it was filed by a person entitled to file
it. Tenn.Code Ann. sec. 47-9-510 (2001). Brock was entitled to file the UCC-1
only if BMI authorized him to file it in an authenticated record, or Brock had a
security agreement from BMI covering the assets of the UCC-1 filing. See
Tenn.Code Ann. sec. 47-9-509 (2001). To the extent the UCC-1 was effective in
perfecting a security interest in BMI's recording equipment, Brock, as BMI's
President, must have conferred upon himself, individually, a security interest
in the equipment.FN15

FN15. Brock's answers to questions indicate that his
understanding was that BMI did grant Brock a security interest in connection
with the UCC-1 filing.

*14 Brock admitted that the underlying debt for the UCC-1
filing was entirely based on BMI's unpaid rent. Brock also acknowledged that,
before he filed the UCC-1, he did not have a security interest in any of BMI's
assets. The lease agreements on which the back rent was based do not confer on
Brock a security interest in BMI's assets. Brock clearly denied that there was
any consideration given to BMI in exchange for the security interest on which
the UCC-1 was based. Because BMI did not receive reasonably equivalent value for
granting Brock a security interest in all of its tangible property, and because
BMI was insolvent at the time of the transfer, the transfer was fraudulent.
Before BMI granted to Brock the security interest on which the UCC-1 filing was
based, Brock was similarly situated to TRG: an unsecured creditor with a large
claim against BMI. By fraudulently granting Brock a security interest in BMI's
property, BMI made Brock a secured creditor on all of its tangible assets. This
placed Brock in a much better position than it did TRG to collect from BMI, even
though TRG was but weeks away from obtaining a default judgment against BMI.
Once TRG had a judgment, it could have easily become a secured creditor. This
fraudulent transfer weighs in favor of piercing BMI's corporate veil. FN16 See
Allen, 584 F.Supp. at 398 (relying on fraudulent transfers under Tennessee
version of Uniform Fraudulent Transfer Act to pierce corporate veil).

FN16. The court's finding of fraudulent transfer with
respect to Brock's UCC-1 filing in support of TRG's piercing claim is not the
same as a declaration that this transfer was fraudulent. See infra at sec. V.

G

Brock, BMI, and BMPI all failed to maintain an arms-length
relationship among themselves. Beginning in March 2006, when BMPI first began to
operate, BMPI "loaned" BMI money by periodically paying BMI's bills. The only
documentation for these loans is the record that the bills were paid. Brock
testified that the name of the entity billed did not matter, and that what
mattered was who was paying the bill. BMPI also began making salary payments to
Brock that were owed by BMI for periods of work when BMPI did not even exist.
Brock initially stated that these BMPI salary payments on behalf of BMI were not
loans, but he later testified that they were. Brock asserted that his
handwritten salary log was the documentation for these "loans" to BMI. But when
reviewing the copies of the BMPI checks going out of the 357 account after March
2006, Brock was unable to identify which checks were on behalf of BMI and which
were on behalf of BMPI, although this was then a BMPI account. After March 2006
Brock paid legal fees for himself and for BMPI from 357 account. But BMI also
paid legal fees for BMPI and for Brock individually. Although BMPI and Brock are
the only defendants in this case, BMPI and Brock individually have not paid any
legal fees in connection with this case. BMI has paid all the legal fees of
Brock and BMPI through "loans" from BMPI or from the meager funds that BMI has
earned since March 2006. It is not clear what business justification BMI had in
paying BMPI's and Brock's legal fees in this case.

H

*15 The court finds that BMPI was a sham corporation. BMI
and BMPI's stated business objectives were very similar. BMI's business purpose
from its creation was to produce jingles, songs, advertisements, and other
musical compositions. BMPI was also set up for the purpose of producing record
projects and other types of musical endeavors. The names of the two companies
are almost exactly the same: BMPI's name includes the word "Productions." BMPI's
name is even closer to the name of BMI's predecessor, "Brock Musical
Productions, Inc." BMI and BMPI had exactly the same corporate structure, and
the same directors, officers, and employees. But BMPI never had any clients,
never performed any projects, and never made any sales. Other than monies coming
in from the CC account, BMPI never had any income of its own. Brock never
developed a budget for BMPI. Brock incorporated BMPI on February 17, 2006. By
October 2006, BMPI was functionless.

The timing of BMPI's formation is also suspect. When TRG
filed suit against BMI in December 2005 to reduce its arbitration award to a
judgment, Brock made a conscious decision not to defend the suit. By January
2006 Brock knew that TRG would obtain a default judgment against BMI for over
$200,000. Brock incorporated BMPI just 11 days before TRG obtained a default
judgment. And as noted supra at sec. IV(D) and (E), shortly after BMPI's
formation, BMI transferred to BMPI a substantial amount of money: the balances
in the 357 account and the CC account, and the future income stream of Creative
Caffeine.

I

Last, TRG has proved that Brock's control of BMI and BMPI
has proximately caused TRG's inability to collect its judgment.FN17 Defendants
emphasize that TRG has not attempted to execute on its judgment. But as of March
1, 2006, all of BMI's tangible assets were encumbered by Brock's lien, and there
was less than $8,000 in the BMI bank account. Within a few months, BMI's account
balance was just a few hundred dollars. In his October 26, 2006 deposition,
Brock explained that BMI was no longer doing any business because it had no
money and no assets. Attempting to execute on TRG's judgment would have been
largely futile and a waste of resources.

FN17. But for the abuse of the corporate form, TRG would
have been able to collect on at least some of its judgment. There is no
indication that Tennessee law requires that, but for the misconduct of Brock,
BMI, and BMPI, TRG would have been able to satisfy the entire judgment.

J

Considering all these facts as a whole, the court finds by
a preponderance of the evidence that BMPI and Brock are the alter egos of BMI,
and that justice requires that TRG pierce BMI's and BMPI's corporate veils. The
court declares that BMI, BMPI, and Brock are a single business enterprise and
that BMPI and Brock are jointly and severally liable for the state court
judgment that TRG obtained against BMI.FN18

FN18. Defendants do not dispute that, if they are liable to
TRG, such liability is joint and several.

V

TRG seeks in its second claim a declaration that various
transfers from BMI to BMPI were fraudulent and are therefore void. TRG also
seeks a declaration that BMI's granting a lien to Brock was fraudulent and is
therefore void. In light of the relief granted supra at sec. IV(J), the court in
its discretion opts not to resolve these latter declaratory judgment requests.
Because TRG can now enforce its judgment against Brock individually and against
BMPI, these additional declarations, even if meritorious, do not appear to be
sufficiently necessary to warrant the entry of declaratory judgment.

* * *

*16 For the reasons stated, the court finds in favor of TRG
on its claim that Brock and BMPI are the alter egos of BMI, that all three are a
single business enterprise, and that BMPI and Brock are jointly and severally
liable for the state court judgment. The court therefore enters judgment in
favor of TRG against Brock and BMPI.

Labels: Alter Ego, asset protection, corporate veil, fraudulent transfer