Summary of a Recent
Judicial Development in
Secured Transactions

Piercing the Corporate Veil and Determining Ownership of a
Corporate-Debtor's Assets

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re Phillips, Bankr. No. 05-87521, Adv. No. 06-8123, 2007 WL 2122405 (Bankr. C.D. Ill. July 20, 2007), the United States Bankruptcy Court for the Central District of Illinois denied a creditor's motion for summary judgment after finding that the creditor had failed to meet its burden of proof regarding a corporate-debtor's ownership of certain property.

Background

In May 2004, the Debtors incorporated their farming operation in the name of PFI to keep their personal and farming operation finances separate. Id. at *1. They borrowed money from 1st Farm Credit Services (Farm Credit) and State Bank of Augusta (Augusta) to finance their farming operation. Id. From 2004 to 2006, Farm Credit loaned $58,000 to the Debtors as individuals. Id. The loans were secured by a security agreement dated December 8, 1999, covering "all crops growing or to be grown in Illinois during the term of the Security Agreement." Id. To perfect its interest, Farm Credit relied on a financing statement in the name of the Debtors filed in December 1998 by its predecessor in interest, Farm Credit Services of Central Illinois. Id. In 2005, Farm Credit also made loans to PFI in the amount of $710,000, but incorrectly identified PFI in the financing statement as "Phillip Farms, Inc." instead of "Phillips Farms, Inc." Id.

One of the Debtor-spouses, Kim, borrowed money from Augusta in 2004-2005 using the same collateral covered by Farm Credit's loan, but the loan only named Kim as a debtor instead of both spouses. Id. at *2-3. Augusta perfected its security interests by filing a financing statement in Hancock County in Kim's name only. Id. It also filed a financing statement with the Illinois Secretary of State on March 15, 2002, as an "in lieu of continuation" statement for the Hancock County financing statement. Id. at *3. The Debtors filed for Chapter 12 bankruptcy relief in September 2005, but their case was later dismissed because they exceeded the maximum Chapter 12 debt limit. Id. While that case was pending, PFI also filed for Chapter 12 relief, and Farm Credit moved to dismiss the case, arguing that the Debtors' and PFI's debts should be combined because PFI had not observed corporate formalities and had commingled its assets with the Debtors' assets to obtain financing. Id. PFI did not object to the motion and allowed its case to be dismissed. Id. The Debtors subsequently filed another Chapter 12 petition listing their assets and liabilities plus PFI's, and Farm Credit brought this adversary proceeding to determine the extent and validity of its claims, and sought determination of ownership of crops harvested in 2005. Id. at *4.

Arguments

As to the validity and priority of its claims, Farm Credit argued that Augusta had not provided any proof that it had an unterminated commitment and obligation to lend money to the Debtors at all times after 1992. Id. As to ownership of the 2005 crops, Farm Credit argued that they did not belong to PFI because it never truly operated, or alternatively that it should be allowed to pierce PFI's corporate veil under the alter ego theory and the crops should be deemed to belong to the Debtors. Id. at *6.

Augusta argued that the 2005 crops were owned by PFI and not by the Debtors individually, and that it had a first priority lien on all farm products, assets and proceeds of PFI. Id. at *5.

Analysis and Holdings

As to Farm Credit's argument that PFI could not own the crops because it was not operational, the court stated that ownership of property and operational status are two separate things; a corporation can own property whether it is operational or not. Id. at *6. Because there was no deed or certificate of title for the 2005 crops, the court looked at the Debtors' intent and the surrounding circumstances to determine ownership. Id. at *7. The court concluded that the Debtors' intent was that PFI own the crops, because the purpose of its formation was to keep the Debtors' farming and personal assets separate, and found that Farm Credit had failed to prove otherwise. Id. at *8.

Regarding piercing PFI's corporate veil, the court reasoned that "piercing the veil" was an equitable remedy usually granted to fasten liability to members of a corporation who have perpetrated fraud or some other injustice, but Farm Credit sought its application to deem the Debtors the owners of the 2005 crop. Id. at *8. The court called this purpose "questionable," and stated that Farm Credit could not claim to be defrauded or surprised by PFI's existence since it had previously loaned it money, and therefore refused to allow Farm Credit to pierce the veil. Id.

Concerning the priority of Farm Credit's claims, the court held that although it issued loans to PFI before Augusta did, it failed to properly perfect its interest since it incorrectly identified PFI as "Phillip Farms, Inc." instead of "Phillips Farms, Inc." Id. at *9. Under the applicable Illinois statute, a financing statement sufficiently provides the name of a debtor corporation "only if the financing statement provides the name of the debtor indicated on the public record of the debtor's jurisdiction of organization which shows the debtor to have been organized." Id. A financing statement containing minor errors may still be sufficient unless the mistakes make it "seriously misleading." Id. However, the court stated that if a UCC search using the correct name, "Phillips Farms, Inc." would reveal Farm Credit's financing statement filed under "Phillip Farms, Inc." it was not "seriously misleading." Id. at *10. On the other hand, if a UCC search would not reveal the financing statements, then it would be seriously misleading and Augusta's interest in the crops would be superior to Farm Credit's. Id. Therefore, the court denied Farm Credit's motion for summary judgment. Id.

The case was decided on July 20, 2007.