THIS ISSUE'S HEADLINES

Rhode Island Supreme Court Adopts Balanced Rule in Announcing Duty Owed by Accountants to Third Parties

A Primer on “Piercing the Corporate Veil” Decisions

Employer Alert: DOL Issues New Opinion on Expanding Benefits Under the FMLA


RHODE ISLAND SUPREME COURT ADOPTS BALANCED RULE IN ANNOUNCING DUTY OWED BY ACCOUNTANTS TO THIRD PARTIES

In a recent decision, the Rhode Island Supreme Court adopted “the most sensible middle-of-the-road approach” for determining what duty is owned by accountant/auditors to non-client third parties. The case, The Rhode Island Industrial-Recreational Building Authority v. Capco Endurance, LLC et al., No. 2017-229-A (R.I. Mar. 26, 2019), involved the review of a summary judgment decision in favor of the accounting firm Feeley & Driscoll, P.C. (“Feeley”). The plaintiff, Rhode Island Industrial-Recreational Building Authority (“RIIRBA”) alleged that it relied on 2009 audited financial statements that Feeley had prepared for Capco in deciding to approve a credit increase for Capco in 2011. Importantly, the financial statements were prepared for use by Capco, but were later provided to RIIRBA. Ultimately, Capco failed to make payments on the bonds that RIIRBA had insured, thus triggering RIIRBA’s obligations as insurer. RIIRBA alleged that but for the audited financial statements prepared by Feeley—which RIIRBA alleged were negligently prepared—RIIRBA would not have consented to the credit increase.

The singular issue before the Court was whether or not Feeley owed a duty of care to RIIRBA, a third party that was not at the relevant point in time a client of Feeley. The Court first identified the three prevailing tests used by other courts to determine the extent of the duty owed by accountants to third parties: (1) the near-privity test, which limits accountants' exposure to parties with whom they are in a relationship with that approaches privity; (2) the known users or the Restatement rule, which limits liability to third parties that the accountant knows will receive the information and only for such transactions that are the same or substantially similar to the one which the accountant knows will be influenced by the information; and (3) the reasonable foreseeability rule, which opens liability to any person the accountant could have reasonably foreseen would obtain and rely on the information. The Court noted that the near-privity test was too restrictive, while the reasonable foreseeability rule was too expansive; instead, the Court opted for the Restatement rule, which the Court stated “strikes the appropriate balance between the open-ended nature of the reasonable foreseeability rule and the overly constrained near-privity rule.”

In applying the Restatement rule to the case at hand, the Court determined that Feeley did not owe a duty of care to RIIRBA and affirmed the judgment of the Superior Court in favor of Feeley. Going forward, accountants and recipients of accountants’ work product should be aware of the limits and exposure created by this duty. For further information on this issue, please contact Attorney Patrick J. McBurney at 401-824-5100 or email pmcburney@pldolaw.com.

[back to top]


A PRIMER ON “PIERCING THE CORPORATE VEIL” DECISIONS

The phrase, “piercing the corporate veil,” relates to a circumstance in which a claimant is attempting to hold individuals (shareholders or members) liable for the debts and/or obligations of the entity. This issue is also confronted in a parent-subsidiary structure when the claimant is seeking to hold the parent liable for the debts and obligations of the wholly owned subsidiary. Courts are faced with applying a balancing test in deciding as to whether or not the corporate veil should be pierced in the above described circumstances. The factors to be reviewed and method of applying the balancing test may vary from state to state; however, most state law or court decisions proclaim that the piercing of the corporate veil to expose shareholders and members to personal liability should be an extra-ordinary event. The Rhode Island courts generally apply a balancing test on a case-by-case basis, which is a similar approach to Delaware, by considering the following factors:

• Capitalization of the entity;
  
• Interlocking boards;
  
• Who are the officers and what is their authority;
  
• Do the shareholders/members share premises with the entity;
  
• Do they not deal together at arm’s length;
  
• Is there confusion in the marketplace over the entity being part of the shareholder;
  
• Were corporate formalities observed, including keeping of separate financial and corporate records;
  
• Did the shareholder regularly siphon off cash of the entity;
  
• Did the shareholder provide or arrange the entity’s capital in the form of loans so that the corporation was “thin”;
  
• Did the entities use separate attorneys and professionals;
  
• Were employees shared;
  
• Did the shareholder guarantee the debts of the entity; and
  
• Does the fact pattern smell of fraud or sharp practices by which a counterparty would be misled to economic disadvantage?

In a parent-subsidiary structure, the analysis may involve capitalization; i.e., insufficient capital, or the advancing of loans by a parent to a subsidiary in less than arm’s length fashion, which can result in adverse tax consequences. Thin capital in the tax sense is not determinative of a piercing situation in corporate cases; however, this fact may inform a decision maker in applying a balancing test of all factors. Courts are generally reluctant to pierce the corporate veil unless the facts demonstrate that the pierced entity is a sham designed to defraud investors and creditors.

Piercing the veil may occur when a tort has occurred, a contract has been breached, a corporation has been party to a fraud, or when a corporation is a mere agent of shareholders. A common-sense approach would be to answer the following question: Has someone been injured by being misled materially. Rhode Island courts look to inequity, fraud, undercapitalization or in a parent-subsidiary circumstance, the domination by the parent of the activities and decision-making of the subsidiary. To learn more about corporate and compliance legal issues, please contact PLDO Managing Principal Gary R. Pannone at 401-855-2601 or email gpannone@pldolaw.com.

[back to top]


EMPLOYER ALERT: DOL ISSUES NEW OPINION ON EXPANDING BENEFITS UNDER THE FMLA

With the latest pronouncement by the Department of Labor (“DOL”) regarding the Family Medical Leave Act (“FMLA”), employers are wise to review and revise leave policies to ensure that they do not run afoul of the agency’s most recent interpretation of the law.

On March 14, 2019, the DOL’s Wage and Hour Division (“WHD”) issued its first opinion letter (FMLA2019-1-A) of the year concerning the FMLA, specifically prohibiting an employee’s ability to expand the 12-week benefit period of protected leave provided under the FMLA, in two ways:

Employees May NOT Delay the Designation of FMLA-Qualifying Leave
Employers are prohibited from delaying designation of FMLA-qualifying leave once an employee has communicated the need to take leave for an FMLA-qualifying reason. Some employers permit employees to use accrued paid leave prior to designating leave as FMLA-qualifying. Such policies ultimately result in an employee receiving an extended benefit period beyond the 12 weeks provided under the FMLA. See WHD Opinion Letter FMLA2003-5, 2003 WL 25739623, at *2 (Dec. 17, 2003) (“Failure to designate a portion of FMLA-qualifying leave as FMLA would not preempt … FMLA protections). Accordingly, the recent DOL opinion letter clarifies that, “once an eligible employee communicates a need to take leave for an FMLA-qualifying reason, neither the employee nor the employer may decline FMLA protection for that leave … As such, employers may not delay designating leave as FMLA-qualifying, even if the employee would prefer that the employer delay the designation.” (emphasis added).

Employees May NOT Substitute Accrued Paid Leave for Unpaid FMLA Leave to Extend the Benefit Period
Employers may not permit employees to substitute accrued paid leave for unpaid FMLA leave, such that it expands the employee’s 12-week entitlement. According to the opinion letter, “[i]f an employee substitutes paid leave for unpaid FMLA leave, the employee’s paid leave counts toward his or her 12-week (or 26-week) FMLA entitlement and does not expand that entitlement.”

Employers that currently allow employees to either 1) delay the designation of FMLA-qualifying leave, or 2) decide whether to use accrued paid leave during otherwise unpaid FMLA leave, should reconsider such policies to be in compliance with the law. For further information on your organizations leave policies or other business and employment matters, please contact Attorney Meagan L. Thomson at 401-824-5100 or email mthomson@pldolaw.com.

[back to top]