Editor’s Note: This story is from Working RE HomeInspector’s latest May 2017 print magazine! OREP insureds](http://orep.org/home-inspectors-eo-insurance/) receiveguaranteed delivery.
$300,000 Lawsuit: Piercing Corporate Veil
By Isaac Peck, Editor
In what may be one of the largest public judgmentsagainst a home inspector in recent years, a $300,000 jury verdict in the caseof Mellem vs. Standard Home Inspections, Inc. et al. is a sobering look at whatis at stake when an inspection is performed poorly and how little liabilityprotection incorporating actually affords (Montana Fourth District Court, CauseNo. DV-14-257).
The suit names Standard Home Inspections, Inc.(SHI—name changed for privacy reasons), a corporate entity, and the entity’sfounder, president, and sole home inspector, Tom Smith (name changed forprivacy reasons). In what quickly became an exercise in “piercing the corporateveil,” this case provides a stark warning for inspectors who believe thatincorporating is a foolproof way to limit their personal liability and protecttheir personal assets.
The Mellems hired SHI, owned and operated by Smith, toperform a professional home inspection before they finalized the purchase oftheir home in August 2013. After purchasing the property, the Mellemsdiscovered a number of defects in the property that were not disclosed in thehome inspection report. The suit, filed by C.J. Johnson from the law firmKalkstein, Johnson, and Dye P.C., alleges that Smith failed to identify gradingand drainage defects, structural defects in basement framing and supports,evidence of long-term moisture problems in the basement, residual mold in thebasement and attic, and defects in the siding and gutters.
**After gathering evidence, the plaintiffsfocused much of their attack on the fact that Smith failed to note significantstructural problems in the basement, including a missing king jack stud,missing structural headers, and large holes through joists, and more.
The deposition of inspector Smith is revealing inregards to the alleged errors and omissions made about the property’sstructural problems. In his deposition, Smith admits that he entered thedownstairs bathroom and did not even look up at the ceiling. This caused him tomiss, among other things, several openly exposed and readily-visible joistswhich were broken, had rectangular cuts and holes or were missing altogether.
Smith ultimately claimed that he had no memory ofseeing the structural problems during his inspection, causing the Mellems toargue that he “exercised no care” and “effectively skipped” this portion of hisinspection while falsely marking the framing “acceptable” in his report.
**Water Damage **
In addition to failing to mention any structural damage, the Mellems arguedthat Smith failed to report “extensive and significant evidence” of outsidewater intrusion and water damage in the basement, including efflorescence, alsoknown as salt staining, rusted foundation wall metal, rust weep down thebasement walls and stained and rotted wood.
The deposition of the inspector regarding the waterdamage is also quite surprising. In his testimony, Smith admits to observingrusty metal in the foundation, rusty snap ties and a trail of rust “weepingdownwards toward the floor,” but confesses that he did not take any pictures ofthese conditions or mention them in his report. Despite significant and readilyvisible evidence of moisture and water intrusion, including wood rot, he failedto call out the defects.
The plaintiffs ultimately used Smith’s testimony toargue that the inspector had left large areas uninspected and had effectively“admitted negligence” with regards to the structural problems and the evidenceof water intrusion and damage.
**Corporate Veil **
Smith’s attorneys initially argued that much of what Smith was being sued forwas outside of the scope of the home inspection, but as the case progressedthey began to lean heavily on the argument that as a corporate officer, Smithshould not be liable for the contract breach of SHI, the corporate entity, andconsequently was not accountable for the alleged mistakes. Corporate officersand agents are shielded from personal liability “for acts taken on behalf ofthe corporation in furtherance of corporate goals, policies and businessinterests,” his lawyers argued.
The lead attorney representing the plaintiffs argued thatthis rule does not apply in this case because “the exception to this policy iswhere the officer personally committed a tort: a wrongful act or aninfringement of a right (other than under contract) leading to civil legalliability.” In other words, the corporate protection does not shield corporateofficer Smith from personal responsibility because he himself made the errorand/or omission.
The plaintiff’s attorney cites a number of differentlegal cases to support the finding that Smith should be held personally liablefor his negligence: “It is well settled that an individual member of a limitedliability company or an office of a corporation may be individual liable forhis or her own torts, including negligence.” (Wilson v. McLeod., 327 N.C. 491)
“A corporate agent cannot shield himself from personalliability for a tort he personally commits or participates in by hiding behindthe corporate entity; if he is shown to have been acting for the corporation,the corporation also may be held liable, but the individual is not therebyrelieved of his own responsibility.” (Sturm v Harb Dev., LLC, 2 A.3d 859)
In other words, if an agent of a corporation or an LLCcommits a tort, they can be held individually liable. A tort is defined by theCornell University Law School as “an act or omission that gives rise to injuryor harm to another and amounts to a civil wrong for which courts imposeliability.” There are a number of different kinds of torts, and to the extentthat a lawyer can prove that a corporate officer committed a tort, personalliability exists.
In this case, the plaintiff’s lead attorney arguedthat Smith should be personally liable because his actions were negligent andagainst the best interests of the corporation. Under Montana law, where the inspectionwas conducted, if an officer of a corporation “acts against the best interestsof the corporation, for his own pecuniary benefit, or with the interest to harmthe plaintiff, he/she is personally liable.”
The jury ultimately did find that SHI and Smith were negligent, and Smithconducted his home inspection in a manner that was “against the best interests”of his corporation, SHI. Smith was consequently held liable as an individual,with a jury finding that his poor home inspection performance constituted“unfair or deceptive acts or practices” which violated the Montana HomeInspection Trade Practices Act and the Montana Consumer Protection Act.
Under Montana law the judge has the option ofincreasing the award by triple and awarding attorneys’ fees for any verdictthat is a violation of the state’s Consumer Protection Act. The Mellems wereawarded $300,000 in damages and attorney’s fees. The case was thereaftersettled confidentially, but if the court had ultimately issued a ruling on theverdict, this amount could have been tripled to $900,000, plus attorney’s fees.
LLC or Corporation: How Much Protection Is There?
**The case of SHI and Tom Smith is acompelling example of how the “corporate veil” can be pierced but it does notmean that corporate forms of organization are categorically useless for homeinspectors. Indeed, the degree of negligence involved directly relates to howeasy it is for opposing counsel to “pierce the veil” in the manner described inthis case. In other words, if the inspector is grossly negligent and it isreadily apparent to a jury that obvious defects in a property were missed, itis much easier to prove that the inspector should be personally liable. And itcan be asserted that he/she acted against the best interests of the corporateentity. If the claim of negligence is not as clear cut, the plaintiff’sattorneys will have a much harder time proving personal liability.
Additionally, home inspector attorney Joseph Dennelerexplains that state licensing laws also play an important role in whether aninspector can be held personally liable. “Generally, inspectors in licensedstates are individually liable for their actions regardless of whether theyoperate under a corporate entity. They are individually responsible forinspecting to their state’s standards of practice. That is why E&Oinsurance is so critical. There is no way to hide personal assets except thatin many states there is a homestead exemption and/or an exemption for allmarital property.”
E&O insurance is really the only way to protectyour assets, says David Brauner, Senior Broker at OREP. “I have been in thisexact position. When I was forming OREP I asked everyone I could find foradvice—my CPA, my attorney and my mentor at the Small Business Administrationwhether I should incorporate to protect the few assets I had at the time—namelymy house. To a person, they all said incorporating may have other benefits butfor liability protection, E&O is the best protection. That, and beingcareful,” Brauner said.
The state-specific nature of these legal argumentsmeans that home inspector licensing laws (or their absence), usually have a centralrole in the proceedings. In the New Jersey case of Kinoian v. Independent HomeInspection Service, Inc., homebuyers sued their home inspection company afterdiscovering asbestos in their home a year after the purchase. The homeinspection was performed in 1993. The appeals process dragged on until 2004. Atthat time, a New Jersey Appellate Court rejected the plaintiff’s attempt tohold the individual home inspector liable, in part, because the inspection wasprior to state licensing laws taking effect, ruling that the inspector “did notviolate any duties specifically imposed by law.”
The Appellate Court addressed the common comparisonbetween home inspectors and doctors, lawyers, and other licensed professionalsthis way: “So too, certain professionals, such as doctors, lawyers, andaccountants have been found liable under both tort and contract theories foreconomic losses causes by misrepresentations during contractual relationships.Such liability, however, has not been broadly extended to other classes ofservice providers and is apparently premised upon duties specifically imposedby law (emphasis added). We find no basis on the present record to now includehome inspectors within the class of those subject to that wider liability.”
In other words, because home inspector licensingdesignates specific duties and responsibilities to individuals who practice ashome inspection professionals, licensing also potentially subjects inspectorsto increased liability because, similar to doctors, lawyers or accountants,licensed inspectors have “duties specifically imposed by law” which they arebound to as individuals. Just as a doctor working for a corporation might beheld individual liable for violating his standards of practice, inspectors inlicensing states are also bound by law and can be found liable under tort andcontract theories if found to be Working RE Inspector Summer 2017 9 grosslynegligent or acting in violation. It’s important to note that in Montana, thestate where this suit occurred, there is no home inspector licensing program.However, Montana has passed the Montana Home Inspection Trade Practices Act,which outlines the duties and responsibilities of a home inspector.
**Liability Bottom Line **
Despite the arguments against the effectiveness of incorporating for homeinspectors, some experienced attorneys point out that there is little downsideto forming a corporation. Doing business through a corporation has likely nevermade a home inspector more liable, they argue, and in some cases has successfullyprotected the inspector as an individual. So despite its less than ironcladprotection, inspectors arguably are at least more protected when doing businessin a corporate form. But incorporating may be more costly depending on yourstate. It’s best to ask your accountant.
Todd Stevens, veteran home inspector trial lawyer andpast President of the San Diego Bar Association, says that while not effectivein every case, a corporate form can still be useful. “Corporate formation is anadditional layer of protection for inspectors. You certainly aren’t going to bescot-free just because you incorporate but it is another layer of protectionthat I would never discourage anyone from doing. It’s especially useful ifyou’ve got a bigger operation with lots of employees and independentcontractors working for you. There are advantages and disadvantages that varyby state in terms of taxes, so I’d definitely recommend speaking to anaccountant and a lawyer to decide which form is best for you, but as a methodof limiting your liability, it can’t hurt,” says Stevens.
**Other Considerations **
The issues explored here, admittedly, are not the only issues that come intoplay when a plaintiff attempts to “pierce the corporate veil” in ahome-inspector related lawsuit. Lawyers frequently attempt to prove that aninspector’s corporation is a “sham” corporation, and there is no realdifference between the inspector and the corporate entity.
For this reason, home inspectors utilizing a corporateform are advised to observe the required corporate formalities, such as issuingstock, holding shareholder and board of directors meetings, keeping adequateminutes for meetings, and keeping separate financial records and separate bankaccounts—ensuring clear financial boundaries between the individual and thecorporation. The complexity of these issues is beyond the scope of this story,but inspectors interested in limiting their liability through a corporatestructure should research them accordingly and seek professional legal advice.Stay safe out there!
To read the suit and deposition in its entirety, click here.](http://www.workingre.com/300000-lawsuit-piercing-corporate-veil-suit-and-deposition/)