Tuesday, July 26, 2016

Slow Down on the Reverse Veil Piercing of LLCs (Which Are STILL Not Corporations)

Anyone who reads this blog knows that I have issues with how people mess up the distinction between LLCs (limited liability companies) and corporations. In some instances, it is a subtle, likely careless, mistake.  Other cases seem to be trolling me.  Today, I present you such a case: Sky Cable, LLC v. Coley, 2016 WL 3926492 (W.D.Va., July 18, 2016).  H/T: Jay D. Adkisson. The case describes the proceedings as follows: 

DIRECTV asks the court to reverse-pierce the corporate veil and declare that Randy Coley is the alter ego of his three limited liability companies, such that the assets held by those LLCs are subject to the judgment in this case.

Okay, so claiming to pierce the "corporate veil" of an LLC is wrong (it doesn't have a "corporate" anything), but it's also exceedingly common for lawyers and courts to make such an assertion. This case takes the improper designation to the next level.  

First, the court describes the LLCs in questios as "the Corporate Entities."  It then goes on to discuss "Coley's limited liability companies."  Ugh.  The court further relates, "DIRECTV stated that in a forthcoming motion, it would ask the court to reverse-pierce the corporate veil given Coley's abuse of the corporate form."  No such form, but perhaps we can now blame DIRECTV's counsel, in part, for this hot mess.  

Here's the court's Legal Framework: 

Generally, corporations are recognized as entities that are separate and distinct from their officers and stockholders. [Author's note: THERE ARE NO SHAREHOLDERS IN LLCS!] "But this concept of separate entity is merely a legal theory, 'introduced for purposes of convenience and to subserve the ends of justice,' and the courts 'decline to recognize [it] whenever recognition of the corporate form would extend the principle of incorporation "beyond its legitimate purposes and [would] produce injustices or inequitable consequences.' "" DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co., 540 F.2d 681, 683 (4th Cir. 1976) (citations omitted). When appropriate, and " 'in furtherance of the ends of justice,' " a court may pierce the corporate veil and treat the corporation and its shareholders as one, id. (quoting 18 Am. Jur. 2d at 559), if it finds a corporation and its shareholders have misused or disregarded the corporate form, United States v. Kolon Indus., Inc., 926 F. Supp. 2d 794, 815 (E.D. Va. 2013). This is often referred to as an "alter ego theory."

The court continues: "Delaware courts take the corporate form and corporate formalities very seriously.... " Case Fin., Inc. v. Alden, No. CIV. A. 1184-VCP, 2009 WL 2581873, at *4 (Del. Ch. Aug. 21, 2009)." The opinion then states that veil piercing concepts"apply equally to limited liability companies which, like corporations, have a legal existence separate and distinct from its members."  The concept may, but LLCs do not have to follow the same formalities as corporations to maintain separate existence.  Even if veil piercing were appropriate here, the entire case continues to misstate the law of veil piercing LLCs. Note: Delaware courts do hold some blame here: Westmeyer v. Flynn, 382 Ill. App. 3d 952, 960, 889 N.E.2d 671, 678 (2008) ("[U]nder Delaware law, just as with a corporation, the corporate veil of an LLC may be pierced, where appropriate.").

Based on the opinion, it does seems as though the defendant here was being shady, at best, and perhaps outright fraudulent.  I don't suggest that, based on the facts presented, the defendant shouldn't be held accountable for his debts. Still, in addition to the misstatements of the law, I am not sure veil piercing was necessary.  As the court notes, "veil piercing is an equitable remedy and an extraordinary one, exercised only in exceptional circumstances "when 'necessary to promote justice.'"  It seems to me, then, the court (and the plaintiff) should discuss other remedies first, relying only on veil piercing where "necessary." 

As such, I'd like to see a discussion of fraudulent or improper transfer before veil piercing -- did the defendant improperly move assets that should have been available to the plaintiff into an entity? Before veil piercing three entities, it seems to me the court should determine what should have been available to the plaintiff -- if the answer is "nothing" then no amount of shady behavior should support veil piercing.  If there should be assets, then the question should still be "which ones?"  If the answer is all of the assets in all of then entities, then okay.  But if the court is veil piercing three entities merely to ensure adequate recovery, that's an overreach, it seems to me.  In addition, how about reviewing if there was actual fraud in how the defendant acted?  That, too, could support recovery without the extraordinary veil piercing remedy.  

Ultimately, it's possible the court got the outcome right here.  But it clearly got the law wrong.  A lot.  



Corporations, Delaware, Joshua P. Fershee, LLCs | Permalink


Reverse veil piercing of a single member LLC (there was a question of fact regarding whether one of the LLCs was a single member LLC or a two member LLC), in which the sole member is also the sole manager, is hardly troublesome. This isn't a case where the shareholder is being held liable for the debts of the LLCs. This is a case where the creditors of the sole member of each LLC (none of which has anything to do with the events of the lawsuit) can seize the property owned by the LLC of which the sole member is the 100% equitable owner.

In a comparable corporation with a single shareholder, a single director and a single officer, the outstanding shares of the corporation could be seized with a writ of execution, and the purchaser of the shares at a sheriff's sale would have a right to replace the director and officer, and to liquidate the corporation. The remedy in reverse piercing is no more dramatic, and it appears that the defendant had transferred all of his personal assets into the LLCs which had no other business purpose.

The default remedy in lieu of reverse veil piercing of the single member LLC would be to limit the creditors to a charging order against distributions made from the LLC to its member in his capacity as member as a dividend-like distribution. But, when most of the assets are use assets that are personally used by the single member owner and his family for non-business purposes, a charging order would not be effective to deny the single member benefit from the company in the same way that it could in a different sort of company, and placing the decision to make distributions subject to the charging order in the sole discretion of a single member-manager when that individual has a history of litigation and non-litigation misconduct, makes an alter ego finding completely appropriate. The gravamen is an alter ego finding, in this case, as in most, is not failure to have meeting minutes and the like, but failure to distinguish between company property which can only be used for the personal purposes of its members with reasonable compensation, and personal property that is not in the LLC. The court's findings support that analysis.

Posted by: ohwilleke | Aug 3, 2016 3:31:38 PM

As applied, I have little trouble with this, but the fact remains that the transfer into the LLCs was fraudulent. Had there been preexisting assets in the LLC that belonged to the LLC (and should be available to that LLC's creditors), reverse veil piercing would make those assets available to creditors who did not have a right to them. I don't quibble with the outcome here, but I maintain there is a better way to achieve that outcome in a manner that makes future decision making more just, more accurate, and more predictable.

Posted by: Joshua Fershee | Aug 3, 2016 3:37:18 PM

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