Reverse veil-piercing has become a limited means to remedy fraud and injustice between shareholders and corporations.
Reverse piercing of the corporate veil occurs when a claimant seeks to hold a corporation liable for the obligations of an individual shareholder.[1] Instead of holding an individual responsible for corporation acts, reverse veil piercing seeks to satisfy an individual’s debt through the assets of an entity of which the individual is an insider.[2] As the doctrine has evolved, two types of reverse veil-piercing are now recognized: insider and outsider reverse veil-piercing. Insider reverse veil piercing is where “the controlling member [] urges the court to disregard the corporate entity that otherwise separates the member [] from the corporation.”[3] Outsider reverse veil-piercing is implicated where “an outside third party, frequently a creditor, urges a court to render a company liable in a judgment against its member.”[4] Moreover, so long as the law allows associated groups to maintain an independent unity, the sanction of reverse veil piercing is not easily evaded.[5]
Courts declining to allow reverse veil-piercing have primarily relied on a desire to protect innocent parties.[6] This was revealed through two noteworthy cases: Acree v. McMahan and Postal Instant Press, Inc. v. Kaswa.[7] In Acree, the Supreme Court of Georgia rejected reverse veil-piercing and held reverse veil-piercing would facilitate harm, through judicial decree, to innocent shareholders and third-party creditors could not adequately be managed by the courts. In Postal Instant Press, a California appellate court rejected reverse veil-piercing on similar grounds.[8] The well-founded concerns emanating from these cases stress the potential to bypass normal judgment collection procedures by permitting the judgment creditor of a parent to jump in front of the subsidiary’s creditors.[9] More importantly, “to the extent that the corporation has other non-culpable shareholders, they obviously will be prejudiced if the corporation’s assets can be attached directly.”[10]
The risks that reverse veil-piercing may be used as a blunt instrument to harm innocent parties does not justify its outright rejection.[11] Rather, the recognition of the risk creates an opportunity to manage them, and to do so in a matter that serves the interests of equity. At their most basic level, traditional and reverse veil-piercing claims both seek to prevent the same sort of wrongdoing: abuse of the corporate form and fraud.[12]
As a matter of first impression, the Delaware Court of Chancery held in Manichean Cap. reverse veil-piercing is a delicate means to remedy fraud in the most “exceptional circumstances.”[13] The natural starting place when reviewing a claim for reverse veil-piercing are the traditional factors Delaware courts consider when reviewing a traditional veil-piercing claim such as insolvency, undercapitalization, and commingling of corporate and personal funds.[14]
Then, the court should then ask whether the owner is utilizing the corporate form to perpetuate fraud or injustice. This involves a focus on several factors such as “(1) the degree to which allowing a reverse pierce would impair the legitimate expectations of any adversely affected shareholders who are not responsible for the conduct of the insider that gave rise to the claim, and the degree to which allowing a reverse pierce would establish a precedent troubling to shareholders generally; (2) the degree to which the corporate entity whose disregard is sought has exercised dominion and control over the insider who is subject to the claim by the party seeking the reverse pierce; (3) the degree to which the injury alleged by the person seeking a reverse pierce is related to the corporate entity’s dominion and control of the insider, or to that person’s reasonable reliance upon a lack of separate entity status between the insider and the corporate entity” and many others.[15]
In conclusion, reverse veil-piercing is a delicate, but also a strategic tool in the arsenal of securities litigation.
[1] United States v. Boyce, 38 F. Supp. 3d 1135 (C.D. Cal. 2014).
[2] Curci Invs., LLC v. Baldwin, 221 Cal. Rptr. 3d 847 (Cal. Ct. App. 2017).
[3] Sky Cable, LLC v. DIRECTV, Inc., 886 F.3d 375, 385 (4th Cir. 2018).
[4] Id. at 386.
[5] Kingston Dry Doc Co. v. Lake Champlain Transp. Co., 31 F.2d 265 (2d. Cir. 1929).
[6] Manichaean Cap., LLC v. Exela Techs., Inc., No. CV 2020-0601-JRS, 2021 WL 2104857, at *10 (Del. Ch. May 25, 2021).
[7] Acree v. McMahan, 585 S.E.2d 873 (Ga. 2003) (rejecting reverse veil-piercing); Postal Instant Press, Inc. v. Kaswa Corp., 77 Cal. Rptr. 3d 96 (Cal. Ct. Appt. 2008).
[8] Postal Instant Press, supra.
[9] Id.
[10] Id. at 103.
[11] Manichaean Cap., 2021 WL 2104857, at *12.
[12] Id. at *11.
[13] Id. at *13.
[14] Id.
[15] Id.