A recent Court of Chancery decision underscores the difficulty, at least in Delaware, of attempting to disregard the separate existence of a legal entity, sometimes referred to as “piercing the corporate veil”—though in the case styled  Verdantus Advisors, LLC v. Parker Infrastructure Partners, LLC, C.A. No. 2020-0194-KSJM, Order (Del. Ch. Mar. 2, 2022), the goal was to “pierce the veil” and disregard the separate existence of a limited liability company. (Although this decision was in the form of an Order, as compared to a more formal Opinion, it remains permissible in Delaware to cite in briefs to an Order.)

We have written before about piercing the corporate veil on these pages, and have referred readers to a definitive book on the topic by this blog’s favorite corporate law professor, whose scholarship is cited by the Delaware courts: Prof. Stephen Bainbridge.

Highlights of the more noteworthy aspects of the pithy ruling in this matter include the following:

  • The Court explained that: “Veil piercing is a tough thing to plead and a tougher thing to get, and for good reason.” Order at 4 (citations omitted.)
  • In addition, the Court added that: “Delaware is in the business of forming entities, and so ‘Delaware public policy does not lightly disregard their separate legal existence.'” Id.
  • Five factors considered in determining whether to pierce the corporate veil are: (1) whether the company was adequately capitalized for the undertaking; (2) whether the company was solvent; (3) whether corporate formalities were observed; (4) whether the dominant shareholder siphoned company funds; and (5) whether, in general, the company simply functioned as a facade for the dominant shareholder.” Id. at 5. (citations omitted.) See n.14 (citing cases for the position that no single factor will suffice; and in order to apply the alter ego theory, the entity must “exist for no other purposes than as a vehicle for fraud.”)
  • Notably, the Court observed that most single-member LLCs don’t follow many formalities for the good reason that there are “few statutorily mandated formalities imposed on those entities.” Order at 5.
  • In conclusion, the Court noted that, in light of its reasoning and holding, it need not address the argument made that veil-piercing theories should be unavailable or extraordinarily limited in the alternative entity context. n.18.

Regular readers of these pages may recall multiple prior blog posts on both veil-piercing and reverse veil-piercing over the last 16 years. Serious students should review the book on the topic by the renowned corporate law scholar, and a friend of this blog, Professor Stephen Bainbridge. The Delaware Court of Chancery recently recognized reverse-veil-piercing in the matter styled: Manichaean Capital, LLC v. Exela Technologies, Inc., C.A. No. 2020-0601-JRS (Del. Ch. May 25, 2021).

Much commentary has already been published about the public policy and related implications of this decision. See, e.g., Professor Bainbridge’s emphasis that the opinion in this recent Chancery ruling only endorses “outside reverse veil piercing and not insider RVP.” See also Keith Paul Bishop’s commentary on the case.  See generally samples of Professor Bainbridge’s  multiple publications on the topic as referenced in many of this blog posts. I typically do not supplement existing extensive commentary on a decision that has already been the subject of many published insights, but because this is a topic of enduring importance, I want to call to the reader’s intention some of the existing commentary.

Of note, in connection with the facts of this case, is the long list of entities involved as parties, and the court’s observance that to disregard the legal entities, it was first required to engage in conventional corporate veil-piercing, as well as reverse corporate veil-piercing by traveling the following route: reaching upwards to the parent, and then downwards to reach wholly-owned subsidiaries. The court acknowledged that the legality of reverse veil-piercing appeared to be a matter of first impression in Delaware. The ruling was in the context of denying a motion to dismiss under Rule 12(b)(6), so we do not yet know the final outcome if the case goes to trial.

The court found that the pleadings sufficiently alleged fraud and injustice that might result, depending on the evidence presented at trial, from abusing the corporate form to avoid collection of a judgment.

The relatively short Chancery opinion in Doberstein v. G-P Industries, Inc., C.A. No. 9995-VCP (Oct. 30, 2015), is noteworthy for its examination and dismissal of a claim for piercing the corporate veil. It is notable not only because the court describes the standard that will be applied in connection with such a claim, but of equal importance is the fact that the court considered and dismissed the claim on a substantive level, but did not dismiss it for procedural irregularities such as, for example, the failure to obtain a judgment against the entity–before bringing such a claim against the underlying individual.

Notwithstanding the reprehensible behavior of the individual behind the entity involved in this case, this opinion also exemplifies how difficult it is to pierce the corporate veil under Delaware law.

 

James T. Walmsley and Christopher W. Sullivan v. Frederick H. Ehmann, Steven Fishman, et al., C.A. No. 1845 EDA 2009 (Pa. Super. Ct. Feb. 28, 2012).

This decision concerns the Pennsylvania Superior Court upholding the Court of Common Pleas ruling not to pierce the corporate veil of a Pennsylvania LLC, and the factors that are considered when determining whether to pierce the veil of a non-corporate entity. [For supplemental reading on the topic of piercing the corporate veil as applied in the LLC context, a professorial discussion is available on these pages here. Highlights of a Delaware Court of Chancery decision on this topic appear on these pages here. Doug Batey writes here about a recent decision by a Federal District Court in New York that did pierce the veil of a Delaware LLC.]

This summary was prepared by a former associate of Eckert Seamans.

Factual Background

In 1998, Frederick Ehmann, a retired attorney, and Steve Fishman, an accountant and a director of ZA Consulting, formed FELD, LLC in Pennsylvania. FELD filed articles of organization, obtained a federal employee identification number, and filed federal tax returns during the years it was operative. Ehmann and Fishman were 50/50 owners of FELD. FELD acquired and became the sole shareholder of 22 Acquisition Corporation, a Pennsylvania corporation formed in 1998 by Healthcare Financial and CCS, and which acquired leasehold interests in nursing homes. FELD’s only business purpose was to hold the stock of 22 Acquisition; it did not have any employees, it didn’t record minutes at any minutes, it didn’t have a bank account, and its few expenses were handled by Ehmann and Fishman.

FELD and 22 Acquisition executed an agreement whereby 22 Acquisition would be FELD’s agent. FELD appointed both members of 22 Acquisition’s board, including: G. Walmsley (Appellant Walmsley’s brother) and R. Scott (an attorney at Appellee Ehmann’s former law firm). The agreement between FELD and 22 Acquisition provided that 22 Acquisition would act as FELD’s agent in all business affairs, and would act solely at FELD’s direction. The agreement also allowed Ehmann and Fishman (FELD’s 50/50 owners) to take operating losses incurred by 22 Acquisition, thereby providing them with a tangible tax benefit.

Healthcare Financial, one of 22 Acquisition’s founders, was a partner of ZA Consulting. CCS, 22 Acquisition’s other founder, was ZA Consulting’s biggest client and a client of Ehmann’s former law firm. 22 Acquisition’s day to day operations were managed by CSS pursuant to a comprehensive management agreement. In its role as manager, CCS hired NovaCare, a therapy provider, to provide services to the nursing homes held by 22 Acquisition.

In 1999, rising health care costs and Medicare’s reduced payment rates  led to serious financial problems for 22 Acquisition, and it was unable to meet its outstanding obligations to its vendors, including NovaCare. By May 1999, when 22 Acquisition’s debt to NovaCare exceeded $750,000, NovaCare terminated its contract with 22 Acquisition and filed a lawsuit against 22 Acquisition and FELD. While the case was pending, 22 Acquisition filed bankruptcy causing NovaCare’s action to be stayed until 22 Acquisition emerged from bankruptcy in 2005. NovaCare was then able to obtain separate judgments against 22 Acquisition and FELD for almost $2 million. These judgments were ultimately assigned to James Walmsley and Christopher Sullivan, the Appellants.

Procedural History

Appellants filed suit against Ehmann and Fishman to pierce FELD’s corporate veil and enforce the judgments against them personally. Fishman settled with the Appellants before trial, and the court ruled against piercing the corporate veil as to Ehmann following a bench trial. On appeal, the Appellants challenge the trial court’s consideration (or lack of consideration) of certain factors in making its decision, and ask the court to determine whether creditworthiness, undercapitalization, and violations of public policy should be among the factors weighed in determining whether to pierce the corporate veil of a Pennsylvania LLC.

Legal Analysis

“Piercing the corporate veil is a ‘means of assessing liability for the actions of a corporation against an equity holder in the corporation.’” Pennsylvania has a strong presumption against piercing the corporate veil, and the courts will recognize and uphold the corporate entity “unless specific, unusual circumstances” require otherwise. These corporate principles apply equally to LLCs.

Pennsylvania courts consider many factors in determining when it is appropriate to disregard the corporate (or LLC) form and pierce the veil, including: “(1) undercapitalization; (2) failure to adhere to corporate formalities; (3) substantial intermingling of corporate and personal affairs; and (4) use of the corporate form to perpetrate fraud.” These factors focus on actions and conduct that could justify disregarding the corporate form, and particularly consider the actions of the control person, to determine whether that person used his control, or used the company’s assets, to further his own personal interests. This list of factors is not exhaustive, and cases involving veil-piercing require a factual evaluation.

Capitalization

The capitalization of a corporation is an important factor and is primarily relevant “for the inference it provides into whether the corporation was established to defraud its creditors” or other improper purposes. However, for capitalization to be a weighty factor, the corporation cannot simply be short on capital, bankrupt, or insolvent; it must be “so undercapitalized that it is unable to meet the debts that may reasonably be expected to arise in the normal course of business.” (Emphasis added). Accordingly, the court looks to the corporation’s capitalization at the time of formation, and whether the capitalization was reasonable for the nature of the business practiced by the corporation.

In this case, FELD was adequately capitalized for its purpose: to hold the stock of 22 Acquisition. FELD didn’t incur debts or liabilities, and therefore, did not require any capital to fulfill its corporate purpose.

Corporate Formalities

The court determined that in the context of an LLC, “[c]ertain corporate formalities may be relaxed or inapplicable to limited liability corporations . . . ,” since LLCs aren’t required to adhere to the same strict formalities as corporations. The court also noted that a lack of corporate formalities alone is not sufficient to pierce the corporate veil; there must be some “serious misuse of the corporate form.”

As an LLC, FELD was not required to adhere to strict corporate formalities. FELD met the requirements for forming and maintaining an LLC in Pennsylvania, including filing a certification of formation and paying federal taxes. Adherence to further or additional formalities was not required.

Substantial Intermingling of Corporate and Personal Affairs

The record in this case did not show any intermingling of FELD’s assets and Ehmann’s assets.

Use of the Corporate Form to Perpetrate Fraud

Ehmann did not control FELD, and therefore, could not have used the company to perpetuate fraud. FELD was managed/controlled by 22 Acquisition pursuant to the agency agreement between the companies, and 22 Acquisition’s business was managed/controlled by CCS. The debt due to NovaCare by 22 Acquisition was due to CCS retaining NovaCare—and Ehmann had no involvement in CCS’s decision to retain NovaCare, or CCS’s decision not to pay NovaCare its fees.

Because the court concluded that the facts were insufficient to overcome the strong presumption against piercing the corporate veil, the court affirmed the trial court’s decision.

Professor Ann E. Conaway, a distinguished professor at the Widener University Law School, has provided scholarly insights here about her disagreement with some Delaware decisions in terms of how they approach piercing the veil of an LLC and why the analysis should not be the same as would apply to piercing the corporate veil. An excerpt from the good professor’s post follows:

… In light of the recent Delaware Supreme Court opinion in CML V v. Bax, the Supreme Court made clear that investors have a “choice” between a corporation and an unincorporated entity. That choice, according to the Supreme Court, affects the law that applies to the entity. As the Supreme Court made obvious in CML V, corporate law has no place in Delaware LLCs….

The CML V v. Bax decision referenced above was highlighted on these pages here.

Supplement: Prof. Bainbridge comments on Prof. Conaway’s post here. Rebuttal by Prof. Conaway posted here.

Professor Stephen Bainbridge posts here about his scholarly writings in which he argues in favor of abolishing the doctrine of piercing the corporate veil, especially in the LLC context. The good professor also refers to, and links to, an analysis of the topic by Dutch lawyer Jaap Barneveld of The Defining Tension blog, who concludes that the case law in the US on this topic is, at best, lacking in coherence.

 In Winner Acceptance Corp. v. Return of Capital Corp., (Del. Ch., Dec. 23, 2008), read  44-page opinion here, the Chancery Court decided that it had equitable jurisdiction (where it raised the issue sua sponte), over whether the allegations in this case were within its limited parameters. Importantly, there was no specific allegation or request for relief that mentioned the phrase "piercing the corporate veil" but the court noted that no special talismanic words were needed to invoke its jurisdiction and that instead it looks to the essence of the claims made and the relief sought. 

The gist of the complaint was that the individual shareholders should be held personally liable for their fraudulent activities despite the conventional protection of the corporate shield.
The court described the criteria that it will apply to determine whether a claim for "piercing the corporate  veil" will be allowed to proceed, as it was in this case. See footnotes 24, 27 & 29.

 Also addressed were the following claims and issues:

  • Under certain circumstances, the requirement pursuant to Chancery Rule 3(aa) that  all complaints be verified can be satisfied by the attorney as agent for the plaintiff, though in this case the original complaint was amended with the verification of the party being added shortly after the original filing;
  • fraud v. equitable fraud (footnote 56);
  • unjust enrichment;
  • statute of limitations for the above claims; and
  • Indispensable parties pursuant to Chancery Rules 19 and 12(b)(7).

UPDATE: The Wall Street Journal online today highlighted this post here.

Westmeyer v. Flynn,  2008 WL 2152498 (Ill.App., 1st Dist., May 20, 2008). Courtesy of famed Chicago bankruptcy lawyer Steve Jakubowski, this decision  by the Appellate Court of Illinois, First District, Second Division, read opinion here, determined that Delaware law would recognize the concept of piercing the corporate veil in the context of an LLC. However, the 2 or 3 Delaware cases cited by the court are not directly on point in my view. Curiously, the court relies for its conclusion more heavily on opinions by the courts of other states applying Delaware law.  I think that a more nuanced approach is necessary  before one commences a wholesale application to the LLC context of piercing the corporate veil. As we have discussed on these pages frequently, not all the "conventional corporate analyses are automatically subject to being imposed onto the separate LLC framework."
See generally, Donald Wolfe and Michael Pittenger, Delaware Corporate and Commercial Practice in the Delaware Court of Chancery at Section 2.03[b][1][iii] (2008)(discussing  the concept of piercing the corporate veil generally as applied to corporations).

 Midland Interiors, Inc. v. Burleigh, et al. (Del. Ch., December 19, 2006), read opinion  here.  This is one of the few cases where the Chancery Court has pierced the corporate veil to find the shareholder of the corporation responsible for the corporate debt. The threshold in Delaware to reach that result is very high.  A review of the detailed egregious facts supports this rare relief which is very difficult to obtain in Delaware.  The factual basis includes a finding by the court of, inter alia, fraud, as well as failure to follow corporate formalities and failure to pay the annual franchise tax, among other abuses by the defendant who was the sole stockholder, sole director, sole officer and sole employee.  The court made the sole stockholder responsible for the judgment that was obtained previously against the corporation.  See generally, Stephen M. Bainbridge, Abolishing LLC Veil Piercing, 2005 U. Ill. L. Rev. 77, 77 (2005)(Piercing the veil is a “seriously flawed doctrine,” “one of the most befuddled [areas of the law],” and is beset by “uncertainty and lack of predictability); Franklin A. Gevurtz, Piercing Piercing: An Attempt to Lift the Veil of Confusion Surrounding the Doctrine of Piercing the Corporate Veil, 76 Or. L. Rev. 853, 853 (1997). A prior decision in the case was posted here.

UPDATE: Prof. Chiappinelli has a more detailed commentary on the case here.

ASIDE: My schedule for the next few days is quite hectic, so  the several case summaries I have to post will need to wait until I take care of my paying clients.