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.

 

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.

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).

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A recent Delaware Court of Chancery opinion explained the meaning of undefined terms in a limited partnership agreement which required the general partner in the Limited Partnership to use “best efforts” and “sound business practices.” In connection with claims that the general partner breached the agreement, the court in Wenske v. Blue Bell Creameries, Inc., C.A. No. 2017-0699-JRS (Del. Ch. July 6, 2018), explained that it would use dictionary definitions to help illustrate the meaning of those undefined terms. See page 25 and footnotes 91 to 93.

The court did not refer to the more common standard of “commercially reasonably efforts”, but that somewhat related contractual standard has been discussed in cases highlighted on these pages. Instead, the court’s application of dictionary definitions of the terms “best efforts” and “sound business practices” were applied to deny the motion to dismiss for breach of contract.The court also provided helpful contract interpretation principles in connection with how to define terms not defined in an agreement. See footnote 25.

Additional Noteworthy Principles Applicable to Commercial Litigation:

  • The court reiterated the well-known Delaware principle that unless expressly disclaimed, alternate entities such as limited partnerships will be subject to default fiduciary duties. See footnote 3.
  • The court explained that when fiduciary duties are disclaimed, and a new contractual standard is inserted to replace default fiduciary standards, the appropriate nomenclature for a claim for breach of that standard is a simple breach of contract, and not a breach of a “contractual fiduciary duty.” See pages 35 and 36.
  • The court observed in passing what the elements of a claim for piercing the corporate veil are, and even though the plaintiffs did not use that terminology, that is how the court interpreted their claim. The court described why the elements for such a claim were not met. See pages 37 and 38.
  • In connection with granting the motion to dismiss the claim for breach of fiduciary duties, the court discussed the well-recognized concept in Delaware that the controllers of a corporate general partner of a limited partnership may owe fiduciary duties to the limited partnership, if such persons exercise control over the limited partnership’s property—but that claim cannot be made if the limited partnership disclaims all fiduciary duties. See pages 42 and 43 and accompanying footnotes. The Delaware decision that articulated that cause of action against controllers of a corporate general partner of an L.P.is known as In re USA Cafes, L.P. Litigation, 6 A.2d 43 (Del. Ch. 1991).

The Court of Chancery recently allowed, after trial, a claimant to disregard the corporate entity, which the court found was involved in a fraudulent conveyance. The case styled: Fringer v. Kersey Homes, Inc., C.A. No. 9780-VCG (Del. Ch. June 25, 2018), begins with the following three sentences:  “The great advantage of the corporate form is that it permits investment and ownership without risk of personal liability for entity debt.  This advantage has its limits, obviously.  One such limitation is involved here.” (FYI: There is no typo in the Plaintiff’s name in the above case caption.)

For those interested in the topic of “piercing the corporate veil,” friend of the blog, Professor Stephen Bainbridge, has co-authored a book that includes an in-depth scholarly analysis of the topic. The good professor has published a lengthy list of books and articles on corporate law that are often cited by the Delaware courts.

Although the net result is the same, this decision does not undertake a “conventional analysis” that directly addresses piercing the corporate veil, and the facts of this case are not likely to be repeated, but a number of more traditional “piercing the corporate veil” cases have been highlighted on these pages over the last 13 years.

Brief Background:

The corporation involved, Kelsey Homes, Inc., was a defendant in a prior lawsuit based on allegations of fraud in connection with an agreement to sell a modular home. At the time of that agreement, Kelsey Homes, Inc. was “moribund.”  By the time trial approached in the prior fraud suit, its only asset was the modular home at issue in the litigation.  Kersey Homes, Inc. had transferred its only asset in a back-dated bill of sale to a relative of one of the stockholders, and then defaulted on the fraud action.

The court found that the stockholders of the corporate defendant were wrong when they thought that a judgment against the now-insolvent Kersey Homes, Inc. would be beyond the reach of the resulting judgment creditors.

The court held that the “sale” of the only corporate asset to a related party was a “sham” and the transfer was fraudulent under Delaware’s Uniform Fraudulent Transfer Act. The court granted the plaintiff in this case  a levy on the property, to receive the sales proceeds in an amount sufficient to satisfy the judgment.

Procedural History:

The prior fraud suit against Kersey Homes, Inc. regarding the sale of the modular home, resulted in a judgment being entered by the Superior Court.  Although Kersey Homes, Inc. had initially defended the Superior Court action, shortly before trial they informed the court that they would not defend it.  The modular home that was the subject of the Superior Court lawsuit, was transferred by Kersey Homes, Inc. to an affiliated party in exchange for discharging a prior debt of Kersey Homes, Inc.  This transfer of the only asset of Kersey Homes, Inc. was made about one year into the litigation over the home that was the subject of the transfer and about two months prior to judgment being entered shortly before the trial date.

The instant litigation in the Court of Chancery was commenced about two weeks after the judgment was obtained in the Superior Court. The Chancery complaint sought relief against Kersey Homes, Inc. (which filed a certificate of dissolution several months after the Chancery complaint was filed), as well as the principal stockholder of Kersey Homes, Inc. and the related party that had received the fraudulent transfer.  Kersey Homes, Inc. did not defend the Chancery litigation.

The court did not believe the testimony of the principal stockholder in part because the transfers were not documented and the only person available to testify about the transfer was the transferor.

The court determined that a more likely explanation for what happened was that the principals of Kersey Homes, Inc. realized they might be liable for a judgment and decided to take steps to evade any judgment that might be obtained. At the time of the fraudulent transfer, Kersey Homes, Inc. was already out of business and insolvent, without assets to satisfy a judgment.  But about a year earlier, the only asset of Kersey Homes, Inc. had been transferred for no consideration.  In an effort to defend a potential fraudulent conveyance claim, the principals of Kersey Homes, Inc. attempted to cover their tracks and create a story about a backdated transfer one year earlier.  The court found that those transfers were intended to avoid execution on a judgment.

Key Legal Principles:

The court reviewed the elements of a claim under the Delaware Uniform Fraudulent Transfer Act (“DUFTA”) whose purpose the court described as providing a remedy to creditors who were defrauded by debtors who transfer assets or incur obligations with the intent to hinder, delay or defraud any creditor or, without receiving reasonably equivalent value. The court described the elements of a claim as recited in Section 1304(a) of Title 6 of the Delaware Code.

There are eleven factors that the statute lists as non-exclusive factors to consider in determining whether there was actual intent to defraud. It is not necessary that all the factors support a finding of intent.  In this case, the court found that seven of the factors supported a finding of actual intent to defraud.

The court also found that Kersey Homes, Inc. violated Section 1305(a) which provides that a transfer is fraudulent as to a creditor whose claim arose before the transfer was made, if the debtor made the transfer without receiving a reasonably equivalent value or the debtor became insolvent as a result of the transfer. See footnote 117.

The opinion also discussed the broad latitude that a court has to craft a remedy subject to applicable principles of equity. Even though the original judgment was against a defunct corporation, the court traced the fraudulently transferred assets of the corporation to its current owner who was a stockholder in that corporation.

In sum, the court allowed the plaintiff to levy execution on the home involved in order to satisfy the judgment obtained in the Superior Court. The court also required the defendants to account for rental receipts on the house, and to the extent the sale of the property is insufficient to satisfy the judgment, the shortfall shall be made up from the rental receipts.

Because of a statute that applied in the Superior Court to grant treble damages for consumer fraud on senior citizens, the court found it inequitable to depart from the American Rule on fees.

Professor Stephen Bainbridge, a nationally-recognized corporate law scholar whose scholarship has been cited in the opinions of Delaware courts, has added another book to the list of his prolific publications. He has co-authored with Professor Todd Henderson, a book entitled “Limited Liability: A Legal and Economic Analysis“. It has been favorably reviewed in The Economist magazine, and the publisher’s flyer has additional details.

For those interested in the latest cutting-edge analysis of LLC law by leading experts, this book should be on your shelf. One of the gems found in this book is a discussion of how the concept of piercing the corporate veil is applied in the context of an LLC for purposes of imposing personal liability on an LLC member.

In Re: Dole Food Co., Inc., Stockholder Litigation, Cons., CA. No. 8703-VCL (Del. Ch. Feb. 27, 2015). This Delaware Court of Chancery opinion concluded after careful reasoning that in order to serve as an expert witness, one must have a body and a brain and, therefore, a corporation as an entity cannot serve as an expert. This opinion provides a useful review of the rules of evidence that require a human being to serve as a witness, and the truism that a corporation can only act through its agents, but a witness cannot act through an agent, or if stated differently, a witness cannot testify through a proxy. For example, due to its incorporeal nature, a corporation cannot satisfy the statutory requirement that a person take an oath “with uplifted hand.”

The court described the corporation as being a purely metaphysical creature, despite other contexts in which the law “appropriately personifies corporations.” In this context the net result is that the expert witness who was an agent of the corporation was entitled to testify on its own behalf.

My initial reaction is that this holding is not necessarily inconsistent with the recent Supreme Court decision in Hobby Lobby, and related observations by legal experts such as Professor Bainbridge who have observed that based on the “reverse veil piercing theory”, and other theories, an entity controlled by a natural person may be considered to be acting through that entity for purposes of expressing or complying with individual religious beliefs.

This decision is a small aspect of a consolidated case now in the middle of trial on both appraisal and fiduciary claims in connection with a going private transaction involving Dole.