In the corporate world, “pierce” and “veil” are words you don’t want to hear. The whole point of forming a corporation is to avoid individual liability. And so having a judge lift a corporation’s veil of protections to hold the owners personally liable for a judgment against the business is an unsettling prospect.
Veil-piercing can work the other way as well. In reverse piercing, the court holds a corporation liable for a judgment against an owner.
Delaware, a state where more than a million businesses are incorporated, including Facebook and Google, has recognized traditional veil-piercing. But it has never determined whether its laws allow for reverse piercing.
That didn’t stop the 4th U.S. Circuit Court of Appeals from predicting that Delaware law would, in certain situations, allow for reverse piercing. The court made the March 28 ruling in a case pitting DirecTV against a businessman named Randy Coley.
“Veil-piercing has always been this awkward animal because, by its very definition, it’s ignoring the limited liability exceptions. It’s got to be in these rare circumstances” that the courts permit piercing, said Mark Sigmon, a business litigator in Raleigh who reviewed the 4th Circuit’s decision at Lawyers Weekly’s request.
Sigmon added that any lower court in the 4th Circuit that now faces the question of whether it should recognize reverse piercing is “going to find this case pretty persuasive.”
While operating a resort in Virginia, Coley allegedly paid DirecTV for subscriptions for a fraction of the rooms at the resort that were receiving programming and paying Coley for the service. The alleged scheme resulted in a judgment of more than $2.3 million against Coley.
Seeking to collect on the judgment, DirecTV moved to pierce the veil of a Delaware-based LLC that Coley owns by himself. Coley testified that he created his Its Thundertime LLC to hold title to real estate. DirecTV never alleged that the entity was part of Coley’s illegal TV broadcast scheme. The court also did not find that the LLC was created for a fraudulent purpose.
But the 4th Circuit determined that Coley had commingled his money with the LLC and that the corporation was his “alter ego.”
4th Circuit Judge Barbara Keenan, who wrote the unanimous decision, rejected Coley’s assertion that the court had to find that the LLC had a fraudulent purpose to conclude that it was his alter ego. She also rejected his argument that Delaware law doesn’t allow for reverse piercing, even when the corporation is an alter ego of the owner who is on the hook for a judgment.
“Were Delaware to permit courts to hold an alter ego member liable for an entity’s debts without also allowing courts to hold the alter ego entity liable for the member’s debts, fraudulent members could hide assets in plain sight to avoid paying a judgment,” Keenan wrote.
She also stated that “when an entity and its sole members are alter egos, the rationale supporting reverse piercing is especially strong.”
“And because Delaware courts apply the alter ego theory only in exceptional circumstances,” she added, “recognition of reverse veil piercing for the limited purpose of preventing fraudulent conduct would not threaten the general viability of the corporate form in Delaware.”
Coley’s attorney, Robert Shaw of Gordon & Rees in Raleigh, said his client planned to petition for a rehearing before the entire 4th Circuit, but declined to discuss the case. DirecTV’s attorney, John Jamnback, an anti-piracy lawyer at Yarmuth Wilsdon in Seattle, declined an interview request.
A recent law clerk for the 4th Circuit, Travis Hinman, who now practices at Robinson Bradshaw in Charlotte, noted that the court could have asked the Delaware Supreme Court to decide whether its state laws permitted reverse piercing. But she said the 4th Circuit typically only punts to a state court when it is “either really unsure about how the question will turn out or very concerned about the implications of the decision.”
Hinman and law partner John “Buddy” Wester, who specializes in complex civil litigation, said the facts in DirecTV’s case — namely that Coley was the sole owner of the LLC and had commingled funds — made for a compelling argument in support of reverse piercing.
“If the court did not recognize reverse piercing here, what is to prevent a fraudulent member of an LLC from hiding assets in plain sight?” Wester said. “If that had no consequences there can be no valid protection for creditors and others who depend on the integrity of separate enterprises.”
The 30-page decision is Sky Cable LLC v. DIRECTV Inc. (Lawyers Weekly No. 001-056-18). An opinion digest is available at nclawyersweekly.com.