Does Delaware law support reverse veil-piercing? The Fourth Circuit says: YES!

By: Oderah C. Nwaeze & Mackenzie M. Wrobel

Although Delaware has not expressly adopted the remedy of reverse piercing of a corporate veil, the United States Court of Appeals for the Fourth Circuit believes that Delaware LLCs may be deemed the alter ego of their sole or controlling equity-holder and held jointly liable for that individual’s (or entity’s) liabilities. Indeed, in Sky Cable, LLC v. DIRECTV, Inc., 886 F.3d 375 (4th Cir. 2018), the Court of Appeals applied reverse veil-piercing to conclude that the LLCs at issue were properly co-debtors to a $2.3 million judgment against the LLCs’ sole member, Randy Coley.

At the trial level, the Western District of Virginia entered a $2.3 million judgment for DirecTV, after finding that Mr. Coley was liable for a fraud scheme involving the unauthorized transmission of DIRECTV’s programming. See Sky Cable, LLC, 886 F.3d at 377. When DIRECTV could not enforce the judgment against Mr. Coley, DIRECTV moved the district court to pierce the corporate veil of three of Mr. Coley’s LLCs, arguing that the LLCs were Mr. Coley’s alter egos. Id. The district court agreed and granted DIRECTV’s motion. Id. Among the reasons for that holding was that: (1) the LLCs were controlled solely by Mr. Coley; (2) Mr. Coley failed to observe corporate formalities and maintain proper accounting records; and (3) Mr. Coley engaged in significant commingling of assets between the LLCs and his personal finances.  Id. at 390.

Mr. Coley appealed to the Fourth Circuit, seeking a holding that Delaware law does not permit the remedy of reverse piercing the corporate veil of an LLC. Id. at 382. Unfortunately for Mr. Coley, the Fourth Circuit affirmed the district court’s holding. Id.

Typically, an LLC’s independent corporate form protects its “member(s)” from personal liability for the LLC’s debts.  See Sky Cable, LLC, 886 F.3d at 385. Still, courts will disregard the corporate form and the legal separation between an LLC and its member(s) when such separation would “produce injustices or inequitable consequences.” Id. Through reverse veil-piercing, for instance, an LLC may be held accountable for the conduct of its sole member as a consequence of serving as the alter ego of the sole member. Id.

Although Delaware courts have not applied the remedy of reverse veil-piercing, the Fourth Circuit predicted that Delaware law allows for that remedy. The primary reason for the appellate court’s conclusion was that Delaware law does not allow an individual to use a company’s corporate form to shield itself from liability and to hinder creditors from collecting on adjudicated claims. See Sky Cable, LLC, 886 F.3d at 387. In Klauder v. Echo/RT Holdings, LLC, 152 A.3d 581 (Del. 2016), for instance, the Supreme Court for the State of Delaware explained that where an entity is a mere alter ego, “to the extent that the Court may engage in ‘reverse veil-piercing,’ the Court may treat the assets of the [entity] as those of the [controlling entity or person] for the purposes of” unwinding or discouraging the fraudulent transfer of assets designed to avoid financial obligations or court judgments. Additionally, the Court of Chancery, in Cancan Dev., LLC v. Manno, stated that a party’s claim “might have prevailed” had it been properly pleaded reverse veil-piercing. 2015 WL 3400789, at *22 (Del. Ch. May 27, 2015), aff’d, 132 A.3d 750 (Del. 2016).

The Fourth Circuit further held that the LLC charging statute in Delaware does not prohibit the remedy of reverse veil-piercing. See Sky Cable, LLC, 886 F.3d at 388. For the uninitiated, the LLC charging statute provides that “[t]he entry of a charging order is the exclusive remedy by which a judgment creditor … may satisfy a judgment [against an LLC and its members] and attachment, garnishment, foreclosure or other legal or equitable remedies are not available to the judgment creditor. 6 Del. Code § 18–703(d). Notwithstanding the definite nature of that provision, the Fourth Circuit focused on the general phrase at the end: “other legal or equitable remedies.” See Sky Cable, LLC, 886 F.3d at 388. It declared that where a general statement follows a specific list, the general phrase applies only to “other items akin to those specifically enumerated.” Id. (internal quotation omitted). The court concluded that not only is reverse veil-piercing dissimilar to attachment, garnishment, and foreclosure, reverse veil-piercing also challenges the legitimacy of the LLC. Id. at 389. Thus, where reverse veil-piercing may be applied, the entity at issue loses its legal status under Delaware law and the LLC charging statute cannot apply. Id.

Upon determining that reverse veil-piercing is allowed under Delaware law, the Fourth Circuit affirmed the Western District of Virginia’s holding that the LLCs at issue must be responsible for Mr. Coley’s conduct. Id. at 390.

The Takeaway

Although this decision is not from a Delaware court, it presents a potential roadmap for an argument that Delaware law might support reverse veil-piercing in circumstances where the controlling person (or entity) of a corporation treats that corporation as his or her alter ego. A definitive answer will have to await action by Delaware courts.

In the meantime, it is important to observe corporate formalities in order to avoid the risk that your company’s assets may be used to satisfy your personal debts or liabilities. Among other things, you should make sure your company (1) keeps adequate records; (2) has independent officers and directors that are willing to make decisions in the company’s best interest and not in the interests of the controlling person; and (3) has management that meets regularly and is well-informed about company transactions. Finally, and most importantly, the finances and assets of the controlling person or entity should not be comingled with the finances and assets of the corporation.

 

Link to decision: http://www.ca4.uscourts.gov/opinions/161920.P.pdf.