Reverse Veil Piercing for Alternative Entities

Curci Inv., LLC v. Baldwin, No. G052764 (D4d3 Aug. 10, 2017)

As we’ve discussed (on one occasion at very great length), under California law, a creditor can “pierce the corporate veil” of a corporate debtor to get at the assets of its “alter ego” owners. The creditor can do so when the company and the owners share a unity of ownership and interest and when the ends of justice require ignoring the separation between the company and the owners. 

But what about when the owners are the debtors? Can a creditor use veil piercing in a downward direction to get at the assets of a company owned by a debtor? This is generally called “reverse piercing” and one California court rejected it, at least for corporations. Postal Instant Press, Inc. v. Kaswa Corp., 162 Cal. App. 4th 1510 (2008). The court there reasoned that ordinary creditors’ remedies permit creditors to seize shares of corporate stock directly from the debtor. So the creditor does that, and then assumes whatever position the debtor had vis-a-vis the company. Viz., it gets dividends, votes at meetings, has the right to initiate derivative litigation, and can presumably sell the stock to someone else. Maintaining that separation protects other innocent stockholders from an attack on corporate assets due to the malfeasance of some other stockholder.

But here, the company is an LLC, and very closely held one at that. It’s 99 percent owned by debtor and 1 percent by his wife. That, in the court’s view, is a crucial difference, because creditors’ remedies don’t permit seizure of an LLC member’s equity in the entity. The best a creditor can get is a charging order redirecting any distributions out of the LLC to the creditor. But if the LLC is still owned and controlled by the debtor, the debtor can avoid the charging order by simply causing the LLC to stop making distributions. 

That’s what happened here. Debtors’ LLC paid out $178 million in the six years before the judgment. But since the $7.2 million judgment in this case issued, no distributions have been made. (Presumably the debtors aren’t having too hard of a time living off their $178 mil.)

The court here finds the corporate/LLC distinction significant in way that can make reverse piercing equitable for LLCs in a way it is not for corporations. The court isn’t saying that the veil should be reverse pierced in this case, just that it can be. So it reverses and remands for the trial court to conduct a full blown alter ego analysis.

Reversed.