United States: Reverse Piercing Of The Corporate Veil: New Implications In Light Of A Fourth Circuit Decision

Traditional Piercing of the Corporate Veil

Typically, owners or shareholders of a corporation have limited liability over the corporation's actions. In other words, there is a corporate veil that can protect owners and shareholders from liability over a corporation's actions. In some circumstances, an owner or shareholder may be made liable for the corporation's actions. Piercing the corporate veil allows a plaintiff to breach this veil of protection and implicate owners or shareholders for a corporation's actions.

When the veil is pierced, an owner of a corporation is liable on the basis that the corporation is only the "alter ego" or "instrumentality" of the owner. There are two basic requirements for piercing the corporate veil. First, the owners must have exercised domination or control over the corporation. Secondly, the actions taken must have wronged the plaintiff. Additionally, some states require further proof that the domination caused the harm.

Reverse Piercing of the Corporate Veil

Reverse piercing exists when a third party seeks to impose liability on a corporation for the actions of an individual shareholder or owner. Establishing a reverse piercing involves the same requirements as traditional piercing: domination over the corporation and harm caused to an aggrieved party. A reverse piercing typically arises when a third-party plaintiff seeks to collect on a debt or payment owed to the third party. Unlike traditional veil piercing, reverse piercing is not universally nor uniformly imposed. Some states have even rejected a reverse piercing of the corporate veil.

When a party seeks to pierce the corporate veil in reverse, the law where the corporation is incorporated typically determines whether a reverse piercing is permissible. A recent case decided in the United States Court of Appeals for the Fourth Circuit, Sky Cable, LLC v. DIRECTV, Inc., 886 F.3d 375 (4th Cir. 2018), has brought into question whether Delaware law would permit a reverse piercing. Delaware courts have not yet addressed whether a reverse piercing is permissible, but those courts have not expressly prohibited it, either. However, this Fourth Circuit decision authorized a reverse piercing of the corporate veil, and in doing so, it sets the tone for how Delaware courts may act in future reverse piercings.

Sky Cable v. DIRECTV

Randy Coley was the sole owner of three Limited Liability Companies (LLCs). Coley created the LLCs to hold title to real estate properties, and the LLCs managed and controlled Coley's finances in his investments. Coley contracted with DIRECTV, by using one of his LLCs, to provide cable programming to nearly 2,500 rooms in a Virginia resort. Coley paid for services for 168 of the rooms, but he fraudulently retained the excess revenue for over 2,300 units. Each of the three LLCs and Coley engaged in a co-mingling of funds, and Coley disregarded corporate formalities in managing his finances through the LLCs. DIRECTV investigated the matter and discovered the fraud. Sky Cable, a dealer of DIRECTV's services, sued Coley for the scheme.

Until Sky Cable, no case interpreting Delaware law had adopted the reverse piercing remedy. However, the district court held that under Delaware law, the three LLCs were "alter egos" of Coley and that Delaware would recognize reverse veil piercing under such circumstances. In context, Coley's fraudulent actions reversed the presumption of limited liability for his LLCs, which is a reverse piercing of the corporate veil; the now defunct LLCs shared liability for Coley's actions as the sole owner of the LLCs.

The Fourth Circuit affirmed the district court's holding. They did so on the basis that many courts have allowed outsider reverse piercing for creditors. Also, Delaware law does not expressly oppose a reverse piercing. However, the court acknowledged that some states have barred it because of potential harm to innocent shareholders. Before this case, Delaware courts cautioned that a traditional piercing of the corporate veil is appropriate only in exceptional circumstances. In response, the Fourth Circuit noted that reverse veil piercing is particularly appropriate when an LLC has a single member, because it alleviates the concern that reverse veil piercing may affect innocent shareholders. Thus, when an entity and its sole member are alter egos, as was the case with Coley, the argument for reverse veil piercing is strong.

In making its decision, the court was mindful that Delaware has a special interest in assuring that companies incorporated in the state are not conduits for fraudulent activity for shareholders. Piercing the corporate veil is done to promote equity and limit injustice. Coley was the sole member of each of the LLCs, he was the only person paid by the LLCs, and he did not keep complete accounting records for himself or for the LLCs. In Delaware, if legally separate entities do not follow corporate formalities with one another, there may be an inference that the owner and the corporation are alter egos. To the court, a reverse piercing in this case would not compromise Delaware's corporate form nor harm any innocent shareholders.

Implications

The Fourth Circuit acknowledged that even a traditional piercing of the corporate veil is only done in exceptional circumstances. It involves looking past a legal fiction, even though the corporation as a legal fiction with limited liability is a well-established presumption. Veil piercing is an equitable remedy extended in the interest of justice. Still, reverse piercing is not a universal practice, and in practice its application is largely a factual determination. In Sky Cable, the court analyzed the facts and law to determine whether Delaware law would permit a reverse piercing. Ultimately, the court determined that a reverse piercing of the corporate veil is permissible under Delaware law. Given Delaware's traditional and ongoing role as the site of incorporation for many companies, the Fourth Circuit's ruling in this case may have ongoing implications.

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