The law governing California limited liability companies evolves in real time | Lessons from the courtroom battlefront

“Reverse Veil Piercing” to Reach an LLC’s Assets

“Piercing the corporate veil” — also referred to as “alter ego” liability — is a familiar concept under California law.  Ordinarily, a corporation or other entity (such as an LLC) is considered a legal entity separate and apart from its individual owners.  But when the entity is used by an owner to perpetrate a fraud, circumvent a statute, or accomplish some other wrongful purpose, the “corporate veil” can be “pierced” and the owners can be liable for the entity’s obligations.

Less common is “reverse veil piercing” — when an entity’s assets are used to satisfy the obligations of the entity’s owner.

Anyone involved in a California LLC should be aware of both doctrines and their applications.

Corporate separateness and veil piercing

California courts generally respect the concept of corporate separateness.  Ordinarily a corporation is considered a separate legal entity, distinct from its stockholders, officers, and directors, with separate and distinct liabilities and obligations.  The same is true for LLCs and their members and managers.

But where the owners have used the entity for an improper purpose, the corporate veil may be pierced, the entity’s actions will be deemed to be those of its owners, and the owners will be liable.

To apply the alter ego doctrine, two conditions generally must be met:

(1) there must be such a “unity of interest and ownership” between the entity and its owner that the separate personalities of the entity and the owner does not in reality exist; and

(2) there must be an inequitable result if the acts in question are treated as those of the entity alone.

Courts look at numerous factors in deciding whether or not to apply veil piercing, and the outcome will depend heavily on the circumstances of each particular case.  For a more detailed examination of veil piercing and the factors involved, see this post from the Money and Dirt Blog, Seven Critical Mistakes Real Estate LLCs Make (and How to Avoid Them) — Mistake #4: Stepping into “Alter Ego” Liability.

Reverse veil piercing

“Reverse veil piercing” is similar to traditional veil piercing in that corporate separateness will be disregarded by the courts when the ends of justice so require.  But instead of seeking to hold an individual liable for the acts of an entity, reverse veil piercing seeks to satisfy the debt of an individual through the assets of his or her entity.

In a 2017 opinion — Curci Investments, LLC v. Baldwin — the California Court of Appeal for the Fourth District (Division Three) confirmed that reverse veil piercing could be applied to an LLC under appropriate circumstances.

In Curci, a “prominent real estate developer” (James Baldwin) defaulted on a loan and a judgment for $7.2 million was entered against him.  The judgment creditor was unable to collect from Baldwin despite lengthy collection efforts (including obtaining charging orders against 36 business entities in which Baldwin held an interest).  Baldwin dodged his payment obligations under the judgment by using one of his LLCs (in which he owned a 99% interest) to funnel money into various family trusts and “loans” to his related partnerships.

The judgment creditor filed a motion asking the court to add Baldwin’s LLC as a judgment debtor under Code of Civil Procedure section 187.  The trial court denied the motion, concluding that reverse veil piercing was not available under California law.

But the Court of Appeal reversed, holding that reverse veil piercing was an available remedy under California law and could be “appropriate” under the facts of the case.  The opinion rejected the notion that a judgment creditor’s sole remedy against a debtor LLC member was through a charging order against the member’s transferable (or economic) interest under Corporations Code section 17705.03.

Lesson

California law strongly respects the separateness of business entities and their owners.  Under normal circumstances, an LLC owner will not be liable for the LLC’s debts, and likewise, an LLC’s assets will not be available to a creditor of an LLC’s individual member.

But if the entity is used to perpetrate fraud or other wrongful conduct, veil piercing and reverse veil piercing may be applied, and the corporate veil disregarded.

Leave a Reply

Basic HTML is allowed. Your email address will not be published.

Subscribe to this comment feed via RSS