Alter Ego, Equity, and Reverse Veil Piercing for LLCs
The LLC Jungle blog covered “reverse veil piercing” in a 2019 post: “Reverse Veil Piercing” to Reach an LLC’s Assets”
Normally, a business entity is considered a legal person 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 owners can be liable for the entity’s obligations under the “alter ego” doctrine. This is known as “piercing the corporate veil.”
“Reverse veil piercing” is when an entity’s assets are used to satisfy the obligations of the entity’s owner.
An opinion recently published by California’s Second Appellate District — Blizzard Energy, Inc. v. Schaefers — features a judgment creditor’s request to apply reverse veil piercing to an LLC.
Facts: judgment creditor seeks to amend judgment to add judgment debtor’s LLC
Plaintiff Blizzard Energy, Inc. (“Blizzard”) invested in a tire pyrolysis project in Kansas, which aimed to turn old tires into fuel. The investment failed, and Blizzard sued for fraud against Bernd Schaefers (“Schaefers”) and other defendants in Kansas. In 2017, Blizzard obtained a fraud judgment against Schaefers in the Kansas action for $3.825 million.
Blizzard had the Kansas judgment entered in California, and then in June 2019 filed a motion to amend the judgment to add Schaefers’ alleged alter ego, BKS Cambria, LLC, under a “reverse veil piercing” theory. BKS Cambria owned 34 acres of land in Cambria, California, and therefore made a tempting target for collection.
BKS Cambria was owned 50% by Schaefers, and 50% by his wife Karin Schaefers (“Karin”). The Schaefers got married in 1981. In March 1996, they signed a separation agreement. While still separated, in 2001 they formed BKS Cambria. In May 2019, Karin filed a complaint seeking divorce.
Trial court: motion granted; judgment amended to add LLC under alter ego “reverse veil piercing” doctrine
The trial court granted Blizzard’s motion, and amended the judgment to add BKS Cambria as a judgment debtor. The court held that BKS Cambria was Schaefers’ alter ego, and amending the judgment was appropriate under the reverse veil piercing doctrine.
As to Karin’s 50% membership interest in the LLC, the trial court concluded that her LLC interest was community property, and the “community estate is liable for a debt incurred by either spouse before or during the marriage.” The court acknowledged the separation agreement between Schaefers and Karin, but pointed to the LLC tax returns showing that the LLC was still treated as community property.
BKS Cambria and Schaefers appealed.
Court of Appeal: reversed; trial court failed to consider equitable interests of LLC’s other member
The Court of Appeal reversed.
The court first rejected appellants’ argument that Blizzard’s exclusive remedy was to obtain a charging order against Schaefers’ LLC membership interest under Corporations Code section 17705.03. A charging order constitutes a lien on a judgment debtor’s transferable (economic) interest in the LLC, and requires the LLC to pay distributions that would otherwise go to the debtor instead to the holder of the charging order.
The court held that the availability of a charging order did not preclude Blizzard from pursuing an amendment of the judgment on alter ego grounds. The court noted that a charging order might not be effective here, since Schaefers remained a manager of the LLC with authority “to decide when distributions to members are made, if ever.” The evidence also suggested that Schaefers “intended to make it as difficult as possible” for Blizzard to collect on the judgment, including refusing to make LLC distributions “for a long time.”
However, the court sided with appellants on their argument that the trial court failed to appropriately consider the equities — specifically, Karin’s LLC membership interest — in its application of the reverse veil piercing doctrine. The court noted the following considerations that were not given due weight by the trial court:
- Karin was not bound by the LLC’s tax returns. The returns were signed only by Schaefers, who was the LLC’s manager. There was no evidence that Karin reviewed the returns or understood their significance.
- Under the Family Code, any earnings and accumulations incurred “after the date of separation” were separate, not community, property. Karin presented evidence that the funds used to purchase BKS Cambria’s real property came from the proceeds of her sale of her separate property in New Jersey.
- Even if Karin’s LLC interest was community property, the community’s liability does not include a debt incurred after the date of separation. Debts incurred by either spouse after separation are the debtor spouse’s separate obligation.
- Blizzard’s fraud action was based solely on Schaefers’ conduct beginning in 2011 — 15 years after the spouses had separated.
The court concluded: “Thus, the trial court’s determination that it would be inequitable to not add BKS Cambria as a judgment debtor was based in part on mistakes of law and findings unsupported by the record.” The court emphasized that the “essence of the alter ego doctrine is that justice be done” and that “liability is imposed to reach an equitable result.”
The court remanded the case to the trial court for further proceedings on the equitable considerations.
Lesson
To establish grounds for alter ego “reverse veil piercing,” a judgment creditor must show not only that the corporate form was abused, but also that piercing would lead to an equitable result.