By: Raquel Macgregor
On March 28, 2018, the United States Court of Appeals for the Fourth Circuit published an opinion for Coley v. DIRECTV. The court affirmed the district court’s[1] decision to grant a motion to “reverse pierce” the corporate veil of Mr. Coley’s three limited liability companies (“LLCs”).
I. Issue
Does Delaware law allow reverse piercing the corporate veil of an LLC when the sole member of an LLC is its alter ego?
II. Facts and Procedural history
Previously, the district court entered a judgment for DIRECTV for $2.3 million after Mr. Coley fraudulently provided DIRECTV services to over 2,500 units in his resort. Mr. Coley had in fact only been licensed to provide the service to 168 units. In addition to running a resort, Mr. Coley was also the sole manager of three LLCs that were created to hold title to various rental properties.
After DIRECTV was unable to collect its judgment against Mr. Coley due to his few personal assets, DIRECTV filed a motion to reverse pierce the corporate veil of the three LLCs to gain access to their assets. The district court granted the reverse piercing motion, and Mr. Coley appealed to the Fourth Circuit.
III. Piercing the corporate veil and applicable law
Generally, an LLC shields its members from personal liability because an LLC has a separate identity, and “those debts are not imputed to the [members].” Yet, courts disregard the legal separation between an LLC and its members when such a separation would “produce injustices or inequitable consequences.” Thus, at times a court will allow a plaintiff to “pierce the corporate veil” that divides a shareholder and an entity (or here reverse pierce) [2] so a plaintiff can collect from an otherwise judgment-proof defendant.
With corporate law issues, courts apply the law of the state of incorporation. Here, the LLCs’ state of incorporation was Delaware, so the court applied Delaware law to determine the validity of the reverse veil piercing. However, Delaware has not yet expressly adopted the remedy of reverse piercing the corporate veil. Thus, the court then had to predict whether Delaware would recognize this remedy.
IV. Determining whether Delaware would recognize the remedy of reverse veil piercing
The court first acknowledged that past Delaware cases strongly indicate that Delaware would allow the remedy of reverse piercing. Under Delaware law, where an LLC has a single member, “the rationale supporting reverse veil piercing is especially strong.” The court observed that Delaware law does not allow an individual to use “a corporate form . . . as a ‘shield’ to hinder creditors from collecting on adjudicated claims.” Moreover, while Delaware has never had a reverse veil-piercing case, in Spring Real Estate, LLC v. Echo/RT Holdings, LLC, the Delaware Court of Chancery noted that when an LLC is a “mere alter ego . . . the Court may engage in ‘reverse veil-piercing.”
The court then considered how a potentially contradictory Delaware charging statute might conflict with the remedy of reverse veil-piercing. The language of the charging statute mandates that a charging order is the “exclusive remedy.” Yet, the court relied on the canon of construction of ejusdem generis and the concern that courts could not “look through these legal fictions” to conclude that the charging statute did not prevent the court from reverse piercing the corporate veil.
V. Conclusion
After concluding that reverse veil piercing would be permitted in Delaware, the court agreed with the district court that reverse piercing was an appropriate remedy in this case. The court noted several veil piercing factors were present, namely: (1) the LLCs were controlled by a sole individual (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. Thus, the Fourth Fircuit affirmed the district court’s decision to reverse pierce the veil of Mr. Coley’s LLCs.
[1] The appeal arose specifically from the United States District Court for the Western District of Virginia.
[2] “Piercing the corporate veil” refers to when an individual owner or parent entity is held liable for a judgment against a business entity. In contrast, “reverse piercing the corporate veil” creates “liability to the entity for a judgment against the individuals who hold an ownership interest in that entity.”