“Reverse Piercing” the Corporate Veil

June 18th, 2018

One of the fundamental reasons for operating a business as a corporation or limited liability company is to protect the individual owners from personal liability for business-related debts.  That protection is often referred to as the corporate shield, or veil.

This protection is not absolute.  When business owners operate corporations in name only – commingling personal and business finances, or failing to meet the legal requirements for maintaining their corporate form – courts will consider disregarding the corporate liability shield, so as to subject owners to personal liability to company creditors.   “Piercing the corporate veil” claims are commonly associated with creditors who believe that the owners of defaulting debtor businesses have treated their companies as alter egos.

The typical piercing case involves a creditor of the business debtor trying to get at the owner’s personal assets.  But in recent years, courts have seen an increase in cases that reverse that approach, with creditors trying to hold business entities liable for the owner’s personal debts.

Historically one of the leading states in the development of corporate law, Delaware has never addressed “reverse piercing” itself.  But in March, a federal appeals court ruled that Delaware law would indeed support such claims.  Thus, if a business owner commingled his funds with those of his company, and parked his assets in the company name, the court would grant the creditor to judgment against the company, so as to allow it to recover from the company’s holdings.

In that case, the court was undeterred by the fact that the three companies sued under the “reverse piercing” theory had not participated in any of the fraudulent schemes for which the companies’ individual owner had already been found liable, and indeed, the companies all had legitimate reasons for having been formed.  But because the defrauder had commingled his funds with those of his companies, and failed to maintain the legal formalities required, the court allowed the creditor to obtain judgment and thus go after assets held by the companies themselves.

Virginia’s corporations statutes are largely modeled after Delaware’s.  In addition, the particular federal appeals court handling the case under Delaware law also presides over cases arising in Virginia.  For these reasons, we could well expect any federal court rulings arising out of Virginia law also to embrace “reverse piercing” as a concept.  And our state courts would most likely follow suit.

The availability of legal rights for cases seeking piercing of the corporate veil has helped to deter improper conduct for decades.  Real cases justifying piercing are actually quite rare.  With the new line of cases demonstrating that piercing can work in both directions, the hope of the courts is that even more misconduct will be stamped out.  But when bad actors do surface, the courts will have another tool available for granting relief.