California Court of Appeal Recognizes Reverse Veil Piercing
for LLCs
(unfortunately, it does not do a good job in doing so)
In a
decision rendered earlier this month, the California Court of Appeals
recognized the possibility that a Delaware organized LLC, namely JPB
Investments LLC (“JPBI”) is subject to reverse piercing. Curci Investments, LLC v. Baldwin, ___ Cal.Rptr.3d ___, 2017 WL
3431457 (Ca. App 4th Dist., August 8, 2017).
Curci
held a judgment against Baldwin individually in the original amount of $7.2
million. Efforts to collect on that judgment were regularly stymied by Baldwin
even as multimillion dollar transfers were made within Baldwin’s family amongst
various trusts, partnerships and JPBI, that last company being the “management
company” for Baldwin’s family assets. Charging orders entered against Baldwin’s
interests in those various entities generated no return to Curci in that the
entities thereafter terminated distributions notwithstanding a prior history of
having made them. “Although Baldwin caused JPBI to distribute approximately
$178 million to him and his wife, as members, between 2006 and 2012, not a
single distribution has been made since the October 2012 entry of judgment on
the Curci note.” 2017 WL 3431457, *2. In addition, loans in the original amount
of $402.6 million made to various family partnerships were unilaterally
extended by Baldwin, thereby delaying JPBI’s receipt of the principal and
accrued interest. On these bases, the plaintiff sought to “reverse pierce” JPBI
in order to directly access its assets and make them available to discharge the
debt owed to Curci. The appellate court would agree that it is conceptually
possible, writing:
For the reasons explained below, we agree with Curci and
find remand appropriate to allow the court to make a factual determination of
whether the facts in this case justify piercing JPBI’s veil. 2017 WL 3431457,
*2.
After
noting the effect of reverse veil piercing, namely that “reverse veil piercing
seeks to satisfy the debts of an individual through the assets of an entity of
which the individual is an insider.” (2017 WL 3431457, *3), the court turned
its attention to whether there should be a particular test for reverse piercing
or whether it should be the same test utilized in traditional piercing to hold
the shareholders liable for a debt of the business organization. The court also
considered another California decision, Postal
Instant Press, Inc. v Kaswa Corp, 162 Cal.App.4th 1510, 77 Cal.Rptr.3d
96 (2008), in which it had been held that it was not possible to reverse pierce
a corporation.
Finding
that Postal Instant Press did not
control in this case, the court first noted that here there is no risk to
innocent owners in that Baldwin and his spouse, her assets being liable on the
judgment pursuant to California community property law, were the only owners.
Hence, there were no independent innocent owners whose interests could be
infringed by reverse piercing. All of that is true, but the reasoning is
somewhat questionable; the Postal Instant
Press decision was not conditioned upon the existence of independent third
parties whose interest would be impacted by reverse pierce. The Curci court also distinguished Postal Instant Press on the basis that
it is “expressly limited to corporations,” and this is a case of trying to pierce
an LLC. 2017 WL 3431457, *4. With due respect to the court, this reasoning is
intrinsically flawed. Piercing is an equitable remedy available to courts to
address situations in which individuals and business organizations are taking
improper advantage of the rule of limited liability and the corresponding
negative/affirmative asset partitioning function. Those concerns are consistent
and equally applicable across all business organization forms that afford asset
partitioning and limited liability, including corporations, LLCs, LLLPs and
LLPs. Saying that a case precluding reverse veil piercing of a corporation may be
distinguished on the basis that this dispute inolves an LLC is without merit. This distinction is especially weak when the
court’s opinion had previously stated: “The question presented is whether
reverse piercing of the corporate veil may be applied under the
circumstances of this case,…” 2017 WL 3431457, *2.
In
turn, the court did note an important distinction between a corporate shares
and an interest in an LLC, namely the rights of a judgment creditor.
Where the debtor is a shareholder, the creditor may step
straight into the shoes of the debtor. They may acquire the shares and,
thereafter, “have whatever rights the shareholder had in the corporation,”
including the right to dividends, to vote, and to sell the shares.
In contrast, if the debtor is a
member of an LLC, the creditor may only obtain a charging order against the
distributions made to the member. The debtor remains a member of the LLC with
all the same rights to manage and control the LLC, including, in Baldwin’s
case, the right to decide when distributions to members are made, if ever. 2017
WL 3431457, **4-5 (citations omitted).
Unfortunately,
the court did not expand on how these distinctions, true as they are, favor
reverse piercing of an LLC as to why even if not allowed in a corporation.
Further, the court failed to address the relationship of the capacity to
foreclose on the charging order, thereby taking title ownership to the
underlying LLC interest, albeit as an assignee, would impact upon this
comparison.
The
court as well skirted the “exclusivity provision” of the charging order
provision, noting that “Reverse veil piercing is a means of reaching the LLC’s
assets, not the debtors’s transferable interest in the LLC.” 2017 WL 3431457, *5.
Ultimately,
the court would conclude:
The case before us presents a
situation where reverse veil piercing might well be appropriate. Curci has been
attempting to collect on a judgment for nearly half a decade, frustrated by
Baldwin’s nonresponsiveness and claimed lack of knowledge concerning his own
personal assets and the web of business entities in which he has an interest.
Although the formation of JPBI predates the underlying judgment, its purpose
has always remained the same—to serve as a vehicle for holding and investing
Baldwin’s money.
With Baldwin’s possession of near
complete interest in JPBI, and his roles as CEO and managing member, Baldwin
effectively has complete control over what JPBI does and does not do, including
whether it makes any disbursements to its members (he & his wife). Since
the time judgment was entered in Curci’s favor, Baldwin has used that power to
extend the payback date on loans made to ultimately benefit his grandchildren
(loans on which not a single cent has been repaid), and to cease making
distributions to JPBI’s himself and his wife, despite having made $178 million
in such distributions in the six years leading up to the judgment.
For all of these reasons, we
conclude reverse veil piercing may be available in this case. However, we
express no opinion as to whether JPBI’s veil should actually be pierced.
Instead, we remand the matter for the trial court to engage in the required
fact-driven analysis in the first instance. As with traditional veil piercing,
there is no precise litmus test. Rather, the key is whether the ends of justice
require disregarding the separate nature of JPBI under the circumstances. In
making that determination, the trial court should, at minimum, evaluate the
same factors as are employed in a traditional veil piercing case, as well as
whether Curci has any plain, speedy, and adequate remedy at law. 2017 WL 3431457, **5-6, citations omitted.
So a
California court, applying California law, may allow, on appropriate
circumstances, the reverse piercing of an LLC.
As that is well and good, but it should never have taken place. JPBI is a Delaware LLC, and the rule
is that the law of the jurisdiction of organization applies to the piercing of
an entity.
