Tuesday, August 22, 2017

California Court of Appeal Recognizes Reverse Veil Piercing for LLCs (unfortunately, it does not do a good job in doing so)

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.

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