Reverse Veil Piercing

Posted on Posted in California, Entities

What is Reverse Veil Piercing?

If you don’t remember what “piercing the corporate veil” means, it’s when a court decides that an individual owner should be responsible for some or all of the liabilities of the company, usually a corporation or LLC.  “Reverse” veil piercing is when a company is made liable for the debts of one of its owners.

Is it allowed in California?

For a long time, courts did not consider reverse veil piercing viable in California.  They were worried that other innocent owners would be forced into paying for one person’s debts, and that didn’t seem fair.  In addition, courts tended to feel that there were other ways for people to enforce judgments that didn’t put the company’s assets at risk.  For example, if an owner illegally tried to hide personal assets in a corporation, the person seeking the assets could bring a fraudulent conveyance claim and force the personal assets back out of the company.

For people trying to get money out of someone who owned interest in an LLC or partnership, there were also charging orders available.  A charging order allows a creditor to get paid directly by the LLC or partnership if a distribution (like a dividend in a corporation) is declared.  The charging order generally does not allow the creditor to vote in the company, or to force a sale of company assets, just to receive money.  However, if the company does not ever declare a distribution, then the creditor does not get the funds.

Last year, however, the courts appear to have moved on allowing reverse veil piercing in limited cases.  Courts may begin to allow reverse veil piercing if the following circumstances are met:

  1. The company is an LLC (still does not apply to corporations).
  2. There are no “innocent” owners.  For example, an LLC with one owner, or one owner who owns 99% of the company and his wife, who owns 1% of the company, if she is also liable for the debts.
  3. There are no other ways for the creditor to reasonably get paid.

Since this is still a relatively new case, there are outstanding questions, such as what is the extent of the “innocent” owner prohibition?  How much of the judgment needs to be satisfied outside the LLC before reverse veil piercing becomes appropriate?  What type of assets can be seized?  If you are in California, have an LLC, and think you might be subject to reverse veil piercing, it’s a good idea to let your attorney know so that you can discuss the possible issues.

How do I prevent reverse veil piercing?

First, try not to get sued.  If you do get sued, try to win, if at all possible.

More seriously, you should discuss this issue with your attorney during the formation phase of the business.  This is especially important if you are starting a business with only one owner, or even just two.  It might be a good idea to discuss alternatives to LLCs or partnerships (such as a corporation), or an alternative way to hold the assets of the business to provide more protection.