Reverse Veil Piercing - Gupta Evans and Ayres

In 2017, the California Court of Appeals ruled that creditors can directly pursue the assets of an LLC owned by a judgment debtor to satisfy the judgment. This process, known as “Reverse Veil Piercing,” marks a significant change in California law as it relates to collections and the way that the assets of an LLC are viewed in the eyes of the Courts. The ruling may also be indicative of how the Courts plan to treat closely held entities in the future.

In late 2017, California’s Fourth Appellate District concluded that “reverse veil piercing” may be used by creditors to add an LLC to a judgment the creditor has against an individual owner of the LLC. The decision, albeit narrow, was set forth in detail in Curci Investments, LLC v. Baldwin (2017) 14 Cal.App.5^th 214 and departed from the well-settled California law against reverse veil piercing set forth in the 2008 appellate decision, Postal Instant Press, Inc. v. Kaswa Corp. (2008) 162 Cal.App.4th 1510. The Curci ruling grants creditors a significant new means of collecting a judgment that otherwise may be extraordinarily difficult, or impossible, to collect.

The Facts

The case of Curci Investments, LLC v. Baldwin involved Mr. James P. Baldwin. Mr. Baldwin was a real estate developer who over his lifetime was involved in hundreds of corporations and limited liability companies. One of the LLCs was named JPB Investments, LLC (JPB). Mr. Baldwin was the 99 percent owner of JPB, with his wife holding the remaining one percent. Mr. Baldwin was also the manager and CEO of JPB and controlled all of its decisions and actions, such as cash distributions to Mr. Baldwin and his wife. JPB’s exclusive purpose was to hold, invest and/or distribute the cash balances of Baldwin and his wife.

Mr. Baldwin defaulted under a $5.5 million promissory note. Curci, the owner of the note, filed suit and eventually obtained a judgment against Mr. Baldwin, personally, in the approximate amount of $7.2 million. When Curci obtained its judgment against Mr. Baldwin personally, Curci pursued several avenues to try and collect on the judgment. However, after exhausting most of its options, Curci was unable to receive any recovery on its judgment. With few options left, Curci filed a motion to expand the judgment to include one of Mr. Baldwin’s LLCs, JPB (above), based on the theory that JPB was the alter ego of Mr. Baldwin. In other words, Curci wanted to utilize “reverse veil piercing” to reach the assets of JPB and satisfy Curci’s judgment.

Hold That Thought…

A quick aside about alter ego and piercing the corporate veil. These concepts are not particularly new and have long been permissible in California[1]. As is well-recognized, a corporation or an LLC are considered a separate legal entity, distinct from its stockholders, officers and directors (or members and managers), with separate and distinct liabilities and obligations[2]. This affords the shareholders of a corporation, or the members of an LLC, protection from judgments against the corporation or LLC.

However, that legal separation (and protection) may be disregarded by the courts when the creditor shows the following exists:

Such a unity of interest and ownership between the corporation (or LLC) and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist (based upon a variety of factors); and
Injustice will result if the acts in question are treated as those of the corporation (or LLC) alone[3].

If these prongs are demonstrated, the actions of the corporation or LLC will be deemed to be those of the persons or organizations actually controlling the corporation. This is known as “piercing the corporate veil”—the creditor is piercing the protective veil of the corporation or LLC to reach the assets of particular shareholders or members[4].

The concept Curci sought to utilize with respect to its judgment against Mr. Baldwin was the concept of reverse piercing of the corporate veil. The concept of reverse veil piercing is similar to traditional veil piercing in that when the ends of justice so require, and the foregoing two prongs are shown to exist, a court will disregard the separation between an individual and a business entity. However, rather than seeking to hold an individual responsible for the acts of an entity, reverse veil piercing seeks to satisfy the debt of an individual through the assets of an entity of which the individual is an insider.

Reverse Veil Piercing In California Before Curci

In Postal Instant Press, Inc. v. Kaswa Corp. (2008) 162 Cal.App.4th 1510, 1513 (Postal Instant Press), the Court held that a third-party creditor may not reverse pierce the corporate veil to reach corporate assets to satisfy a shareholder’s personal liability. In deciding against allowing reverse veil piercing, the Court cited three concerns:

The effect of allowing judgment creditors to bypass standard judgment collection procedures;
The potential of harming innocent shareholders and corporate creditors (i.e. the non-debtor insiders of a corporation or LLC); and
Using an equitable remedy in situations where legal theories or legal remedies are available outweigh the wrong to the judgment creditor.

With the ruling in Postal Instant Press, reverse veil piercing in California was effectively dead, and it remained that way until Curci obtained its judgment against Mr. Baldwin.

The Curci Decision

In Curci, the Court acknowledged the above concerns, but distinguished the facts from those in Postal Instant Press. In doing so, the Court concluded that the three concerns were not present in the case before the Court. The distinction was grounded largely in the fact that Postal Instant Press was dealing with a corporation, whereas Curci was dealing with an LLC owned entirely by Mr. Baldwin and his wife.

The Court identified that a creditor does not have the same options against a member of an LLC as it has against a shareholder of a corporation. If the debtor is a shareholder of a corporation, the creditor can step straight into the shoes of the debtor, acquire the shares and then have whatever rights the shareholder had in the corporation, including the right to dividends, to vote, and to sell the shares. On the other hand, when the debtor is a member of an LLC, the creditor may only obtain a limited charging order to receive any distributions made to the member from the LLC. Here, because Mr. Baldwin had complete management and control over JPB, Mr. Baldwin could manipulate distributions such that no funds went to Mr. Baldwin, which is precisely what Mr. Baldwin had been doing to avoid the judgment.

Additionally, there was simply no “innocent” member of JPB that could be affected by reverse piercing. Mr. Baldwin held a 99 percent interest in JPB and his wife holds the remaining 1 percent interest, who, based on community property principles, was also liable for the debt owed to Curci.

Based on the above, the Court held that reverse veil piercing may be available to Curci with respect to JPB and sent the case back to the trial court to undertake the fact-driven analysis applicable to piercing a corporate veil. In parting words, the Court held that “the key is whether the ends of justice require disregarding the separate nature of JPB under the circumstances.”

What Now?

The ruling from the Court in Curci will likely be construed quite narrowly and only with respect to fact patterns largely mirroring the facts of Mr. Baldwin and his entity. Additionally, the ruling in Postal Instant Press should still be considered binding law with respect to corporations as the Curci ruling was almost entirely founded on the fact that the entity in question was an LLC. Even with the Curci ruling, when corporate entities and LLCs are structured and operated correctly, they will in all likelihood continue to exist separately from the individuals who form and manage them.

That said, the Curci ruling remains notable and opens the door to reverse veil piercing in California, which is a significant shift in California creditor law and a substantial change in the options previously available to creditors struggling to collect a judgment against an individual debtor. Those setting up corporate entities that will be largely controlled and operated by a single individual should keep the Curci case top of mind. Going forward, when a creditor is dealing with an individual judgment debtor actively misusing an LLC, one can all but guarantee that the creditor will now rely upon the Curci ruling to argue “the ends of justice” require reverse veil piercing to be permitted against the debtor’s LLC.

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[1] Sonora Diamond Corp. v. Superior Court (2000) 83 Cal. App. 4th 523, 538

[2] Robbins v. Blecher (1997) 52 Cal.App.4th 886, 892

[3] Sonora Diamond Corp. v. Superior Court, supra, 83 Cal. App. 4th at 538

[4] In addition to piercing the alter ego and piercing the corporate veil, there is a concept known as the Single-Enterprise doctrine which is also recognized in California. While well outside the scope of this article, the Single-Enterprise doctrine can be used to hold multiple, distinct legal business entities liable as if they were a single entity. See Las Palmas Associates v. Las Palmas Center Associates (1991) 235 Cal.App.3d 1220, 1249-50.

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