May 28, 2021

Appraisal: Delaware Chancery Permits Reverse Veil Piercing

In a case of first impression, Vice Chancellor Slights issued a 99-page opinion in Manichean Capital v. Exela Technologies, (Del. Ch.; 5/21), holding that the plaintiffs in an appraisal proceeding could “reverse pierce” the corporate veil and enforce the judgment they obtained against a parent entity against the assets of its subsidiaries.

The plaintiffs were former stockholders of SourceHOV Holdings, and dissented from a merger in which the company was acquired by Exela Technologies. They obtained a judgment in an appraisal proceeding substantially in excess of the merger price, and that’s when the fun began. SourceHOV Holdings stiffed the plaintiffs on the judgment despite a charging order from the Court. In response, the plaintiffs filed actions seeking to both pierce the corporate veil to hold Exela liable for the judgment against SourceHOV, and to “reverse pierce” the corporate veil to reach assets of SourceHOV’s subsidiaries.

Vice Chancellor Slights found that the plaintiffs allegations were sufficient to support a veil piercing claim against Exela, and then turned to the more novel issue of the reverse veil piercing claim. This excerpt from a recent Jim Hamilton blog summarizes the Court’s analysis:

As to the remedy of reverse veil-piercing, the court faced an issue of first impression in that Delaware courts had yet to accept or deny litigants’ request for reverse veil-piercing. Examining other courts’ case law on reverse veil-piercing, the chancery court observed that several have rejected the concept in a desire to protect innocent shareholders and third-party creditors. Reverse veil-piercing may bypass normal judgment collection, allowing the creditor of a parent to jump in front of the creditors of the subsidiary. While these risks are real, the chancery court wrote, they do not justify the outright rejection of the remedy. Those cases that have allowed it did so mindful of the risks and placed limits on the doctrine to manage those risks.

The court accordingly set out a rule for reverse veil-piercing and specifically one applying only to “outsider” reverse veil-piercing, in which an outside third party such as a creditor urges a court to render a company liable on a judgment against its member. The court also emphasized that the doctrine should only be used in exceptional circumstances and that its framework expressly recognizes the risk to third-party creditors and innocent shareholders. Availability of outsider reverse veil-piercing should begin with the Delaware “alter ego” factors for a traditional veil-piercing claim; the court should then ask whether the owner is using the corporate form to perpetuate fraud or an injustice.

Whenever courts deal with veil piercing issues, they ultimately drag out a laundry list of factors that supposedly determine whether veil piercing is appropriate. The same is true for reverse veil piercing, as the Vice Chancellor considered factors such as whether the reverse pierce would impair the legitimate expectations of innocent stockholders, whether the entity to be pierced exercised dominion and control over the other, and a variety of other factors, including the extent to which the reverse pierce will harm innocent third-party creditors.

Anyway, after dutifully slogging through the laundry list, Vice Chancellor Slights determined that this case represented an exceptional circumstance where a claim for reverse veil piercing was justified, at least at the pleading stage:

It is at least reasonably conceivable that the SourceHOV Subsidiaries are alter egos of SourceHOV Holdings and that the subsidiaries have actively participated in a scheme to defraud or work an injustice against SourceHOV Holdings creditors, like Plaintiffs, by diverting funds that would normally flow to SourceHOV Holdings away from that entity to Exela.

Despite permitting the case to move forward, in reciting the laundry list, VC Slights noted that “as a practical matter, the consideration of whether the reverse pierce will cause harm to innocent third parties will substantially limit the doctrine’s application.”

John Jenkins