A recent California appellate court decision has ruled that reverse veil piercing is permitted in California in the context of limited liability companies. Practically speaking, this means that an LLC’s assets could potentially be at risk for an LLC member’s personal liability under the right circumstances.
Most people are familiar with the concept of “piercing the corporate veil.” This is when shareholders of a corporation can be held liable for the corporation’s debts (which is typically not permitted), if the corporation is not managed in such a way as to warrant the corporate veil of protection. In order to pierce the veil, a plaintiff must prove that there is such a unity of interest and ownership between the corporation and the shareholder that it would be unfair to treat the acts of the individual as being those of the corporation exclusively.
A less familiar, but related, concept is that of “reverse veil piercing,” when a judgment creditor is permitted to enforce a judgment against the corporation for the debts of the shareholder, rather than the other way around.
Historically, this legal theory was not favored in California. In a 2008 Court of Appeals decision (Postal Instant Press, Inc. v. Kaswa (2008) 162 Cal.App.4th), the court held that a judgment creditor could not add a corporation to a judgment against one of its individual shareholders ultimately prohibiting the creditor from reverse-piercing the veil of the corporation. The decision was largely based on the fact that there were other remedies available to the creditor to get its debt repaid that were not as drastic. In addition, there were other non-debtor shareholders of the corporation who would have been adversely (and unfairly) affected if the creditor was allowed to go after the corporation’s assets.
Since the Postal Instant Press decision, the legal community has largely assumed that it created a complete prohibition on reverse veil piercing in California regardless of the structure of the legal entity involved.
Fast forward to 2017 and the issue once again came before California’s Fourth Appellate District in the form of Curci Investments, LLC v. Baldwin, only this time involving a limited liability company.
In Curci, a California real estate developer, James Baldwin, formed a Delaware LLC called JPB Investments LLC (“JPB”). Baldwin owned 99% of the LLC, was the manager and CEO of the LLC, and made all decisions regarding distributions. His wife owned the remaining 1%. Baldwin subsequently borrowed $5.5 million from Curci in his individual name, but failed to pay the note when due. Curci filed suit against Baldwin and won a judgment against him for $7.2 million.
Curci also got a charging order against the LLC to divert distributions until Baldwin’s debt was paid, but this proved fruitless because Baldwin simply opted not to declare distributions. In response, Curci sought to add JPB to the judgment as a judgment debtor using the theory of reverse veil piercing. Curci’s argument was that Baldwin held virtually all the interest in JPB and controlled its actions, and used the LLC as a personal bank account, which justified disregarding the separate nature of JPB to allow Curci to access its assets to satisfy the judgment against Baldwin.
The trial court initially ruled against Curci based on the holding in Postal Instant Press, reasoning that there was a prohibition on reverse veil piercing in California. Curci appealed, arguing that this case was distinguishable because it involved an LLC rather than a corporation.
The Court of Appeals agreed and remanded the case back to the trial court.
In its ruling, the court was careful to note that Postal Instant Press was correctly decided as it applies to corporations because LLCs and corporation are treated differently for judgment enforcement purposes. The major difference is that corporate shares can be levied by a creditor, but interests in an LLC cannot be levied and are only subject to charging orders, which can be thwarted in a single member situation (as mentioned above). The court noted that by placing a complete prohibition on reverse veil piercing in the LLC context, it would essentially allow LLC members to place all of their personal assets into a single member LLC and have those assets enjoy blanket immunity from creditor claims.
The court also distinguished Postal Instant Press because the corporation (like many corporations) had other non-debtor shareholders who would have been adversely affected by reverse veil piercing. In this case, however, it was only Baldwin and his wife who owned the interests in JPB.
It is important to note that the Court of Appeals did not decide whether the veil should, in fact, be pierced. Instead, the case was remanded it back to the trial court to determine whether Curci can pierce the LLC’s veil to gain access to its assets to satisfy Baldwin’s debts. Moreover, even though the court allowed the legal theory to proceed, it warned that reverse veil piercing should remain a remedy of last resort and should only be granted if the facts are closely aligned with this case and a creditor can show that all other remedies were unavailable or impractical.
As a reminder to our clients, it is incredibly important to adhere to corporate formalities, especially as it pertains to single member LLCs. There may be a strong temptation to be lackadaisical in the day to day operations such as opening a separate LLC bank account, signing with proper titles, and documenting LLC member and manager actions. The Curci case demonstrates that these seemingly insignificant actions are vital to preserving not only the limited liability shield but also to protecting the LLC from personal judgments.
If you have further questions regarding this case or what you can do to ensure you are properly operating your LLC or partnership, please contact Heather G. Sapp, Esq. (firstname.lastname@example.org) or Brandon D. Smith, Esq. (email@example.com).
– Written by Heather Sapp