Reverse Veil Piercing: A Judgment Against You Can Become a Judgment Against Your Company
October 4 2017
It happens all the time. A hard fought lawsuit results in a satisfying judgment. Then it comes time to collect and it turns out the judgment is worth no more than the paper it’s written on. For example, sometimes a party obtains a judgment against a company with little to no assets to satisfy the judgment. And since, legally speaking, companies exist separate and apart from the individuals who run them, the individual owners are usually shielded from liability when the company ends up on the wrong end of a judgment.
Except for when they won’t be. Sometimes, courts decide that the idea of a separate corporate entity is baloney. When that happens, they utilize one of the more dramatic sounding legal terms and “pierce the corporate veil,” adding the individuals as defendants on the judgment. But can the reverse ever occur? Let’s say a plaintiff obtains a judgment against an individual and wants to collect against that person’s company. Can courts engage in “reverse veil piercing”? Until last month, the answer under California law had been no. But the times they are a changing. In Curci Investments, LLC v. James Baldwin, a California Court of Appeal held that a judgment against an individual defendant could in fact become a judgment against his company under the right circumstances.
The plaintiff was James Baldwin, a prominent real estate developer. Back in 2004, he formed JPBI, LLC for the exclusive purpose of holding and investing Baldwin and his wife’s cash balances. The only two members were Baldwin, with a 99% interest, and his wife, who had the remaining 1%. Baldwin was both the manager and CEO of the company and determined when, if at all, the company made distributions to him and his wife.
A couple years later, Baldwin borrowed $5.5 million in his individual capacity. Baldwin failed to pay back the money when the note came due. The plaintiff, Curci Investments LLC, sued and ultimately recovered a $7.2 million judgment against Baldwin. That judgment proved incredibly difficult to collect because Baldwin held almost no assets individually. In 2014, Curci obtained a charging order against JPBI requiring JPBI to pay Curci any distributions that it was otherwise going to make to Baldwin. There was just one problem with that. Baldwin controlled when, if at all, JPBI made any distributions to him. Shockingly, JPBI ceased making distributions to Baldwin, notwithstanding that it had made $178 million in distributions during the prior 8 years. Yeah, this guy clearly had the resources to satisfy the “meager” $5.5 million judgment.
Curci then asked the trial court to add JPBI to the judgment directly (the aforementioned reverse veil piercing). Baldwin and JPBI argued that such brazen tactics were not allowed in California. The trial court agreed and denied the motion, relying on past California precedent disallowing reverse veil piercing. Curci asked the Court of Appeal to reverse that decision and, surprisingly, the court obliged.
In disallowing reverse veil piercing in prior cases, California courts have expressed concern that it would allow judgment creditors to bypass normal collection procedures while also harming innocent shareholders and corporate creditors. In disregarding those concerns, the Curci court held that there were no innocent shareholders here because JPBI’s only two members were Baldwin and his wife (who was also individually liable for the judgment under California’s Family Code). The court also held that this case had already proven that “normal judgment collection procedures” were ineffective. Normally, the way to go after an individual’s interest in an LLC is to obtain a charging order against his or her distributions. Curci had already done that and Baldwin, as JPBI’s manager, simply stopped making any distributions. Given that, the court held that reverse veil piercing may be allowed on these facts and remanded the case back to the trial court to determine whether it should do so.
The facts in this case are pretty extreme. When structured correctly, corporate entities will continue to exist separately from the individuals who form them. That said, litigants on both sides of a lawsuit should take note of this case, as should individuals when setting up corporate entities that are controlled largely by a single individual. Where, as here, it is pretty evident that an individual has near absolute ownership of and control over a company, courts may utilize reverse veil piercing to prevent that individual from controlling the company in a manner that prevents creditors from collecting judgments.