First Tuesday Update is our monthly take on current issues in judgment enforcement. A Delaware Chancery Court—for the first time by a Delaware Court—recognized that reverse veil piercing is an available remedy under Delaware Law in Manichaean Capital, LLC v. Exela Technologies, Inc. Vice-Chancellor Slights, in a 50-page opinion memorandum denying a motion to dismiss, summed up his analysis as follows: "After carefully reviewing the justifications for and against the adoption of reverse veil-piercing, I find that this equitable remedy (or right) is an appropriate means, in limited circumstances, to remedy fraud and injustice." The authors of this note are counsel in this action on behalf of judgment-creditors. 

This action involves efforts by former stockholders of a merged entity to enforce their statutory appraisal judgment of approximately $60 million. Appraisal judgments are unique, statutory creations that displaced a stockholder's common law right to veto a merger. The Delaware legislature decided that rather than allow one stockholder to prevent a merger, a stockholder could either participate in the merger on the terms negotiated by the board of directors or dissent and receive a court-determined appraisal value for their stock (thereby being bought out but permitting the merger to proceed).

Here, the dissenting shareholders pursued their appraisal remedy, which the defendant opposed and resisted. After the appraisal judgment was entered, the Chancery Court issued a charging order against the judgment-debtor's main assets. Yet the judgment remains unsatisfied. As far as the court and the litigants are aware, this is the first time that a Delaware appraisal judgment has remained unsatisfied. VC Slights described it as "the highly unusual circumstance where an appraisal judgment debtor cannot or will not pay."  

The judgment-creditors did not stand idly by. They brought two parallel actions to expand the scope of the judgment and hold liable the parent and subsidiary entities of the judgment-debtor and the officers and directors for breaching their fiduciary duties by taking steps to frustrate the charging order and leave the appraisal judgment unsatisfied. The Chancery Court analyzed the complaint and found that "Plaintiffs' well-pled allegations support a reasonable inference that Exela, lacking in corporate formality, engaged in a transaction, as described in the plaintiffs' complaint, for the purpose of preventing funds that would otherwise flow from SourceHOV Holdings' subsidiaries directly to SourceHOV Holdings to flow instead directly to Exela, thereby leaving the judgment debtor unable to satisfy the plaintiffs' appraisal judgment." Because "the charging order requires any money flowing through SourceHOV Holdings first to be paid to the judgment creditors, including the plaintiffs, Exela's participation in a scheme to deprive SourceHOV Holdings of those funds has conceivably rendered the charging order worthless parchment.'

Judge Slights was aware that no Delaware court had heretofore permitted a reverse veil piercing claim to go to discovery. Judge Slights analyzed the history and rationale of the statutory appraisal structure, citing several academic articles for support. He noted that, for the appraisal structure to make sense, "the dissenting shareholder should, absent compelling circumstances, actually get paid the fair value of ‘that which has been taken from him.' Anything less frustrates the origin and purpose of the statutory appraisal remedy."  

VC Slights posed the central question in this case, and almost every judgment enforcement action we engage in, on behalf of the creditor: "This Opinion considers what options are available to the judgment debtor in an appraisal action if, after a plaintiff receives a writ of execution or charging order, an appraisal judgment is still left unpaid."

With respect to traditional veil-piercing, that is piercing the veil of the corporate entity up to the owners, VC Slights noted "Plaintiffs make a compelling case in their Complaint that Exela and SourceHOV Holdings 'operate[] as a single economic entity such that it would be inequitable for this Court to uphold a legal distinction between them.'" He recognized it is "reasonably conceivable that SourceHOV Holdings is insolvent and that its insolvency, at least in part, is the result of Exela's undercapitalization of SourceHOV Holdings," and that Exela engaged in an "apparently deliberate effort to starve SourceHOV Holdings of cash,' and failure to observe certain corporate formalities. The "combination of insolvency, intentional undercapitalization and a lack of corporate formalities, coupled with valid claims of fraud and injustice, is enough to meet Plaintiffs' pleading stage burden."  

As for reverse veil-piercing—that is piercing the veil down from the corporate debtor towards the subsidiaries, he concluded: "I am satisfied that Delaware law allows for reverse veil-piercing in limited circumstances and in circumscribed execution." He then went through a thorough history of reverse veil-piercing, beginning in 1929, and touched on cases from several state supreme courts that explained their rationale for either accepting or rejecting reverse veil-piercing. The judge distinguished the cases that reject reverse veil-piercing by noting the "risks that reverse veil-piercing may be used as a blunt instrument to harm innocent parties, and to disrupt the expectations of arms-length bargaining, while real, do not, in my view, justify the rejection of reverse veil-piercing outright."

VC Slights then stated "Delaware will not countenance the use of the corporate form as a means to facilitate fraud or injustice," and concluded he is “satisfied there is a place for a carefully circumscribed reverse veil-piercing rule within Delaware law." The rule, as the judge articulated it, is limited to outsider reverse veil-piercing only, limited to "cases alleging egregious facts, coupled with the lack of real and substantial prejudice to third parties," and has the purpose of acting "as a deterrent to owners of companies, particularly those that are closely held, from shuffling their assets among their controlled entities with the express purpose of avoiding a judgment."

The test for reverse veil-piercing first looks to the "traditional factors Delaware courts consider when reviewing a traditional veil-piercing claim—the so-called "alter ego" factors that include insolvency, undercapitalization, commingling of corporate and personal funds, the absence of corporate formalities, and whether the subsidiary is simply a facade for the owner." Then the court will “ask whether the owner is utilizing the corporate form to perpetuate fraud or an injustice." This inquiry considers eight additional factors, largely drawn from a law review article, which generally consider the impact on innocent third parties, the extent of the parent company's dominion and control, whether public convenience would be served, and whether there are alternative remedies to recover the debt. Because reverse veil-piercing "is rooted in equity," the court "must consider all relevant factors, including those just noted, to reach an equitable result."

VC Slights recognized 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,” but noted “the fact the doctrine will rarely be invoked by the court to reach assets does not suggest that it should be unavailable to aggrieved creditors in all instances as a matter of law.” He then concluded that this case presents an exceptional circumstance, noting it has been well pled that the SourceHOV subsidiaries are alter egos of SourceHOV, and have actively participated in a scheme to defraud or work an injustice against SourceHOV's creditors; there are no innocent third parties that would be harmed by reverse veil-piercing; and "it is reasonably conceivable that reverse veil-piercing will be the only means by which Plaintiffs may collect the Appraisal Judgment."

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