Contributed by Sara Coelho
In a typical application of the veil piercing remedy, an equity holder is held liable for the debts of the corporate entity it owns and controls. The tests courts use for determining when the remedy is available vary, but generally veil piercing may occur only where the equity holder has abused the corporate form, by using its control over an entity to commit a fraud or other injustice. Accordingly, in the context of a corporate family, most people assume that veil-piercing may cause liabilities to travel up the corporate chain, with parents sometimes liable for actions they have caused their subsidiaries to take. But when can a subsidiary business be liable for the actions of its owners? And how can this even be fair since subsidiaries do not control parents? One court recently asked this question, and in so doing provided insights into how such a “reverse veil-piercing” claim might be possible under alter ego doctrine.
2004 was a bad year for George Badger. After pleading guilty to multiple offenses in connection with the sale of securities, he entered into a consent judgment with the SEC under which he agreed to pay $19.2 million. Badger paid only $6,548 under the settlement over eight years, and so the government pursued him a second time, seeking a declaration that certain entities were Badger’s alter egos and that Badger could be ordered to disgorge their assets pursuant to the settlement. The putative alter egos included a corporation, an LLC, and a trust, and the government claimed they were controlled by Badger and used to fund personal investments and living expenses for Badger and his family. The District Court granted summary judgment in favor of Badger, holding that Utah law did not recognize a reverse veil-piercing doctrine whereby an “alter ego” corporate entity could be held liable for the debts of its owner.
The Court of Appeals for the Tenth Circuit disagreed. It found that there was no controlling Utah law on point and, therefore, asked how the state’s highest court would rule if presented with the question. As a federal court, it could not itself make new state law precedent through its own rulings. In the absence of a holding by the Utah Supreme Court on reverse-piercing claims, it had to consider what could be learned about that court’s likely rulings from that court’s declarations and holdings.
In a sprinkling of statements and decisions, the Circuit Court found indications that the Utah courts would recognize reverse-piercing as a variant of an alter ego claim, which is recognized under Utah law. The Circuit Court found that Utah’s highest court “expressed sympathy for reverse piercing” when the Utah court said the doctrine “follows logically from the basic premise of the alter ego rule and appears consistent with our case law.” It also cited decisions in the lower Utah courts using alter ego doctrine to hold corporate entities liable for debts of people who controlled them, and interpreted those decisions as examples of reverse piercing. A list of factors in one of those decisions was cited by Utah’s highest court in a traditional veil-piercing case, without discussion of whether a reverse-piercing test applies in a traditional-piercing case. The Circuit Court found this omission revealing. It said that the failure to mention the point “makes sense if the issue is only whether two parties are alter egos, regardless of which is to be held liable for the other’s debts.”
The unusual posture of the Badger case provides insight into how at least one court views the relationship between alter ego and veil piercing. Courts rarely discuss the relationship between these two doctrines, even though they apply similar tests and reasoning. In Badger, however, faced with a limited body of precedent, and an inability to make new law through its own rulings, the court considered how these doctrines may inter-relate. Its holding reveals that, applying alter ego principles, on the right fact pattern, a court might make the assets of a corporate entity available to satisfy the debts of its owner, implicitly sanctioning the concept of a “reverse veil-piercing” claim.
Sara Coelho is an Associate at Weil Gotshal & Manges, LLP in New York.
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