By Susan J. King, Esq.
Traditionally, corporations and limited liability companies are treated as legal entities that are separate from their officers and equity holders, and the debts of the company are not debts of the owner and vice versa. The courts have, however, held owners personally liable for debts of the entity where the owners have misused or disregarded the corporate form. This is known as piercing the corporate veil. While it does not happen frequently, it is not unusual for a plaintiff to seek to pierce the corporate veil when an entity defendant has no or limited assets.
It is much more unusual for a plaintiff to seek to “reverse pierce” the corporate veil and hold entities liable for the debts of their owner. That is what happened in Sky Cable, LLC et al. v. Colely, a U.S. District Court for the Western District of Virginia case. DirectTV obtained a judgment of over $2.6 million against Colely for collecting and pocketing unauthorized subscriber fees. Colely evaded a series of actions DirectTV took to collect the judgment. At the time of the court action, Colely reportedly held no assets in his own name, but he did own three limited liability companies. DirectTV successfully collected the judgment against Colely from those three entities through a reverse piercing of the corporate veil.
The three entities collected rents on various properties, co-mingled assets, and paid debts owed by the other entities. Certain assets were owned by one of Colely’s companies, but managed by another one of his companies. Applying Delaware law, the court found that Colely was the alter ego of the three entities, noting that Colely and his companies “operate as a single economic entity in which money flows freely between them at Colely’s whim.” The court also found that Colelys’ personal expenses were paid by the companies, and that there was a failure to observe corporate formalities, a lack of proper accounting records and extensive comingling of assets.
Colely argued the court could not apply reverse piercing as it would effect “innocent” third parties, namely his wife, whom he contended was a member of his three limited liability companies. Although there was conflicting evidence as to whether Colely’s wife was a member of the limited liability companies, the court found that it did not need to resolve the issue because the Colelys had asserted in the underlying proceedings that she was not a member of any of the entities and, therefore, Colely was equitably estopped from asserting that his wife had any membership interest in the companies.
The court also rejected the Colely’s contention that the entities needed to be formed after the judgment against him to apply the alter ego theory. The court found that in order to prevail, the plaintiff only needed to establish that the entities were a “sham and exist ‘for no other purpose than as a vehicle for fraud.’” The court ultimately concluded that the three limited liability companies were sham entities and the alter ego of their owner
Colely is an example of someone who tried very hard to make himself judgment proof by running personal assets and expenses through various corporate entities. But you don’t need to be actively trying to evade judgments to find yourself in the position where you are found to be the alter ego of your entity, or your entity is found to be your alter ego. Comingling assets and accounts, and an extended failure to observe formalities, can land you in the same place. Having your lawyers, accountants, and/or other advisors perform an annual review of your company can go a long way to ensure that you do not fall into an alter ego situation.
If you would like to learn more about piercing the corporate veil in reverse, please contact Caulkins & Bruce, PC to schedule a consultation.
The information presented here should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
"Obtained a judgment for condominium association in excess of $1 million against developer of condominium in Fairfax County."
"Defended an officer of a government contractor in a case involving enforcement of a non-competition agreement."
"Defended and achieved favorable settlement of wrongful termination and discrimination claims brought in United States District Court for the Eastern District of Virginia."
"Served as outside counsel to several franchisors, prepared franchise agreements, franchise disclosure documents and state franchise registrations, and counseled franchisors regarding franchise compliance issues."