An Evolving Way To Attack Assets

Piercing the corporate veil. It sounds painful, and it is. A judgment is entered against a corporation with no assets. To collect the court allows the judgment creditor (the winner in the case) to pierce through the corporation and reach the personal assets of the shareholder.

A new twist on this method of collection has appeared. It is called reverse piercing of the corporate veil. It is reversed because instead of a judgment against a corporation there is a judgment against an individual. The individual has no assets, but their entity does. So in this case the court allows the judgment creditor to go past the individual and gain access to assets of their corporation or LLC. Graphically, the difference is:

California has joined the list of states allowing for reverse piercing. The following goes through the Curci case in question. If you don’t have time to read the entire case write up, please know that asset protection is a constantly evolving area of law.

ISSUE

What is the potential impact on outside reverse veil piercing of the recent California Court of Appeal, Fourth District, decision in Curci Investments, LLC v. Baldwin, 14 Cal.App.5th 214, 221 Cal.Rptr.3d 847 (Cal.App., Aug, 10, 2017)

APPLICABLE LAW

In Curci Investments, LLC v. Baldwin, 14 Cal.App.5th 214, 221 Cal.Rptr.3d 847 (Cal.App., Aug, 10, 2017), the California Court of Appeal, Fourth District, concluded that a judgment creditor was not per se precluded from outside reverse piercing the corporate veil to add a Delaware limited liability company (LLC), and that the California statute providing for charging order levying distributions from an LLC to a debtor member did not preclude application of outside reverse veil piercing to allow a judgment creditor to add an LLC as a judgment debtor on a judgment against the holder of an LLC interest.

The Fact of Curci

In January 2004, James P. Baldwin (“Baldwin”), a prominent real estate developer, formed JPB Investments, LLC (“JPBI”), a Delaware limited liability company, for the exclusive purpose of holding and investing Baldwin and his wife’s cash balances. Over the course of his lifetime, Baldwin had formed and held interests in hundreds of corporations, partnerships, and LLCs. JPBI had two members: (1) Baldwin with a 99 percent member interest; and (2) his wife with a one percent member interest. Baldwin was a manager and the chief executive officer (“CEO”) of the company. In these roles, and given his member interest, Baldwin determined when, if at all, JPBI made monetary distributions to its members, i.e., Baldwin and his wife. Two years after forming JPBI, Baldwin, individually, borrowed $5.5 million from Curci’s predecessor in interest. The loan was memorialized in a promissory note executed by Baldwin and the managing member of Curci’s predecessor (the “Curci note”). In the Curci note, Baldwin agreed to pay back the principal amount of the loan, with interest, by January 2009. Curci was assigned the lender’s interest in the Curci note shortly after it was executed. One month after executing the Curci note, Baldwin settled eight family trusts to provide for his grandchildren during and after their college years (the “family trusts”). Baldwin’s children were the designated trustees. (At least one of his sons, however, was unaware of the family trusts despite his signature on the trust documents.) Not long after the family trusts were settled, JPBI loaned a total of approximately $42.6 million (the “family notes”) to three general partnerships (the “family partnerships”) formed by Baldwin for estate planning purposes. Because the partners of the family partnerships were various combinations of the family trusts, certain of Baldwin’s children signed the family notes in their capacity as trustees. Baldwin signed the family notes in his capacity as manager of JPBI. Each family note indicated the principal amount of the loan was to be repaid by July, 2015. Although all the family notes were in favor of JPBI, Baldwin and his wife listed them as “Notes Receivable” on their personal financial statements.

When the Curci note came due in January, 2009, Baldwin had not made any payments. Curci filed a lawsuit against him to recover the amount owed. Not long thereafter, the parties entered into a court-approved stipulation establishing a payment schedule for Baldwin to avoid entry of judgment. About a year later, the trial court approved an amended stipulation that modified the payment schedule due to Baldwin’s continued failure to make the agreed upon payments. Baldwin ultimately failed to make the agreed upon payments, so Curci sought entry of judgment against him. In October, 2012, the trial court entered judgment in favor of Curci and against Baldwin in the amount of approximately $7.2 million, including prejudgment interest and attorney’s fees and costs. In the year after entry of judgment, Curci propounded extensive post-judgment discovery requests aimed at understanding the nature, extent, and location of Baldwin’s personal assets. Baldwin did not timely respond to the discovery, and Curci filed a motion to compel. Though the motion was moot by the time it was heard, the trial court awarded sanctions against Baldwin.

As of February, 2014, no payments had been made on the family notes. Baldwin, as manager of JPBI, and for reasons unexplained, chose to execute amendments to the family notes to extend their terms by five years, to July, 2020. No consideration was provided in exchange for the extensions. A few days later, Baldwin responded to a discovery request made by Curci one year earlier. Among the documents he produced were the family notes, including the five-year payment extensions. Based on Baldwin’s discovery responses, and Baldwin’s failure to pay any of the judgment, Curci filed a motion seeking charging orders against 36 business entities in which Baldwin had an interest. Among those entities was JPBI. The trial court granted Curci’s motion in August, 2014. From and after that date, any monetary distributions made by JPBI to Baldwin, in his capacity as a member, were ordered to be paid to Curci instead. Curci received no money as a result of the charging order.

Although Baldwin caused JPBI to distribute approximately $178 million to him and his wife, as members, between 2006 and 2012, not a single distribution had been made since the October, 2012, entry of judgment on the Curci note.

This is a key factor. When that much money has been previously distributed, courts will ask why Curci can’t be paid. As well, there had been no payments made by the family partnerships to JPBI on the family notes. In June, 2015, Curci filed a motion to add JPBI as a judgment debtor pursuant to California Code of Civil Procedure, Section 187. Curci based its motion on the outside reverse veil piercing doctrine. Curci argued that JPBI was Baldwin’s alter ego, that Baldwin was using JPBI to avoid paying the judgment, and that an unjust result would occur unless JPBI’s assets could be used to satisfy Baldwin’s personal debt. Baldwin did not initially oppose the motion. The trial court issued a tentative ruling denying Curci’s motion, based upon the earlier California Court of Appeal, Fourth District, decision in Postal Instant Press, Inc. v. Kaswa Corp., 162 Cal.App.4th 1510, 77 Cal.Rptr. 3d 96 (Cal.App., Aug. 27, 2008). Following additional briefing from the parties on that issue, and a hearing, the trial court adopted its tentative ruling as its final decision. Because it believed outside reverse veil piercing was not viable in California, it did not make any factual findings related to Curci’s arguments thereunder. Curci timely appealed.

The Decision in Curci

Curci sought to add JPBI as a judgment debtor on the $7.2 million judgment it had against Baldwin personally. Curci asserted that Baldwin held virtually all of the interest in JPBI and controlled its actions, and that Baldwin appeared to be using JPBI as a personal bank account. Curci argued that, under these circumstances, it would be in the interest of justice to disregard the separate nature of JPBI and allow Curci to access JPBI’s assets to satisfy the judgment against Baldwin. Citing Postal Instant Press, Inc., supra, the trial court denied Curci’s motion based on its belief the relief sought by Curci, commonly known as outside reverse veil piercing, was not available in California. On appeal, Curci asserted that Postal Instant Press was distinguishable, and urged the California Court of Appeal to conclude that outside reverse veil piercing was available in California and appropriate in this case. The California Court of Appeal agreed with Curci, that Postal Instant Press was distinguishable, and concluded that outside reverse veil piercing was possible under these circumstances. Therefore, the California Court of Appeal reversed and remanded the case to the trial court to make a factual determination as to whether JPBI’s veil should be pierced.

The Rationale in Curci

In Curci, the California Court of Appeal noted that the question presented was whether outside reverse piercing of the corporate veil could be applied under the circumstances of this case, giving Curci the ability to reach JPBI’s assets by adding it as a judgment debtor. Curci contended that the facts of this case justified making such a remedy available, and argued that neither the decision in Postal Instant Press, nor state statutory law, precluded such a result. Baldwin disagreed, asserting that Postal Instant Press established a broad and all-encompassing rule of no reverse piercing in California; and, alternatively, that California Corporations Code, Section 17705.03, provided the sole remedy available to Curci with respect to JPBI. The Court agreed with Curci, and found that remand was appropriate, in order to allow the court to make the factual determination of whether the facts in this case justified piercing JPBI’s veil.

A. CCP 187.

In Curci, the Court initially noted that, pursuant to Code of Civil Procedure, Section 187, a trial court has jurisdiction to modify a judgment to add additional judgment debtors, and that granting or denying a motion to add a judgment debtor lies within the discretion of the trial court.

B. Veil Piercing and the Alter Ego Doctrine

In Curci, with respect to traditional veil piercing, the Court noted that, ordinarily a corporation is considered a separate legal entity, distinct from its stockholders, officers, and directors, with separate and distinct liabilities and obligations; and that the same was true of an LLC and its members and managers. The Court pointed out that legal separation may be disregarded by the courts when a corporation or LLC is used by one or more individuals: (1) to perpetrate a fraud; (2) to circumvent a statute; or (3) to accomplish some other wrongful or inequitable purpose. The Court observed that in those situations, the corporation’s or LLC’s actions will be deemed to be those of the persons or organizations actually controlling the corporation, in most instances the equitable owners; and that the alter ego doctrine prevents individuals or other corporations from misusing the corporate laws by the device of a sham corporate entity formed for the purpose of committing fraud or other misdeeds. The Court stressed that, as an equitable doctrine, its essence is that justice be done. The Court stated that, before the alter ego doctrine will be invoked in California, two conditions generally must be met: (1) first, there must be such a unity of interest and ownership between the corporation and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist; and (2) there must be an inequitable result if the acts in question are treated as those of the corporation alone. The Court observed that, while courts have developed a list of factors that may be analyzed in making these determinations, there is no litmus test to determine when the corporate veil will be pierced; rather the result will depend on the circumstances of each particular case.

C. Outside Reverse Veil Piercing

In Curci, the Court noted that outside reverse veil piercing is similar to traditional veil piercing in that when the ends of justice so require, a court will disregard the separation between an individual and a business entity; however, the Court emphasized that the two serve unique purposes and are used in different contexts. Rather than seeking to hold an individual responsible for the acts of an entity, outside reverse veil piercing seeks to satisfy the debt of an individual through the assets of an entity of which the individual is an insider. The Court observed that outside reverse veil piercing arises when the request for piercing comes from a third party outside the targeted business entity; and that as outside reverse piercing has evolved, a growing majority of courts across the country have adopted it as a potential equitable remedy.

D. Postal Instant Press

In Curci, the Court noted that another panel had addressed outside reverse veil piercing in Postal Instant Press, supra. In that case, Postal Instant Press (“PIP”) obtained an $80,000 judgment against an individual, then sought to amend the judgment to add as a judgment debtor a corporation in which the debtor formerly held shares. The PIP court reversed the trial court’s order amending the judgment, based on the conclusion that a third party creditor may not pierce the corporate veil to reach corporate assets to satisfy a shareholder’s personal liability. In reaching its conclusion, the PIP court echoed concerns expressed by non-California courts about making outside reverse veil piercing available with respect to corporations. A