Ward on Iowa Limited Liability Company Law

Right End, Wrong Means

The issue of a parent company's liability for the debts of its wholly-owned subsidiary arises once again in 17315 Collins Avenue, LLC et al v. Fortune Development Sales Corp., 2010 Fla. App. LEXIS 201 (Fla. App, January 15, 2010).

Wavestone Properties, LLC owned all of the membership interests of 17315 and was its managing member.  Wavestone, like so many parent companies, did not conduct any operations, have employees or bank accounts (this last point is a little unusual).  Based on these fact the court concluded that the parent and subsidiary were alter egos and met the first prong of the two-prong test to pierce the corporate veil.

The second prong, an improper purpose or wrongdoing was met when Wavestone transferred escrow funds that were being held for a third-party creditor of its subsidiary to the subsidiary for operating capital.  In doing so Wavestone clearly committed a wrong, but it should have been held liable for this misconduct alone and not for all of the debts of its subsidiary.  A claim of conversion, fraudulent conveyance or third-party beneficiary would have done the trick. 

Holding the parent company liable for the debts of its subsidiary because it is a shell entity goes too far and further undercuts the notion that corporations and LLCs provide a shield from liability.

-Marc Ward

Reverse Piercing is a Flawed Theory

PIP, Inc. v. Kaswa Corporation, 77 Cal Rptr. 3d 96 (Dist. 4, 2008) highlights the problem with the theory of reverse piercing.  As you know, piercing the corporate veil is an equitable theory applied to pierce the liability protections of a corporation to get at the assets of the shareholder to satisfy a corporate debt.  It is an appropriate remedy when a shareholder uses the corporate form to evade personal liability or to commit a wrong. 

Legal theories should follow a certain logic.  A leads to B which leads to C.  Imagine a spear piercing through the corporation to hit the shareholder.  When piercing the corporate veil is applied it is a straight shot.

In a reverse pierce the spear is not straight and that is the problem.  Reverse piercing is used to apply corporate assets to satisfy the debt of a shareholder.  No abuse of a statutory privilege (e.g. limited liability created by the corporate form) or wrongdoing is alleged.  Rather a second defendant is brought in merely because of its connection with the individual.  A does not lead to B, they sit side by side.

Courts recognizing reverse piercing miss two key points.  First, innocents are put at risk.  Because no showing of abuse of the distinction between a shareholder and the corporation is necessary (e.g. alter ego, commingling of assets, etc.) there may be other innocent shareholders whose investments are now at risk.  And corporate creditors, particularly unsecured trade creditors, may have the assets they were counting on to satisfy their legitimate debts swept up by the shareholder’s creditor.  It is arguable that even a secured creditor may see its security vanish because the assets are deemed personal to the shareholder.

Second, there are adequate legal remedies available to the creditor such as conversion and fraudulent conveyance.  This is true even in the most obvious case for applying reverse piercing; when a sole shareholder tries to hide personal assets in a corporation to avoid a personal obligation.  Even in this case there is no need to create another remedy that is not based on sound legal reason.

 

-Marc Ward

Charging Orders and Foreign LLCs

It may come as a surprise that the charging order remedy under Iowa Code 489.503 is only available against domestic (Iowa) LLCs (the phrase "limited liability company" is limited by definition to domestic LLCs).  Thus, if you have a judgment against a debtor who owns an interest in a Delaware LLC, that state is the proper forum to bring a charging order proceeding.  Remember that the charging order directs the company to send its distributions to the creditor, it is not an action against the debtor/member. 

 

There are some contrary opinions out there to the effect that if a state has jurisdiction over a foreign LLC it should be able to impose a charging order against it, but I don't see how you overcome the definitional challenge created by the Iowa Act.

 

This leads to some interesting asset protection planning.  Of course it is an annoyance to a creditor to have to go to Delaware to collect on an Iowa judgment.  But imagine the consternation of the creditor if the interest is in a Proprietary Limited Company in Australia. Happy New Year.