In outsider reverse veil piercing, a personal creditor of the shareholder seeks to disregard the corporation's separate legal existence. Unlike regular veil piercing, in which a creditor of the corporation is trying to reach the personal assets of a shareholder, in this situation a creditor of the shareholder wants to reach the assets of the corporation in order to satisfy the creditor's claims against the shareholder. A number of courts have recognized such a cause of action. I think it’s a pernicious and evil doctrine that should be cast into the outer darkness where there is weeping and gnashing of teeth.
This post is specifically prompted by C.F. Trust, Inc. v. First Flight L.P., 580 S.E.2d 806 (Va.2003), in which the Virginia supreme court recently recognized outsider reverse piercing as valid under Virginia law. (For those who want even more information on regular veil piercing, reverse veil piercing, and/or outsider reverse veil piercing, you can buy my Corporation Law and Economics text and flip to Chapter 4.)
The CF Trust court opined “that there is no logical basis upon which to distinguish between a traditional veil piercing action and an outsider reverse piercing action. In both instances, a claimant requests that a court disregard the normal protections accorded a corporate structure to prevent abuses of that structure.” Au contraire. The problem presented by outsider reverse veil piercing is reminiscent of the issues raised by the old "jingle rule" of partnership law. Section 40 of the UPA (1914) provides that personal creditors of a partner have priority with respect to the partner's personal assets and creditors of the partnership have priority with respect to partnership assets. The "jingle rule," however, has been superseded for all practical purposes by section 723 of the federal Bankruptcy Code. That section provides that the firm's creditors will be paid out of firm assets and then have equal rights to participate with personal creditors in dividing up personal assets. The rationale for this change seems to have been that prospective creditors of the partnership rely on the creditworthiness of the individual partners in making lending and contracting decisions. In response to the federal law, UPA (1997) section 807 de facto repealed the jingle rule.
UPA (1997) thus does not allow a personal creditor of a partner direct access to partnership assets. Section 502 limits the partner's "transferable interest" in the firm to "the partner's share of the profits and losses of the partnership and the partner's right to receive distributions." Section 504 then allows a "judgment creditor" of a partner to "charge the transferable interest of the judgment debtor to satisfy the judgment." In effect, the creditor thus gets a lien on the partner's interest. Although a creditor who has foreclosed on that lien may seek judicial dissolution of the partnership, a court will only grant dissolution if "it is equitable to wind up the partnership business." UPA (1997) section 801(6).
Corporate law does not contain comparable provisions, but essentially the same result obtains through application of the standard judgment collection rules. Courts that accept outsider reverse veil piercing, however, disrupt this scheme by allowing personal creditors of a shareholder direct access to corporate assets.
To the extent that outsider reverse veil piercing effectively gives priority to personal creditors in the corporate setting, it seems just as problematic as the old jingle rule, albeit for slightly different reasons. As with the jingle rule question, the issue is: whose creditors shall have priority with respect to which assets? Outsider reverse veil piercing allows the creditor to avoid the more demanding proof required by traditional theories of conversion or fraudulent transfer. Outsider reverse veil piercing also effectively bypasses the standard approach to collecting a judgment against a corporate shareholder, in which the creditor attaches the debtor's shares in the corporation rather than the assets of the corporation itself. Unsecured creditors who relied on firm assets in lending to the corporation are thus disadvantaged. Similarly, if there are other shareholders, their interests are adversely affected if the corporation's assets can be directly attached by the personal creditor of one shareholder. In contrast, in ordinary (i.e., forward) veil piercing cases, a creditor may reach only the assets of the controlling shareholder who is determined to be the corporation's alter ego.