Ownership Piercing by Lécia Vicente: Recommended Reading

I am reading a very interesting paper by Lécia Vicente, which argues that:

In this article, I develop the concept of "ownership piercing." I use the expression to suggest that courts engage in a process of evaluative reasoning to clarify who owns property rights and controls the limited liability company. I show under what circumstances courts should do that. Ownership piercing entails investigating the reality of the company's governance and tracing the real ownership profile of the company. It means defining who materially controls the company (i.e., managers or members?) and how "tamed" or, in other words, restricted the members' property rights are considering the consensual agreements the members and other stakeholders entered into. The idea that there may be situations in which courts should ownership pierce rests on the substance over form principle, which maintains that the economic substance of transactions rather than their legal form be disclosed.

Vicente, Lécia, Ownership Piercing (February 21, 2021). Available at SSRN: https://ssrn.com/abstract=3790108 or http://dx.doi.org/10.2139/ssrn.3790108.

She explains that:

Ownership piercing is not the same as the company's veil piercing. I define ownership piercing as a process of evaluative reasoning that courts undertake to complement the material participation test. Ownership piercing may also shed light on the level of control and the manager's decision-making role. Ownership piercing may help courts understand if an agent occupies a control or decision-making role despite acting under the control of a principal who has the final decision-making authority. In other words, ownership piercing helps understand who exercises ultimate control in the LLC.

I think she is very much on to something here. In particular, I think her work will do much to inform our analysis of cases like AG Resource Holdings, LLC, et al. v. Terral and Focus Financial Partners v. Holsopple. In both of those cases, the question of status as an owner or employee matter a great deal. Ownership piercing gives us a starting point for parsing them out.

Professor Vicente uses Metro Storage International LLC v. Harron to frame her analysis. (I commend to your attention Francis Pileggi's blog post on the case.) On one level, Harron is a constitutional law/civil procedure case, as the question before the court was whether a Delaware court had personal jurisdiction under 18-109(a) of the Delaware code, which implies consent to jurisdiction on the part of both de jury and de facto managers of an LLC. As Professor Vicente points out, however, deciding those issues required the court to parse out what it means to own and control an LLC.

Those who own are not always in control. Therefore, those who control should be held accountable like the owners would if they were in control. ... I am dealing with situations where standard contractual terms give the managers exclusive decision-making power. The role of an acting manager who had that type of exclusive power was analyzed by the Delaware Chancery Court ("Court") in Metro Storage International LLC v. Harron (“Harron”). In light of the company's contractual framework, members are peculiarly vulnerable since they cannot remove the managers, nor is it easy for them to sell their units. I suggest that, under these circumstances, courts may be less willing to give managers the benefit of the doubt as it is done through the application of the business judgment rule.

The first thing that sprang to mind when I read that was Martin Petrin's work on the responsible corporate officer doctrine, which is an analogy I encourage Prof. Vicente to pursue. 

In any case, she poses the question "What does it mean to participate materially in the management of the company?" In doing so, she does a deep dive into there hybrid property and contractual nature of LLC member's rights.

I was interested by her attempt to use the biological concept of pleiotropy to understand legal rights. It's an ambitious attempt at intellectual arbitrage. I'm not 100% convinced, but I admire her scholarly ambition and the modesty that prompts her to forthrightly acknowledge that "legal pleiotropy needs to be continuously studied, particularly to determine the applicable contractual clauses' scope and depth."

There's a digression into some empirical research she did into the UK equivalent of LLCs, which I'm not sure advances the ball. I would urge her to tie it more throughly into the argument throughout. (Or to dump it.)

At page 27, we come to her detailed exposition of how ownership piercing would solve the problems laid out in the preceding sections. What I would encourage her to develop in this section is a clearer statement of how ownership piercing would work. Set out a practical test that a judge could adopt and apply. In particular, it strikes me that she could adapt the veil piercing standard to say something like:

1. Does this individual have de facto managerial control whether by contract or otherwise?
   1. The laundry list of factors used in veil piercing cases could be adapted to ask whether this LLC has de facto allowed this individual to take over the members' control of the company and effect a separation of ownership and control.
2. Would not treating this individual as a controller lead to inequitable results?

Obviously, I'm shooting from the hip here but I think it would be helpful for her to flesh out what it means when she says "Ownership piercing means that the courts engage in a qualified process of evaluative reasoning." How does the court go about unveiling "the company's real owners, that is, the managers."

In sum, I think Prof. Vicente's article has the potential to make a very substantial contribution to an important area of the law that has not been well served by courts or commentators to date.

 

I also note with amusement that my friend Joshua Fershee will be pleased by Prof. Vicente's admonition that "THE LLC IS NOT A BERLE-MEANS CORPORATION." As Josh has often pointed out, much confusion has resulted from courts' failure to understand that point. 

Prof. Vicente draws three points from that distinction:

1. The LLC consists of autonomous individuals and the individualistic aspects of the LLC "do not favor weaker members." The cases in which courts have validated "predatory competition" within LLCs (with appropriate fiduciary duty waivers) come to mind here.
2. The principal-agent problem takes a different form that is "exacerbated by majority rules, the power of controlling or activist members, and the benefit of hindsight of the knowledgeable manager acting opportunistically."
3. The "common understanding in the literature that in LLCs, members are usually part of the management" is simply not true in manager-managed LLCs, where members "grant the managers autonomy, but in the process, become dependent on them to the point that unclear property rights in the units are not sufficient to overcome self-dealing by the management. Hence, without self-motivated investors minding the company's business, managers' effective constraints are small."