Corporate veil-piercing is nearly as old as limited liability, the privilege it circumscribes.[1] Normally, limited liability conjures an image of a veil between a corporation and its owner, thereby shielding the assets of the latter, whether a natural or artificial person,[2] from the claims of the corporation’s creditors. Piercing the veil makes it suddenly diaphanous and exposes the owner to liability for any debts of the corporation. Although the alter-ego doctrine predates this remedy’s concoction,[3] these concepts[4] have become inextricably bound in application,[5] and the alter-ego test subsumed into the common law’s most popular veil-piercing variant.[6]
Although practical, this conflation has allowed a distinction to be formed that can be pivotal to the operation of the Bankruptcy Code — an alter-ego finding necessarily establishes the principal’s direct liability, but piercing in its absence only creates a vicarious obligation — to be consistently overlooked. In particular, as recently recognized in Ng v. Adler (In re Adler),[7] an alter-ego determination will impact the scope of §§ 362(a) and 727(a), but veil-piercing alone affects only that of § 362(a), when an eligible individual[8] files a chapter 7 petition but enumerates neither the debts nor the assets of any debtor-controlled corporation in a single tendered document.[9]
Relevant Facts[10]
To understand Adler, a few facts must be kept in mind. Beginning in 1997, an American entrepreneur (ED), having created five New York corporations, signed production contracts with various non-domestic manufacturers on these entities’ behalves. A foreign-based agent served as the parties’ intermediary. Disputes eventually surfaced and culminated in the agent’s state court lawsuit against ED and the corporations. Of the 10 counts, the seventh was pleaded against ED personally. In this instance, the agent sought to pierce the corporations’ veils.
On July 28, 2004, ED filed a voluntary chapter 7 petition. Nowhere in his petition did ED list a single corporate debt, for he had purportedly never personally guaranteed payment. In the ensuing decade, no corporation filed for bankruptcy while the agent’s suit against that quintuplet continued unabated, the seventh count having been severed. On March 2, 2012, the bankruptcy court applied New York law to pierce each corporation’s veil. Two questions still remained: whether the automatic stay had been violated by the agent’s action against the corporations, and whether ED violated § 727(a) by failing to detail these corporations’ business transactions and property throughout his individual case. On July 11, 2013, the bankruptcy court answered “yes” to both of these questions.
Doctrines Disentangled: Alter Ego and Veil-Piercing
A key recognition underlies Adler: alter ego and veil-piercing are not actually synonymous concepts. Admittedly, for a veil to be pierced in many states, including New York, a plaintiff must prove three elements: (1) the parent person must have exercised “complete domination over the corporation with respect to the transaction at issue,” (2) this domination “was used to commit a fraud or wrong” and (3) that fraud or wrong “injured the party seeking to pierce the veil.”[11] As history attests, the first element of this prominent veil-piercing test — the parent’s domination must be so complete “at the time of the transaction complained of ... that the subsidiary ha[d] become a mere instrumentality of the parent, who is the real actor”[12] — is an unadorned restatement of the common law’s alter-ego doctrine.[13] Indeed, the same protean elements are used to evidence both remedies’ “domination” prong,[14] and both recurrently demand proof of causation and a fraud or wrong.[15] Partly due to these similarities, these concepts are frequently interchangeable in practice.[16]
Nevertheless, in such states as Texas and Delaware, alter ego is “only one of the bases for disregarding the corporate fiction.”[17] For example, the Supreme Court of Texas has identified nine others, such as when the corporate form is used to “evad[e] a legal obligation,” “achieve or perpetrate a monopoly” or “circumvent a statute.”[18] Grossly inadequate capitalization or some substantial public policy’s breach may also often justify veil-piercing.[19] In other words, depending on the relevant corporate regime, an alter-ego relationship need be proven “only when some type of ‘piercing’ is sought.”[20]
Once this bare fact is grasped,[21] each remedy’s analytical peculiarity, so significant for understanding their dissimilar effects on §§ 362 and 727, can be fully discerned. Assuming that an alter-ego judgment is not implicit or compelled, veil-piercing merely establishes a principal’s derivative liability.[22] By itself, its imposition denudes no corporation of legal presence, and it does not automatically classify such an artificial entity as an insubstantial fiction that is realistically and legally indistinguishable from its owner.[23] An alter-ego finding, on the other hand, does so. Axiomatically, it engenders a liability both personal and direct by confirming that the merger into a single legal personality of a corporation and its guiding person had already occurred at the time of the offending transaction.[24] As soon as a corporation becomes its owners’ instrumentality,[25] it confirms, owner and corporation meld into “one entity” in law, and in fact,[26] the acts of one truly become “the acts of all.”[27]
As Adler stresses, this concept is deeply rooted in the common law; therefore, an alter-ego is unable to evade its ramifications by a bankruptcy petition’s simple filing.[28] Accordingly, if an individual debtor is proved to have been any instrumentality’s prepetition alter ego, that debtor must be deemed to have owned that corporation’s every asset and performed that corporation’s every act prepetition.[29] Having untangled these doctrines and delineated their divergent effects, Adler posited two conclusions.
Shields (§ 362) and Burdens (§ 727) of a Debtor/Principal
Its first was not unique that the bankruptcy court built upon its earlier jurisprudence and other precedent.[30] As § 362(a)(1) is confined to “action[s] or proceeding[s] against the debtor,”[31] the automatic stay does not usually protect “nonbankruptcy codefendants.”[32] Nonetheless, courts have not hesitated to extend it to a nondebtor “when a claim against the nondebtor will have an immediate adverse economic consequence for the debtor’s estate.”[33] Critical to this construction has been the assertion that § 362(a) imposes on creditors an affirmative duty to cease the specified actions upon a debtor’s voluntary filing regardless of their awareness of its applicability.[34] It does not matter if this verity is only confirmed after a debtor’s filing; per the statutory language, the action must be reckoned to be void or voidable.[35]
Since either veil-piercing or an alter-ego finding will subject a debtor/principal to personal liability as of the moment in time that the triggering events occurred,[36] this broad reading of § 362 can lead to only one end. Namely, the “adverse economic consequences” justifying § 362(a)(1)’s extension to nondebtor entities[37] always exist on a petition’s filing date as long as one condition is true: the events precipitating either remedy’s application had already materialized.[38] Thus, a party proceeds against a nondebtor entity at its own risk whenever a debtor’s liability, whether due to a pierced veil or an alter-ego decree, is reasonably foreseeable.[39] Based on this prefatory deduction, Adler declared the agent’s state court action against the corporations void, joining a large, persuasive chorus.
Thereafter, Adler posed its novel proposition: Only an alter-ego determination, not piercing unaccompanied, can affect the extent of an individual debtor’s obligations under § 727. By definition, veil-piercing will ensure the debtor/principal’s personal liability, but it will leave these discrete personalities very much cognizable and real. In contrast, if an alter-ego relationship developed prepetition, a decision acknowledging this affirms that the consolidation of ostensibly distinct personalities into one indivisible person — the controlling debtor/principal — was a prepetition fact.[40] Consequently, in demonstrating ED to have been the corporations’ dominant principal, as New York law requires in order for a veil to be pierced, the agent in Adler did more than subject the debtor to personal liability.[41] In so doing, it concurrently proved that “the same entity”[42] had owned every asset and orchestrated every transaction prior to the bankruptcy filing: a corporeal ED, the corporations’ once and future principal. ED had technically filed an individual petition,[43] yet as a prepetition alter ego, he alone bore the responsibility for any corporate asset that was concealed or destroyed, any corporate record that was mislaid and any corporate loss that was unexplained.[44] These assets were his to itemize and these dealings his to clarify, even in his individual guise.[45]
Unfortunately, ED did not do so.[46] Instead, he chose to omit any data regarding those five sham corporations, his individual persona’s component selves, from his petition.[47] These lapses amounted to four violations of § 727(a) and ED’s discharge was denied.[48]
Takeaways
Adler’s primary tenets — an alter-ego finding verifies the past merger of two or more persons, and veil-piercing by itself effects no such union — are venerable features of the common law.[49] Therefore, it is unsurprising that courts have extended the automatic stay to nondebtor entities when the possibility of veil-piercing can be reasonably supposed.[50] Veil-piercing will always render a debtor financially liable for a corporate debt so that “adverse economic consequences”[51] will always be extant as long as this remedy’s predicate facts emerged prepetition.[52]
In its explication of how the alter-ego doctrine broadens an individual debtor’s § 727 duties, Adler did break new ground. In essence, Adler explicates, so as not to run afoul of § 727(a), an individual debtor/principal must account for the assets, transactions and records of its every prepetition instrumentality. In such situations, even if no judicial decision so recognizing this alter-ego relationship has been issued prepetition, it was nonetheless a legal fact that no debtor/principal can avoid by asserting a flimsy ignorance. For creditors, a once-hidden avenue has now been illuminated; for debtors, a long-eluded menace now looms.
[1] Karen Vandekerckhove, Piercing the Corporate Veil 76 (2007).
[2] Black’s Law Dictionary 1257, 1258 (9th ed. 2009).
[3] Peter B. Oh, “Veil-Piercing,” 89 Tex. L. Rev. 81, 83 (2010).
[4] Commonly, veil-piercing is characterized as a remedy and alter ego as a cause of action. However, both can be described as purely remedial theories. 1 Fletcher, Cyclopedia Corporations § 41.10 (1990). This article does so.
[5] Oh, supra n.3, at 83-84.
[6] Bd. of Trs. v. Elite Erectors Inc., 212 F.3d 1031, 1038 (7th Cir. 2000); Wm. Passalacqua Builders v. Resnick Developers S., 933 F.2d 131, 137-38 (2d Cir. 1991).
[7] 494 B.R. 43 (Bankr. E.D.N.Y. 2013).
[8] 11 U.S.C. §§ 109 and 727(a)(1).
[9] For clarity’s sake, this article uses the term “alter ego” to refer to the controlling principal and “instrumentality” to refer to the dominated corporation.
[10] The facts are drawn from the Adler decision discussed in this article, as well as an interim ruling similarly titled. Ng. v. Adler (In re Adler), 467 B.R. 279 (Bankr. E.D.N.Y. 2010).
[11] See, e.g., Rochester Gas & Elec. Corp. v. GPU Inc., 355 Fed. App’x. 547, 549-50 (2d Cir. 2009); Hillsborough Holdings Corp. v. Celotex Corp. (In re Hillsborough Holdings Corp.), 166 B.R. 461, 468-69 (Bankr. M.D. Fla. 1994) (similarly interpreting Florida and Delaware law).
[12] Passalacqua, 933 F.2d at 138.
[13] Taylor Steel Inc. v. Keeton, 417 F.3d 598, 605 (6th Cir. 2005).
[14] Leek v. Cooper, 194 Cal. App. 4th 399, 417-18 (Cal. Ct. App. 2011) (summarizing California’s factors); Passalacqua, 933 F.2d at 139 (enumerating New York’s 10 factors).
[15] Tamko Roofing Prods. Inc. v. Smith Eng’g Co., 450 F.3d 822, 828 (8th Cir. 2006).
[16] Morris v. N.Y. Dep’t of Taxation & Fin., 623 N.E.2d 1157, 1160-61 (N.Y. 1993); Mesler v. Bragg Mgmt. Co., 702 P.2d 601, 300 (Cal. 1985).
[17] Castleberry v. Branscum, 721 S.W.2d 270, 272 (Tex. 1986); accord, Geyer v. Ingersoll Publ’ns Co., 621 A.2d 784, 793 (Del. Ch. 1992).
[18] Castleberry, 721 S.W.2d at 272 and n.1; Oh, supra n.3, at 132-39 (surveying rationales).
[19] Cathy S. Krendl and James R. Krendl, “Piercing the Corporate Veil: Focusing the Inquiry,” 55 Denv. L.J. 1, 47 (1978); cf. Michnovez v. Blair LLC, 795 F. Supp. 2d 177, 185-86 (D.N.H. 2013) (elaborating different grounds for piercing under New Hampshire law).
[20] SEC v. Hickey, 322 F.3d 1123, 1130 (9th Cir. 2003) (emphasis added).
[21] Int’l Union, UAW v. Aguirre, 410 F.3d 297, 302 (6th Cir. 2005).
[22] United States v. Bestfoods, 524 U.S. 51, 68 (1998) (opining that piercing creates “indirect liability”); see also Carter-Jones Lumber Co. v. LTV Steel Co., 237 F.3d 745, 750 (6th Cir. 2001) (same).
[23] Castleberry, 721 S.W.2d at 272; Passalacqua, 933 F.2d at 137-38.
[24] Thomson-CSF S.A. v. Am. Arbitration Ass’n, 64 F.3d 773, 778 (2d Cir. 1995).
[25] United States v. Ne. Pharm. & Chem. Co., 810 F.2d 726, 744 (8th Cir. 1986).
[26] Flynn v. Greg Anthony Constr. Co., 95 Fed. Appx. 726, 733-34 (6th Cir. 2003); see also Ret. Plan of the Unite Here Nat’l Ret. Fund v. Kombassan Holdings AS, 629 F.3d 282, 288 (2d Cir. 2010).
[27] Doctor’s Assocs. v. Distajo, 66 F.3d 438, 453-54 (2d Cir. 1995) (quoting Fisser v. Int’l Bank, 282 F.2d 231, 234 (2d Cir. 1960)).
[28] In re Adler, 494 B.R. at 61-62; Rupp v. Ayres (In re Fabbro), 411 B.R. 407, 420-21 (Bankr. D. Utah 2009) (citing Butner v. United States, 440 U.S. 48, 55 (1979)); United States v. Singleton, 165 F.3d 1297, 1302 (10th Cir. 1999).
[29] In re Adler, 494 B.R. at 56-57.
[30] Mokuba N.Y. LLC v. Pitts (In re Pitts), Case No. 808-74860-reg, 2009 Bankr. LEXIS 4023, at *15-19, 2009 WL 4807615, at *5-7 (Bankr. E.D.N.Y. Dec. 8, 2009).
[31] 11 U.S.C. § 362(a)(1).
[32] Teachers Ins. & Annuity Ass’n of Am. v. Butler, 803 F.2d 61, 65 (2d Cir. 1986).
[33] Queenie Ltd. v. Nygard Int’l, 321 F.3d 282, 287 (2d Cir. 2003); A.H. Robins Co. v. Piccinin, 788 F.2d 994, 999 (4th Cir. 1986).
[34] Pa. Dep’t of Pub. Welfare v. Davenport, 495 U.S. 552, 560 (1990).
[35] Most circuits hold that actions taken in violation of § 362 are void. Donna Renee Tobar, “The Need for a Uniform Void Ab Initio Standard for Violations of the Automatic Stay,” 24 Whittier L. Rev. 3, 23-34 (2002) (summarizing case law). Relatedly, whether a state court judgment regarding the stay’s applicability is subject to the Rooker-Feldman Doctrine is still hotly debated. Compare Gruntz v. County of Los Angeles (In re Gruntz), 202 F.3d 1074, 1079 (9th Cir. 2000) (doctrine does not apply), with Castelle v. New York, 39 Fed. App’x. 665, 667 (2d Cir. 2002) (doctrine does apply).
[36] In re Adler, 494 B.R. at 57-58.
[37] Queenie, 321 F.3d at 287.
[38] For purposes of the alter-ego doctrine, the relevant date would be determined by pinpointing when the debtor/principal assumed impermissible control and exploited that control to wrongfully injure the plaintiff. The effective date for veil-piercing will depend on the chosen basis.
[39] In re Adler, 494 B.R. at 60-61. In Adler, foreseeability was not an issue, the agent having included a piercing count in its original complaint.
[40] Id. at 61-62.
[41] Id. at 56-57.
[42] Bd. of Trs., 212 F.3d at 1038 (emphasis in original).
[43] In re Adler, 494 B.R. at 57.
[44] See 11 U.S.C. § 727(a)(2)(A), (3) and (5). A sincere failure to recognize this obligation may arguably defeat these subsections’ intent requirement.
[45] In re Adler, 494 B.R. at 53-54.
[46] Id. at 79-80.
[47] Id. at 61-62.
[48] Id. at 79-80.
[49] See Stephen B. Presser, Piercing the Corporate Veil 1-12 (2004).
[50] Adler v. Ng (In re Adler), 395 B.R. 827, 839 (E.D.N.Y. 2008); S.I. Acquisition Inc. v. Eastway Delivery Serv. Inc. (In re S.I. Acquisition Inc.), 817 F.2d 1142, 1147-50 (5th Cir. 1987).
[51] Queenie, 321 F.3d at 287.
[52] Aguirre, 410 F.3d at 302.