Reverse PiercingLeave It for the Punk Rockers

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Nov 1999

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<img src="/AM/images/letters/u.gif" align="LEFT" border="0" hspace="5" vspace="5">nsecured creditors looking to wring every last dollar from a distressed debtor situation
sometimes go to extraordinary lengths. One of those is known as "reverse piercing," not to be
confused with the removal of the nose ring you woke up with after a night of drunken revelry.

"Reverse piercing" involves an attempt by creditors to pierce the corporate veil by bringing a corporation's assets into a bankruptcy proceeding of the corporation's primary
stockholder. It is viewed as "reverse piercing" primarily because piercing of the corporate
veil usually goes the other way around—specifically, the individual stockholders' assets are
sought to pay the debts of a corporation. The issue came up in a very recent opinion by the Third
Circuit in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Blatstein, ___ F.3d ___, 34 BCD 1198 (3rd Cir. Sept. 3, 1999)</a>.

Blatstein is a very convoluted case but essentially involves a creditor's attempt to ignore the
corporate identity of entities under the joint control of a control person. In this case, Eric
Blatstein was the controlling shareholder of numerous corporations, many of which had
substantial assets. An unsecured creditor, joined in by the trustee of a Blatstein-controlled
entity that was in its own bankruptcy proceeding, sought, among other things, to have the
bankruptcy court in Blatstein's personal bankruptcy determine that numerous corporations
that were owned by Blatstein were the alter egos of Blatstein, and therefore their assets should
be available for payments of Blatstein's personal debts.<a href="#1" name="1a">1</a> Notwithstanding a vigorous attack, the
creditors were unsuccessful.

The Blatstein opinion is an excellent recitation of the standards in the piercing of corporate
veils, and also is instructive because it shows how the same facts can be interpreted quite
differently by different triers of fact.

After a lengthy trial, the bankruptcy court determined that Blatstein's transfer of his shares in
the various corporations to his wife was not a fraudulent conveyance because the stock at issue
at all times was held by Blatstein and his wife as tenants by the entireties. Since the timing of
the stock transfers required that the creditors look to the Pennsylvania Uniform Fraudulent
Transfer Act, the bankruptcy and district courts determined that there was no transfer of stock
between Blatstein and his wife because under Pennsylvania Uniform Law, "property of a
debtor" does not include "an interest in property held in tenancy by the entireties to the extent
it is not subject to process by a creditor holding a claim against only one tenant." The Third
Circuit affirmed that determination.

The more interesting issue, and the one that resulted in a thorough and vociferous dissenting
opinion by Circuit Judge Rosenn, was the issue as to whether the bankruptcy court was correct
in refusing to do a "reverse piercing" and determine that numerous corporations were the alter
ego of Blatstein. While the court looked at the usual alter ego types of factors that were present,
a few factors seemed to be particularly persuasive to the lower court. Specifically,
notwithstanding the adjudicated existence of numerous transfers between Blatstein and some of
his corporations, including corporate payment of clearly personal expenses, and further despite
the fact that Blatstein was clearly using the corporations as his own bank account for purposes
of paying expenses, at the end of the day when you netted out the transfers in and transfers out of
the corporation, Blatstein paid about $90,000 more in corporate expenses into the
corporations than he had taken out. Moreover, Blatstein was diligent enough to always record
when a corporation would pay his personal expenses, showing it as an account receivable on the
corporate books. The fact that the advances were interest-free, or the probability of repayment
was very low, while true, did not convince the bankruptcy court to order a reverse piercing
under these circumstances.

In addition, the lower court found that each of the corporations involved adhered to at least the
basic corporate formalities, kept financial records and bank accounts, and that each of the
businesses was successful in its own right.<a href="#2" name="2a">2</a> The district court affirmed the bankruptcy court's
finding, and a majority of the Third Circuit affirmed as well.

To underscore just how close a call these cases tend to be, it is interesting to note the dissenting
opinion of Circuit Judge Rosenn, which is almost as long as the majority opinion. Judge Rosenn,
based on the identical facts, thought that the corporate form of all corporate defendants should be
pierced to avoid "manifest injustice." Judge Rosenn found that even though expenses paid on
behalf of Blatstein were recorded as accounts receivable on corporate books, there were never
any formal resolutions or loan documents accompanying any of these transactions.

Moreover, numerous transactions apparently occurred among the corporations themselves, and
they frequently borrowed money from each other for start-up costs and for capital. As the
dissent neatly summarized, "Essentially, Blatstein used his corporation as his personal
bank...He had no personal bank account."

District Judge Rosenn made an interesting observation about the defendant's expert witness.
The bankruptcy judge was persuaded that the transactions involved were, while perhaps not the
cleanest, at least within the range of acceptability, primarily based upon the opinion of
Blatstein's expert, Mr. Miller. While the decision does not state exactly why Mr. Miller was an
expert in this matter, at least in the author's view, Mr. Miller should not be using this
particular published opinion on his curriculum vitae. Essentially, the expert testified that even
though the practices between Blatstein and his corporations may not have been technically
correct, he had seen them often enough in his experience that they were "acceptable business
practices." This led Judge Rosenn to give this ringing endorsement of Miller's credentials and
testimony:

<blockquote>
As the majority observes, the bankruptcy court, relying heavily on testimony of
defendant's expert witness, Miller, declined to pierce the corporate veil. The bankruptcy
judge relied on Miller, although he realized that Miller's experience with debtors of
questionable moral and legal standards "may have jaded his perceptions..." He also
thought that Miller was occasionally "over-aggressive in defending himself on what he
claimed were distortions of the facts introduced by plaintiff's counsel..." Miller
apparently impressed the bankruptcy court with his general thesis that in his
experience, "he had observed all or most of the practices at issue and found them
acceptable business practices." Two or more wrongs, however, do not make a right, and,
in some instances, Miller's testimony has the ring of judge and jury, as well as expert.
</blockquote>
Not exactly a resume-builder for Mr. Miller, but hey, his testimony carried the day.<a href="#3" name="3a">3</a>

At the end of the day, lest one believe that Mr. Blatstein escaped unscathed, it is important to
note that notwithstanding that his corporations survived the reverse piercing attack, he himself
was denied a discharge under Bankruptcy Code §§727(a)(2)(A) and (a)(7) based upon his
fraudulent conveyance of other assets in another proceeding.

Karma, baby, Karma.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Actually, by the time Blatstein filed his own bankruptcy, he had transferred the stocks in these various corporations to his wife. That was yet another dispute. <a href="#1a">Return to article</a>

<a name="2">2</a> This was, of course, exactly the point. The corporations were successful, so they could pay for the creditors of Blatstein. If the corporations were all destitute, no one would be going after them. <a href="#2a">Return to article</a>

<a name="3">3</a> Of course, to the extent the market segment one is targeting are companies of "questionable moral and legal standards," perhaps this opinion is better than a "two-thumbs-up" review. <a href="#3a">Return to article</a>

Journal Authors

Thomas J. Salerno

Journal Date

Monday, November 1, 1999 - 12:00