Battle Royale: Piercing and Reverse Piercing of the Corporate Veil

Breaking WallModern day business can be complicated. Most business is conducted through corporate entities formed to provide a shield to the individuals “behind-the-scenes.” It is not uncommon to have more than one corporate entity created to shield the ultimate party.  These corporate entities serve much the same way as the great curtain in “The Wizard of Oz”; they provide a “wall” or “veil” behind which the individuals can safely transact business while appearing to be much larger or greater than they would be without such protection. The difficulty arises when assets are hidden in the corporate structure thus resulting in a shield for an individual debtor against a creditor’s collection efforts.  Jurisprudence has long recognized this potential problem, and case law exists to unwind this Gordian knot particularly when closely-held corporations are involved. These remedies are commonly known as “piercing the corporate veil.” To be successful, a creditor would need to prove that the corporation is merely a shell or instrumentality of the individuals that own it, and its use is merely designed to protect them. In essence, it is necessary to show that there is no separation between the corporate entity and those that “own” it; it is merely a shadow of the owners. The corporate veil would be torn down to reveal those behind it, and permit their assets to be “in play” to recover the corporate entities debts.

It is oftentimes worthwhile to check and see if a potential claim for piercing the corporate veil exists. The advantage of doing this is that, if successful, the creditor is able to pursue the assets of the corporation and the shareholder(s) since the corporation is merely a “shell corporation and an instrumentality” of the shareholder(s). See Genuine Auto Parts Co. v. Convenient Car Care, Inc., 2005 Tenn. App. LEXIS 368 (Tenn. Ct. App. 2005). The party asserting that the corporation is a mere “shell” or “instrumentality” of the shareholder(s) bears the burden of proof on this point. Schlater v. Haynie, 833 S.W.2d 919 (Tenn. Ct. App. 1991). While there is a presumption that a corporate entity is a distinct legal entity from the shareholders, this presumption is not absolute and can be overcome.  Amanda Constr., Inc. v. White, 2004 Tenn. App. LEXIS 818 (Tenn. Ct. App. 2004). Some of the factors relevant in determining whether the corporate veil can be pierced include:

(1) whether there was a failure to collect paid in capital; (2) whether the corporation was grossly undercapitalized; (3) the nonissuance of stock certificates; (4) the sole ownership of stock by one individual; (5) the use of the same office or business location; (7) the use of the corporation as an instrumentality of business conduit for an individual or another corporation; (8) the diversion of corporate assets by or to a stockholder or other entity to the detriment of creditors …; (9) the use of the corporation as a subterfuge in illegal transactions; (10) the formation and use of the corporation to transfer to it the existing liability of another person or entity; and (11) the failure to maintain arms’ length relationships among entities.

F.D.I.C. v. Allen, 584 F.Supp. 386, 397 (E.D. Tenn. 1984); see also Money & Tax Help, Inc. v. Moody, 2005 Tenn. App. LEXIS 72 (Tenn. Ct. App. 2005).

If the creditor is successful, then the prospective pool of assets available to satisfy a judgment is greatly increased. The creditor is not limited to pursuing just the assets of the corporation, but it can also pursue the shareholder’s assets. While this tool is not available in all circumstances, creditors would be wise to explore its viability before simply dismissing it.

Another situation that could increase the ability of a creditor to collect on its judgment is the theory of “reverse piercing” of the corporate veil. Remember that piercing the corporate veil, whether directly or in reverse, is undertaken with the goal of reaching assets that a creditor would not normally be permitted to reach but for a “sham” intermediary layer of corporate protection. In the case of “reverse piercing,” a creditor would attempt to pierce the corporate veil by attacking the stockholder’s role; it would attempt to prove that the sham exists so as to gain access to the corporation’s assets to satisfy the stockholder’s liability and debts.

For example, if a creditor has a lawsuit against an individual shareholder in a corporation, the creditor may seek to have the corporate veil pierced in order to include the assets of the corporation in the pool of assets available for recovery. Both Nadler v. Mountain Valley Chapel Business Trust, et al., 2004 WL 1488544 (Tenn. Ct. App. 2004), and Reagan v. Connelly, 2000 WL 1661524 (Tenn. Ct. App. 2000), deal with creditors’ attempts to “reverse pierce” the corporate veil. While the Tennessee Supreme Court has recognized this action in the context of a parent/subsidiary relationship, it has not yet recognized it in the context of the corporate entity/shareholder relationship. Yet a review of the Nadler and Reagan cases reveals that the door has been partially opened for the recognition of this action in the corporate entity/shareholder context.

The facts in the Nadler and Reagan cases do not lend themselves to establishing a reverse piercing case. The court in Reagan specifically noted that the application of “reverse piercing,” while not yet formally recognized in Tennessee, could be possible in the context of a corporate entity/shareholder relationship but several problems must first be addressed before it could be viable. Those problems include: (1) the bypassing of normal collection procedures; (2) prejudice to innocent third-party corporate creditors; (3) the unsettling nature of the risk of potential loss by corporate creditors if “reverse piercing” is allowed; and (4) the possibility that there are other theories which would work the same result without attacking the corporate form. Reagan, 200 WL 1661524, footnote 2. Once these issues are resolved, the door would be wide-open for the recognition and utilization of reverse piercing as a method of accessing corporate assets to satisfy a shareholder’s liabilities. Despite the fact that it has yet to be formally recognized by the Tennessee courts, it lurks in the ether waiting for the right set of facts to breathe life into it.  Creditors should still be aware of its potential, and should evaluate whether they have the “right” set of facts to argue it. If successful, it would change the scope of collection work and expand all creditors’ ability to reach presently untouchable assets.

For more information on this or any other related topic, please contact Ronn Steen.  He can be reached at 615.465.6010 or by email at [email protected]