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At its most basic level, reverse veil-piercing involves the imposition of liability on a business organization for the liabilities of its owners. In the parent/subsidiary context, where the subsidiary is a mere alter ego of the parent the Court will treat the assets of the subsidiary as those of the parent. As the doctrine has evolved, courts now recognize two variants of reverse veil-piercing: insider and outsider reverse veil-piercing. Insider reverse veil-piercing is implicated where the controlling member urges the court to disregard the corporate entity that otherwise separates the member from the corporation. Outsider reverse veil-piercing is implicated where an outside third party, frequently a creditor, urges a court to render a company liable on a judgment against its member.
The plaintiffs here, former stockholders of SourceHOV Holdings, Inc., ("SourceHOV Holdings") dissented when presented with the decision of the SourceHOV Holdings board of directors to merge the company with Exela Technologies, Inc., and then sought statutory appraisal of their SourceHOV Holdings shares. They pursued their appraisal rights at great costs, both opportunity and financial, and were vindicated in their efforts when the court awarded them an appraisal judgment reflecting their shares were worth well in excess of what they were offered in the merger. SourceHOV Holdings appealed and the plaintiffs prevailed again. Following the entry of final judgment, the court entered a charging order against SourceHOV Holdings' interests in its subsidiaries to facilitate the payment of the judgment. Yet the judgment remains unsatisfied. Confronted with the highly unusual circumstance where an appraisal judgment debtor cannot or will not pay, the plaintiffs in this action, and in a parallel action, sought to hold Exela (as acquirer) and its affiliated entities accountable for the appraisal judgment. According to the plaintiffs, as the appraisal action was nearing its inevitable conclusion, and since the appraisal judgment and subsequent charging order were entered against SourceHOV Holdings, Exela and its subsidiaries have been executing a scheme to prevent post-merger SourceHOV Holdings from paying the judgment.
Should plaintiffs’ reverse veil-piercing claim be allowed?
It is at least reasonably conceivable that the SourceHOV Subsidiaries are alter egos of SourceHOV Holdings and that the subsidiaries have actively participated in a scheme to defraud or work an injustice against SourceHOV Holdings creditors, like Plaintiffs, by diverting funds that would normally flow to SourceHOV Holdings away from that entity to Exela. At this stage, from the well pled allegations in the Complaint, the court found no innocent shareholders or creditors of the SourceHOV Subsidiaries that would be harmed by reverse veil-piercing, nor any potential alternative claims at law or in equity, as against the SourceHOV Subsidiaries or SourceHOV Holdings itself, that would for certain remedy the harm. Certain of the SourceHOV Subsidiaries' active participation in a potential fraudulent or unjust scheme, as pled, is evident with a glance at the First Tier Purchase and Sale Agreement associated with the A/R Facility. Under this agreement, thirteen of the SourceHOV Subsidiaries sold their receivables to another one of Exela's indirect subsidiaries. The Complaint alleges that the managers of these SourceHOV Subsidiaries knew about SourceHOV Holdings' inadequate capitalization and, knowing that certain of their proceeds would otherwise go to the judgment creditors of SourceHOV Holdings, they actively "divert[ed] assets away from SourceHOV by pledging certain accounts receivable as collateral for a $160 million accounts receivable security facility." As mentioned in the discussion of traditional veil-piercing, discovery will bear out whether (or not) Plaintiffs accurately describe the mechanics and purpose of the A/R Facility in the Complaint. For now, accepting those allegations as true, it is reasonably conceivable that certain SourceHOV Subsidiaries used the A/R Facility to prevent their proceeds from going to SourceHOV Holdings' judgment creditors.