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Manichaean Capital, LLC et al v. Exela Technologies, Inc., et al begins with the Delaware Court of Chancery recounting the results of an appraisal action with respect to the acquisition of SourceHOV Holdings, Inc.  The former shareholders of Source HOV who properly exercised their appraisal rights received a significant award. SourceHOV appealed and the plaintiffs prevailed again. Following the entry of final judgment, the court entered a charging order against SourceHOV’s interests in its subsidiaries to facilitate the payment of the judgment.  However, the judgment was not satisfied.

As a result, certain of the appraisal award recipients sought to hold the acquirer, Exela, and its affiliated entities accountable for the appraisal judgment.  One of the theories plaintiffs argued was given the abuse of corporate form by Exela and its subsidiaries, principally through fraudulent maneuvers, the Court should pierce the SourceHOV corporate veil upwards to reach Exela and downwards to reach SourceHOV’s solvent subsidiaries so that plaintiffs can enforce their charging order against those entities.

According to the Court the plaintiffs had adequately pled that Exela, lacking in corporate formality, engaged in a transaction for the purpose of preventing funds that would otherwise flow from SourceHOV’s subsidiaries directly to SourceHOV to flow instead directly to Exela, thereby leaving the judgment debtor unable to satisfy the plaintiffs’ appraisal judgment. Because the charging order required any money flowing through SourceHOV Holdings first to be paid to the judgment creditors, including the plaintiffs, Exela’s participation in a scheme to deprive SourceHOV of those funds had conceivably rendered the charging order worthless. Those facts supported the plaintiffs’ requested relief in the form of traditional veil-piercing (i.e., piercing SourceHOV Holdings’ corporate veil to reach upwards to Exela).

The Court also found it was reasonably conceivable that SourceHOV’s subsidiaries knowingly participated in the wrongful scheme, such that the plaintiffs’ requested relief in the form of reverse veil-piercing (i.e., piercing SourceHOV’s corporate veil to reach downwards to its wholly owned subsidiaries) is likewise appropriate. However, the Court noted that the legality of reverse veil-piercing appeared to be a matter of first impression in Delaware.

Since it was a matter of first impression, the Court examined other judicial precedents regarding reverse veil piercing.  Courts declining to allow reverse veil-piercing have relied primarily on a desire to protect innocent parties. Reverse veil-piercing has the potential to bypass normal judgement collection procedures by permitting the judgment creditor of a parent to jump in front of the subsidiary’s creditors.  The Court found that these risks were not sufficient to reject reverse veil piercing.  Rather, the recognition of the risks creates an opportunity to manage them, and to do so in a manner that serves the interests of equity per the Court.

Reviewing the other precedents, the Court noted there were common sense ways to manage the risk of harm to innocent parties in reverse veil piercing. The Court then outlined an analytical framework for reviewing reverse veil piercing claims.  The starting place is to evaluate the traditional factors Delaware courts consider when reviewing a traditional veil-piercing claim—the so-called “alter ego” factors that include insolvency, undercapitalization, commingling of corporate and personal funds, the absence of corporate formalities, and whether the subsidiary is simply a facade for the owner.

The court should then ask whether the owner is utilizing the corporate form to perpetuate fraud or an injustice. This inquiry should focus on additional factors, including:

  • the degree to which allowing a reverse pierce would impair the legitimate expectations of any adversely affected shareholders who are not responsible for the conduct of the insider (here the insiders are SourceHOV’s subsidiaries) that gave rise to the reverse pierce claim, and the degree to which allowing a reverse pierce would establish a precedent troubling to shareholders generally;
  • the degree to which the corporate entity whose disregard is sought (here, disregard is sought for SourceHOV) has exercised dominion and control over the insider who is subject to the claim (here the insider are SourceHOV’s subsidiaries) by the party seeking a reverse pierce;
  • the degree to which the injury alleged by the person seeking a reverse pierce is related to the corporate entity’s dominion and control of the insider, or to that person’s reasonable reliance upon a lack of separate entity status between the insider and the corporate entity;
  • the degree to which the public convenience, as articulated by the Delaware General Corporation Law and Delaware’s common law, would be served by allowing a reverse pierce;
  • the extent and severity of the wrongful conduct, if any, engaged in by the corporate entity whose disregard is sought by the insider;
  • the possibility that the person seeking the reverse pierce is himself guilty of wrongful conduct sufficient to bar him from obtaining equitable relief;
  • the extent to which the reverse pierce will harm innocent third-party creditors of the entity the plaintiff seeks to reach; and
  • the extent to which other claims or remedies are practically available to the creditor at law or in equity to recover the debt.

After carefully reviewing the complaint, the Court was satisfied this was one of those “exceptional circumstances” where a plaintiff has well pled a basis for reverse veil piercing.  This was a motion to dismiss under Court of Chancery Rule 12(b)(6).  Under Court of Chancery Rule 12(b)(6) all well-pled factual allegations are accepted as true amongst other things. Thus the Court did not determine the truth or falsity of plaintiff’s allegations.

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