In a case of first impression in Delaware, the Court of Chancery adopted the equitable doctrine of reverse veil-piercing1 in Manichaean Capital LLC v Exela Technologies Inc., a post-merger action to enforce an appraisal valuation judgment. The opinion, partially denying a motion to dismiss, is significant for both its adoption of reverse veil-piercing and for its clear outline of the factual allegations and policy considerations relevant to an assessment of the doctrine’s applicability.

The lawsuit was brought by a group of dissenting shareholders of a merger acquiree. Delaware allows shareholders to accept merger terms proposed by a board, or object and seek a judicial appraisal valuation of their shares pursuant to Section 262 of the Delaware General Corporation Law (the DGCL). Section 262 was enacted in part to (a) end “nuisance blocking” where a shareholder held up a merger until consideration in excess of the deal’s terms was paid; and (b) allow dissenting shareholders an opportunity to justify and enforce a higher price for their shares.

The dissenting shareholders proceeded under DGCL Section 262 and secured a court-determined appraisal, judgment, and a later charging order against the acquiree’s assets reflecting a higher price per share than the merger price per share. The judgment was appealed and upheld en banc by the Delaware Supreme Court.

During the pendency of the appraisal action and shortly before the Chancery Court’s valuation decision, the acquiror allegedly engaged in a series of post-merger securitization transactions that transferred assets of the acquiree’s subsidiaries to the acquiror, bypassing the acquiree entity. The dissenting shareholders alleged that, because the acquiree was an assetless holding company, the transfer of assets from the acquiree’s subsidiaries directly to the acquiror (bypassing the acquiree) deprived them, as judgment creditors, of the ability to satisfy their judgment against the acquiree holding company and its asset-laden subsidiaries. Plaintiffs’ lawsuit sought to enforce its judgment against the acquiror and the acquiree’s subsidiaries.

Vice-Chancellor Slight confronted what he termed the “highly unusual” situation where an appraisal judgment debtor refuses or cannot pay. The statutory appraisal process contained in DGCL Section 262 assumes solvent merger parties and that successful acquiring entities will honor the letter and spirit of the statutory appraisal process – a compromise to allow mergers to proceed without “nuisance blocking,” and allow dissenting shareholders to seek what they believe is a fair value for their property taken from them via a merger. The Court noted that the entire statutory valuation process is thwarted if dissenting shareholders, absent compelling circumstances, cannot actually get paid. The Court also noted that in appraisal actions, the acquiror and not the acquisition target is the real party in interest.

Nonetheless, the Court stressed that reverse veil-piercing should be employed only “in limited circumstances and in circumscribed execution . . . [and] only in cases alleging egregious facts, coupled with the lack of real and substantial prejudice to third parties . . . .” The Court stressed that Delaware law protects the corporate form, but that Delaware recognizes traditional veil-piercing in the face of “fraud or injustice.”

The facts alleged in support of reverse veil-piercing, which at the motion to dismiss stage must be accepted as true with all reasonable inferences in favor of the non-moving party, included the following:

  • The acquiror diverted funds that would normally flow to the judgment debtor entity;
  • The judgment debtor entity and its subsidiaries are insolvent and undercapitalized;
  • The managers of the judgment debtor knew of the inadequate capitalization and knew that certain proceeds would otherwise have gone to the judgment creditors;
  • The managers of the judgment debtor diverted assets away from the judgment debtor;
  • The judgment debtor and the acquiring entity have overlapping personnel and directors and share the same offices;
  • Many of the judgment debtor’s subsidiaries have stale corporate registrations and failed to maintain accurate or complete corporate records;
  • The acquiror must give its approval before the judgement debtor and its subsidiaries can pay debts;
  • All post-merger acquiror related entities were collectively referred to as one acquiror-controlled enterprise in SEC filings.

The Court’s starting point was the traditional alter ego factors (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 then listed eight additional considerations when assessing the viability of the reverse-piercing doctrine at the pleading stage.

Of these considerations, a few figure prominently: (1) the degree to which the legitimate expectations of shareholders not responsible for the conduct giving rise to the reverse piercing claim are impaired; (2) the extent to which innocent creditors of the reverse piercing target may be harmed; and (3) the extent to which other claims or remedies are available to the judgment creditor in law or equity. Given the unusual facts alleged, and that there was no identifiable harm to third-party shareholders or creditors if a reverse pierce was allowed, the Court concluded that the plaintiffs should be allowed to proceed on a reverse veil-piercing theory.

The opinion should be of value to lawyers and to mangers of Delaware-governed entities as a refresher course in what may support the imposition of traditional veil-piercing and as a primer on reverse veil-piercing.

Vice-Chancellor Slights’ opinion is also an excellent example of equity’s role within the common law – to fashion a remedy where the law has none and where the status quo absent a remedy is repugnant to what Blackstone called, “the soul and spirit of all law.” In this instance, absent the exercise of equity (at least at the pleading stage), a dismissal would arguably have been an affront to the entire statutory appraisal process in DGCL Section 262, which balances the interests of corporate boards and shareholder alike.

1Reverse veil-piercing involves the imposition of liability on an entity for the liability of its owners. Traditional veil piercing involves piercing the corporate form to reach the owners of a corporation for corporate liabilities because the corporation is the “alter ego” or “instrumentality” of the owners.