Manichaean Capital, LLC v. Exela Technologies, Inc.Manichaean Capital, LLC v. Exela Technologies, Inc.
T. Brad Davey, Esquire, Matthew F. Davis, Esquire and Andrew H. Sauder, Esquire of Potter Anderson & Corroon LLP, Wilmington, Delaware and Jennifer Barrett, Esquire, Dennis H. Hranitzky, Esquire and Blair Adams, Esquire of Quinn Emanuel Urquhart & Sullivan, LLP, New York, New York, Attorneys for Defendants.
SLIGHTS, Vice Chancellor
Under the Delaware General Corporation Law, a board of director’s decision to cause the company it serves to merge leaves the company’s stockholders with one of two options: participate in the merger as negotiated by the board, or dissent to the merger and seek statutory appraisal. It has not always been this way. At common law, all major corporate decisions, including whether to merge, required unanimous stockholder consent, providing each and every shareholder an effective veto power over any corporate transaction.1 That veto right created an unhealthy phenomenon known as “nuisance blocking,” where a single stockholder could withhold consent to a merger in order to extract hold up consideration. This dynamic, and others, prompted the Delaware General Assembly to create a statutory right of appraisal as a means to quash the minority’s blocking right while also addressing the non-consensual taking of the stockholders’ property (their stock).2
The plaintiffs here, former stockholders of SourceHOV Holdings, Inc., (“SourceHOV Holdings“)3 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
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.
Against this backdrop, the plaintiffs seek to hold Exela and its subsidiaries liable under two theories: (1) given the abuse of corporate form by Exela and its subsidiaries, principally through fraudulent maneuvers, the Court should pierce the SourceHOV Holdings corporate veil upwards to reach Exela and downwards to reach SourceHOV Holdings’ solvent subsidiaries so that Plaintiffs can enforce their charging order against these entities; and (2) given that Exela now holds a 100% stake in SourceHOV Holdings but has refused to pay all SourceHOV Holdings stockholders for their share of the company, the Court should determine that Exela was unjustly enriched and order it to pay the plaintiffs restitution in the amount of the appraisal judgment plus interest.
Plaintiffs’ well-pled allegations support a reasonable inference that Exela, lacking in corporate formality, engaged in a transaction, as described in the plaintiffs’ complaint, for the purpose of preventing funds that would otherwise flow from SourceHOV Holdings’ subsidiaries directly to SourceHOV Holdings to flow instead directly to Exela, thereby leaving the judgment debtor unable to satisfy the plaintiffs’ appraisal judgment. Because the charging order requires 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 Holdings of those funds has conceivably rendered the charging order worthless parchment. This supports the plaintiffs’ prayer for relief in the form of traditional veil-piercing (i.e., piercing SourceHOV Holdings’ corporate veil to reach upwards to Exela).
It is likewise reasonably conceivable that SourceHOV Holdings’ subsidiaries knowingly participated in the wrongful scheme, such that the plaintiffs’ prayer for relief in the form of reverse veil-piercing (i.e., piercing SourceHOV Holdings’ corporate veil to reach downwards to its wholly owned subsidiaries) is likewise appropriate. The legality of reverse veil-piercing appears to be a matter of first impression in Delaware. After carefully reviewing the justifications for and against the adoption of reverse veil-piercing, I find that this equitable remedy (or right) is an appropriate means, in limited circumstances, to remedy fraud and injustice.6 Under the framework set out below, the plaintiffs’ claim for reverse veil-piercing, which, again, seeks to hold SourceHOV Holdings’ subsidiaries liable for its debts, is, I believe, viable as a matter of Delaware law.
On the other hand, the plaintiffs’ claim for unjust enrichment is not viable because the charging order, as a matter of law, prevents the use of equitable claims and
The procedural posture in which these issues are presented to the Court is a motion to dismiss all claims under Court of Chancery Rule 12(b)(6). For reasons stated below, the motion is granted in part and denied in part.
I. BACKGROUND
I have drawn the facts from well-pled allegations in the Verified Complaint (the “Complaint“) and documents incorporated by reference or integral to that pleading.7 For purposes of the motion, I accept as true the Complaint’s well-pled factual allegations and draw all reasonable inferences in the plaintiffs’ favor.8
A. Parties
Plaintiff, Manichaean Capital, LLC, a Delaware LLC, along with individual plaintiffs, Charles Cascarilla and Emil Woods, both New York residents, and LGC Foundation, Inc. and Imago Dei Foundation, Inc., both Ohio corporations,
(collectively, “Plaintiffs“), were equity holders in SourceHOV Holdings prior to its acquisition by Exela in a merger consummated on July 12, 2017.9
Defendant, Exela, a Delaware corporation, sits atop a network of “resident and non-resident direct and indirect subsidiaries,” many of which have been named as defendants here (the “Exela Subsidiaries“).10 Exela operates in the business process automation space.
The Exela Subsidiaries include: Ex-Sigma LLC, the Delaware LLC formed to combine with SourceHOV Holdings in the Merger, SourceHOV Holdings, the surviving entity from the Merger, SourceHOV, LLC, an entity immediately below SourceHOV Holdings in which SourceHOV Holdings maintains a 100% membership interest, and then a number of subsidiary LLCs, which I refer to as the “SourceHOV Subsidiaries.”11 The Exela network is depicted in the chart below:
Remainder of Page Intentionally Left Blank
On July 12, 2017, SourceHOV Holdings merged with Ex-Sigma LLC and Ex-Sigma Merger Sub, Inc., in a transaction whereby each share of SourceHOV Holdings common stock was converted into a right to receive one membership unit of Ex-Sigma LLC (the “Merger“).12 Prior to the Merger, Plaintiffs held 10,304 shares of common stock in SourceHOV Holdings.13 The creation of Ex-Sigma and subsequent conversion of stock was a preliminary step to effectuate the merger of SourceHOV Holdings into SourceHOV Merger Sub, with SourceHOV Holdings
emerging as the surviving entity.14 The Merger made SourceHOV Holdings an indirect subsidiary of Quinpario Acquisition Corp. 2, which was later renamed Exela.15
Under the Consent, Waiver and Amendment to the Business Combination Agreement (the “Modification Agreement“), dated June 15, 2017, any Merger consideration was to be delivered to Ex-Sigma LLC without deductions for dissenting shares.16 The Modification Agreement declared that if a stockholder sought appraisal, Ex-Sigma would send that stockholder’s equity interests in SourceHOV Holdings to Exela.17
C. The Appraisal Action
Plaintiffs expressly dissented with respect to the Merger and, on September 27, 2017, filed an appraisal action in this court (the “Appraisal Action“).18 This Court issued its post-trial memorandum opinion on
2021.19 As is typical in appraisal litigation, the parties’ experts were miles apart in their determinations of SourceHOV Holdings’ fair value as of the Merger. For reasons stated in the post-trial opinion, the Court, in large measure, adopted the petitioners’ fair value evidence and appraised the fair value of their shares in SourceHOV Holdings at the time of the Merger at $4,591 per share.20 This valued the petitioners’ stake at $57,684,471 plus interest, significantly above the consideration they would have received in the Merger.21 The Court entered its final judgment to this effect on March 26, 2020 (the “Appraisal Judgment“).22 SourceHOV Holdings moved for reargument and then for a new trial; both motions were denied.23 SourceHOV Holdings appealed the Appraisal Judgment and our Supreme Court summarily affirmed.24
While the appeal was pending, Plaintiffs sent a demand letter to SourceHOV Holdings requesting immediate payment of the Appraisal Judgment.25 As of the filing of this lawsuit, none of that judgment had been paid.26 According to Plaintiffs, when Ex-Sigma transferred Plaintiffs’ SourceHOV Holdings shares to Exela over their dissent to the Merger, shares that constituted 6.5% of SourceHOV Holdings’ outstanding stock, and then Exela subsequently failed to pay the $57.6 million owed for that stock as determined by the Appraisal Judgment, Exela, in essence, seized Plaintiffs’ property without paying for it.27
D. The Charging Order
On July 15, 2020, Plaintiffs filed a Motion for Charging Order against SourceHOV Holding’s membership interest in SourceHOV, LLC.28 The Court granted the Motion on August 15, 2020.29 The charging order mandated that “[a]ny and all distributions made by SourceHOV, LLC and payable to SourceHOV Holdings, Inc. in respect of SourceHOV Holdings, Inc.’s membership interest in
SourceHOV, LLC shall be paid to [Plaintiffs]” (the “Charging Order“).30 In other words, to the extent Exela, as parent of SourceHOV Holdings, wishes to receive distributions from its subsidiaries below SourceHOV Holdings, any money that flows through SourceHOV Holdings must first be paid to Plaintiffs as SourceHOV Holdings’ judgment creditors before it reaches Exela.
On January 10, 2020, mere weeks before this Court’s decision in the Appraisal Action, Exela, through its subsidiaries, entered into a $160 million accounts receivable securitization facility (the “A/R Facility“).31 To facilitate the transaction, Exela created two entities, Exela Receivables Holdco LLC (“Receivables Holdco“) and Exela Receivables I LLC (“Receivables I“).32 Under the First Tier Purchase and Sale Agreement, thirteen of the SourceHOV Subsidiaries sold their accounts receivable to Receivables Holdco.33 Then, under the Second Tier Purchase Agreement, Receivables Holdco sold those receivables to Receivables I.34 Under the Loan and Security Agreement, Receivables I then pledged the receivables as
collateral for loans and letters of credit to be issued to Receivables I.35 More specifically, Receivables I pledged certain collection accounts, including sixteen “Interim Collection Accounts,” all but three of which were accounts owned directly by the SourceHOV Subsidiaries.36 The A/R Facility permitted value once held by the SourceHOV Subsidiaries to be held by Exela’s indirect subsidiary, allowing a diversion of funds around SourceHOV Holdings and directly into the coffers of Exela.37
II. ANALYSIS
The standard for deciding a Motion to Dismiss under Court of Chancery Rule 12(b)(6) is well-settled:
(i) all well-pleaded factual allegations are accepted as true; (ii) even vague allegations are “well-pleaded” if they give the opposing party notice of the claim; (iii) the Court must draw all reasonable inferences in favor of the non-moving party; and (iv) dismissal is inappropriate unless the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof.38
A. The Rationale for Statutory Appraisal
The creation of a statutory appraisal right was a significant step forward in the development of our corporate law. Before then, at common law, “an arbitrary minority” could prevent a transformative transaction with the wave of a hand, holding the majority hostage to their whim.39 The appraisal right granted under
shareholder should, absent compelling circumstances, actually get paid the fair value of “that which has been taken from him.”42 Anything less frustrates the origin and purpose of the statutory appraisal remedy.
In the ordinary course, when judgment debtors fail to pay, the legal remedies of a charging order against a judgment debtor’s LLC interests or a writ of execution against the judgment debtor’s assets are available as tools for collection.43 This Opinion considers what options are available to the judgment debtor in an appraisal action if, after a plaintiff receives a writ of execution or charging order, an appraisal judgment is still left unpaid. In considering the question, it is useful to remember that in appraisal actions, it is the acquirer, not the target, who is “the real party in interest on the respondent’s side of the case.”44
B. The Impact of the Charging Order
Upon request by a judgment creditor of a member of a Delaware limited liability company, the court “may charge the limited liability company interest of the judgment debtor to satisfy the judgment.”45 Once entered, the charging order acts as a lien on the judgment debtor’s membership interest.46 Importantly,
The Acquisition and Sale of Emerging Growth Companies: The M & A Exit § 11:33 (2d ed. 2017) (“From an acquirer’s perspective, target stockholders pursuing appraisal rights create uncertainty as to how much [the] acquirer will have to pay for the shares of target.“); Joseph Evan Calio, New Appraisals of Old Problems: Reflections on the Delaware Appraisal Proceeding, 32 Am. Bus. L.J. 1, 68 n.64 (1994) (“[E]ither in the market or in an appraisal the acquiror pays the entire bill no matter how it is apportioned.“); Ethan Klingberg & Yavor Efremov, Delaware’s M&A Wildcard-Appraisal Rights, 9 No. 2 M & A Law. 1 (June 2005) (discussing the effects of dissenting target shareholders on the acquirer’s pre- and post-acquisition role).
possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.”48
While the charging order statute clearly limits the types of actions a judgment creditor may take against a debtor to fulfill its judgment once the charging order is in hand, it does not limit the means by which the judgment debtor may enforce the charging order itself. To the extent a judgment creditor seeks merely to define which entities are (or should be) subject to the charging order, that action is not barred by the charging order statute. That is precisely what Plaintiffs’ veil-piercing claims seek to do here.
On the other hand, if a judgment creditor seeks to bypass its charging order to enforce its judgment through “other legal or equitable remedies,” that action is barred by statute and must be dismissed.49 That is what Plaintiffs seek to do through their unjust enrichment claim. I address the effects of the Charging Order more specifically below as I address each of Plaintiffs’ claims in turn.50
C. Traditional Veil-Piercing
Plaintiffs allege that Exela’s undercapitalization of its subsidiary (SourceHOV Holdings), lack of corporate separateness and subsequent attempts to divert funds away from SourceHOV Holdings to avoid the claims of its creditors provide ample bases to pierce SourceHOV Holdings’ corporate veil to reach up the chain to Exela. “Delaware public policy disfavors disregarding the separate legal existence of business entities.”51 With that said, in “exceptional case[s],” corporate veil-piercing is necessary and appropriate.52
Delaware courts consider a number of factors in determining whether to disregard the corporate form and pierce the corporate veil, including: “(1) whether the company was adequately capitalized for the undertaking; (2) whether the company was solvent; (3) whether corporate formalities were observed; (4) whether the dominant shareholder siphoned company funds; and (5) whether, in general, the company simply functioned as a facade for the dominant shareholder.”53 While these
As to the specific factors, Plaintiffs make a compelling case in their Complaint that Exela and SourceHOV Holdings “operate[] as a single economic entity such that it would be inequitable for this Court to uphold a legal distinction between them.”55 First, accepting the allegations in the Complaint as true, it is reasonably conceivable that SourceHOV Holdings is insolvent and that its insolvency, at least in part, is the result of Exela‘s undercapitalization of SourceHOV Holdings. Insolvency is adequately pled if a plaintiff‘s allegations allow a reasonable inference of either “(1) a deficiency of assets below liabilities with no reasonable prospect that the business can be successfully continued in the face thereof or (2) an inability to meet maturing obligations as they fall due in the ordinary course of business.‘”56
SourceHOV Holdings is a holding company with no direct operating assets.57 In fact, its only asset is its membership interest in SourceHOV, LLC, which in turn holds interests in its solvent subsidiaries.58 SourceHOV Holdings has no bank account, money market account or brokerage account.59 With those facts as background, the Complaint alleges funds that once flowed up from the SourceHOV Subsidiaries to SourceHOV Holdings as a matter of course, are now bypassing SourceHOV Holdings and flowing directly to Exela.60 According to Plaintiffs, this arrangement was put in place by Exela and others while the likelihood that SourceHOV Holdings would face a substantial appraisal judgment was well known to all involved in the A/R Facility.61 Now that SourceHOV Holdings has no funds, and no prospect of securing funds, it is unable to meet its obligations as they become due, and it is at least reasonably conceivable that it will never be able to do so. The fact that certain of the SourceHOV Subsidiaries might be profitable, say Plaintiffs, does not suggest that SourceHOV Holdings itself is solvent, absent evidence that such money flows through SourceHOV Holdings, which, according to the Complaint, is not and may never again be the case.
The Complaint‘s case for veil-piercing does not rest on insolvency alone.62 It alleges
Beyond the apparently deliberate effort to starve SourceHOV Holdings of cash, Plaintiffs further allege that Exela failed to observe certain corporate formalities. Specifically, Plaintiffs allege that Exela: (1) is headquartered at the same address as SourceHOV Holdings,69 (2) has failed to maintain proper business registrations for SourceHOV Holdings,70 (3) has significantly overlapping personnel with SourceHOV Holdings,71 (4) has referred to Exela and its subsidiaries as one combined enterprise in SEC filings72 and (5) requires SourceHOV Holdings to obtain Exela‘s consent before SourceHOV Holdings may pay its own creditors.73
With concerns about insolvency, undercapitalization and corporate formalities well pled, Plaintiffs turn next to the fraud and injustice associated with the A/R Facility. “Acts intended to leave a debtor judgment proof are sufficient to show
According to the Complaint, and as discussed above, the A/R Facility created a structure whereby thirteen of the SourceHOV Subsidiaries sold certain receivables to Receivables Holdco, and those receivables were subsequently sold to Receivables I.78 As designed, Receivables I, an indirect subsidiary of Exela but not SourceHOV Holdings, pledged those receivables as collateral under the Loan and Security Agreement in exchange for money paid by the lender under the facility.79 Exela is the guarantor for all moneys borrowed under the A/R Facility and is the servicer on the Loan and Security Agreement.80 According to Plaintiffs’ well-pled allegations, the receivables pledged were not Exela‘s to pledge and yet, as a result of the pledge, accounts receivable income that should flow up to SourceHOV Holdings no longer does.81
Defendants take issue with the Complaint‘s pled characterization of the A/R Facility. The arguments are granular and, if accepted, would re-write Plaintiffs’ pleading. To be sure, the A/R Facility is a complicated transaction. And Defendants’ characterization of it may well prove to be the better one. But this is not the time to make that potentially dispositive determination, particularly given the fact-intensive intricacies of the transaction.82 Taking Plaintiffs’ well-pled characterization as fact, it is reasonably conceivable the A/R Facility was created in order deliberately to prevent funds from flowing through
D. Reverse Veil-Piercing
The question of whether and to what extent courts of Delaware should allow so-called reverse veil-piercing is one of first impression. This is not to say that parties in litigation have not asked our courts to authorize reverse veil-piercing. They have. But our courts have yet to accept or deny the claim.83 For reasons explained below, I am satisfied that Delaware law allows for reverse veil-piercing in limited circumstances and in circumscribed execution.
1. The Mechanics of Reverse Veil-Piercing and its Proper Application
At its most basic level, reverse veil-piercing involves the imposition of liability on a business organization for the liabilities of its owners.84 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.”85
As the doctrine has evolved, courts now recognize two variants of reverse veil-piercing: insider and outsider reverse veil-piercing.86 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.”87 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.”88 Given Plaintiffs are creditors of SourceHOV Holdings, the single member and 100% owner of SourceHOV LLC, which in turn is the single member and owner of the SourceHOV Subsidiaries, and Plaintiffs seek to hold the subsidiaries liable for a judgment held against the member, this case concerns outsider veil-piercing.
The case associated with the first substantive treatment of reverse veil-piercing is Judge Learned Hand‘s decision in Kingston Dry Dock Co. v. Lake Champlain Transp. Co.89 There, the court considered a trial court order allowing a judgment creditor to seize property of a subsidiary controlled by the judgment debtor in satisfaction of the judgment.90 In refreshingly short order, Judge Hand found that reverse veil-piercing was not warranted. In doing so, he observed that the subsidiary had not “interpose[d] in any way in the conduct of [the parent‘s] affairs.”91 He also emphasized that “[s]o long as the law allows associated groups to maintain an independent unity, its sanction is not so easily evaded, and persons dealing with either do so upon the faith of the undertaking of that one which they may select.”92 And so began the reverse veil-piercing debate. Since then, many courts have adopted the doctrine, while others have shied away.93
Courts declining to allow reverse veil-piercing have relied primarily, and understandably, on a desire to protect innocent parties. This is revealed in the two most often cited state court decisions rejecting reverse veil-piercing, Acree v. McMahan94 and Postal Instant Press, Inc. v. Kaswa Corp.95 In Acree, the Supreme Court of Georgia rejected reverse veil-piercing, holding that the risk reverse piercing would facilitate harm, through judicial decree, to innocent shareholders and third-party creditors could not adequately be managed by the courts.96 In Postal Instant Press, a California appellate court rejected reverse veil-piercing on similar grounds.97
The concerns expressed in Acree and Postal Instant Press are well-founded. To start, 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.98 For obvious reasons, this dynamic would “unsettle the expectations of corporate creditors who understand their loans to be secured . . . by corporate assets” and could lead to corporate creditors “insist[ing] on being compensated for the increased risk of default posed by outside reverse-piercing
The risks that reverse veil-piercing may be used as a blunt instrument to harm innocent parties, and to disrupt the expectations of arms-length bargaining, while real, do not, in my view, justify the rejection of reverse veil-piercing outright. 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.102
In C.F. Trust, Inc. v. First Flight L.P., the Supreme Court of Virginia adopted reverse veil-piercing upon observing that, at their most basic level, traditional and reverse veil-piercing claims both seek to prevent the same sort of wrongdoing: abuse of the corporate form and fraud.103 The court recognized the risk that reverse veil-piercing could negatively impact innocent third-parties and defined the reverse veil-piercing standard expressly to manage that risk.104 Specifically, the court held that a plaintiff asking the court to authorize reverse veil-piercing, in addition to proving the elements required to justify traditional veil-piercing, must also demonstrate that reverse veil-piercing will not cause harm to “innocent investors . . . [or] innocent secured and unsecured creditors,” and that there are no other legal or equitable remedies “availab[le] . . . [for] the creditor [to] pursue.”105
Similarly, in In re Phillips, the Supreme Court of Colorado determined that outside reverse veil-piercing claims must be permitted when justice so requires “[d]ue to the similarities and parallel goals achieved in outside reverse piercing and traditional piercing.”106 The court then clarified that,
In the only case cited by the parties that purported to apply Delaware law, Sky Cable, the court likewise acknowledged the risks of reverse veil-piercing and then addressed how limits on the doctrine would adequately manage those risks.110 As with other courts that have adopted reverse veil-piercing, the Fourth Circuit found it difficult to justify an outright rejection of the doctrine when “the same considerations that justify [traditional] piercing [of] the corporate veil” are at work to justify a plaintiff‘s request to “pierc[e] the veil in reverse.”111 In the traditional veil-piercing context, Delaware courts have forcefully stated that “Delaware has a powerful interest of its own in preventing the entities that it charters from being used as vehicles for fraud. Delaware‘s legitimacy as a chartering jurisdiction depends on it.”112 With this in mind, the Sky Cable court noted that if reverse veil-piercing was not available, such that an alter ego entity could not be held liable for its member‘s debts under any circumstance, “fraudulent members could hide assets in plain sight to avoid paying a judgment.”113 To address this unacceptable outcome, the court held that where: (1) an LLC has a single member, (2) that LLC is the member‘s alter ego, and (3) that member is using the LLC as a fraudulent shield against judgment creditors, reverse veil-piercing is a tool available to the court to avoid fraud and injustice when other legal and equitable means are unavailing.114
Delaware embraces and will protect “corporate separateness”115; but Delaware will not countenance the use of the corporate form as a means to facilitate fraud or injustice.116 Mindful of the need to balance these important policies, and taking the
In defining the rule, I begin by stressing that I am not endorsing “insider” reverse veil-piercing.118 The rule stated here applies only to “outsider” reverse veil-piercing. Also at the threshold, it must be emphasized that, just like with traditional veil-piercing, reverse veil-piercing should be sanctioned only in the most “exceptional circumstances.”119 The framework outlined here to evaluate reverse veil-piercing claims comes with an express recognition that such claims, if not guided by appropriate standards, can threaten innocent third-party creditors and shareholders and lead to a host of unpredictable outcomes for these constituencies.120 Only in cases alleging egregious facts, coupled with the lack of real and substantial prejudice to third parties, should the court even consider utilizing the reverse veil-piercing doctrine.121 With prejudice to third-parties in mind and a framework designed to deal with such concerns, however, reverse veil-piercing can act as a deterrent to owners of companies, particularly those that are closely held, from shuffling their assets among their controlled entities with the express purpose of avoiding a judgment.
The natural starting place when reviewing a claim for reverse veil-piercing are 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.122 The court
Applying this framework, Delaware courts will be well-equipped to handle the varying concerns courts and commentators have rightfully expressed regarding reverse veil-piercing. The expectations of third-party creditors and investors will be well-protected.126 And the “public convenience” factor will require “the balancing of the social value of upholding the legitimate expectations of the affected corporate creditors or debtors, applying a rebuttable presumption in favor of assuring such expectations, against the importance of the policies served by allowing a reverse
2. Plaintiffs’ Reverse Veil-Piercing Claim Is Well-Pled
After carefully reviewing the Complaint, I am satisfied this is one of those “exceptional circumstances” where a plaintiff has well pled a basis for reverse veil-piercing. 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, I see 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.128
Beginning with the “alter ego” factors, as previously discussed, the Complaint well-pleads facts that allow a reasonable inference that SourceHOV Holdings is insolvent and that it is undercapitalized.129 The Complaint also pleads a reasonably conceivable basis to conclude that corporate formalities have not been maintained since the Merger. As alleged, all of the Exela entities, including SourceHOV Holdings and the SourceHOV Subsidiaries, have overlapping personnel and directors130 and share the same offices;131 many of the SourceHOV Subsidiaries do not have updated corporate registrations;132 the entities have failed to maintain accurate or complete corporate records;133 Exela must give its approval before SourceHOV Holdings can pay debts;134 and all Exela-related entities have been collectively referred to as one Exela-controlled enterprise in SEC filings.135
Turning to the broader fraud or injustice inquiry, the question here is whether the subsidiaries are being used to perpetuate fraud or injustice against a judgment creditor of their parent. 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.136 Under this agreement, thirteen of the SourceHOV Subsidiaries sold their receivables to another one of Exela‘s indirect subsidiaries.137 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
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. Specific allegations of intentional acts aimed at avoiding judgments through the use of legal constructs are sufficient to well plead fraud under traditional veil-piercing, and the review of such pled facts in support of a reverse veil-piercing claim is no different.139
Finally, the Complaint well pleads a bases to infer that Plaintiffs will be able to satisfy the additional elements to sustain a reverse veil-piercing claim. I address them briefly in turn.
Impairment of expectations of adversely affected shareholders. The Complaint pleads no basis to infer that other owners of SourceHOV Holdings or the SourceHOV Subsidiaries will be adversely affected by reverse veil-piercing. The SourceHOV Subsidiaries indirectly are wholly owned by SourceHOV Holdings, which in turn is wholly-owned by Exela.140 Thus, all entities involved in the alleged scheme to starve SourceHOV Holdings of funds are connected by unified ownership.141
The exercise of dominion and control and degree to which that caused Plaintiffs’ injury. According to the Complaint, Exela and certain of the SourceHOV Subsidiaries agreed to the A/R Facility without the involvement or consent, and to the detriment of, the dormant SourceHOV Holdings.142 This allows a pleading-stage inference of dominion and control causing injury to Plaintiffs sufficient to justify reverse veil-piercing.
The public convenience as articulated by the DGCL and Delaware Common Law. As noted at the outset, Delaware‘s statutory appraisal scheme eliminated the minority stockholder‘s common law right to prevent a merger and replaced it with a mandatory statutory right to obtain the fair value of what is to be taken from the minority stockholder via the merger (his shares) over his dissent. Plaintiffs allege, “Exela and SourceHOV have retained all of the benefits of the [Merger] at issue in the Appraisal Action without paying compensation for Plaintiffs’ dissenting shares and are using their corporate structure as a sham in an attempt to render SourceHOV ‘judgment proof.‘”143 The Complaint then alleges that the scheme by which the SourceHOV Subsidiaries have agreed to channel funds directly to Exela is “fundamentally inequitable because Exela‘s own financial statements recognize the [Appraisal] Judgment as ultimately Exela‘s
The extent of the wrongful activity. The Complaint well-pleads that Exela and the SourceHOV Subsidiaries (with SourceHOV Holdings’ acquiescence) have initiated a scheme to ensure that Exela retains the significant value of Plaintiffs’ ownership in pre-Merger SourceHOV Holdings, interest taken over Plaintiffs’ dissent to the Merger, without paying a nickel for that equity. If true, this is the sort of wrongful conduct that justifies reverse veil-piercing.
Plaintiffs’ wrongful conduct. There is no basis in the Complaint to infer that Plaintiffs themselves have engaged in wrongful conduct that would disable them from calling upon equity to address their harm. They lawfully dissented to the Merger, properly sought statutory appraisal of their SourceHOV Holdings shares, prevailed at trial, prevailed on appeal, obtained a final judgment and diligently sought to execute on that judgment.
Harm to innocent third-party creditors. There is no basis in the Complaint to infer that reverse veil-piercing will cause harm to innocent third-party creditors. In this regard, Defendants argue that because the SourceHOV Subsidiaries are primary obligors on certain debt at a level above SourceHOV Holdings, those debt holders will be prejudiced if SourceHOV Holdings’ judgment creditors can hold those subsidiaries liable for the Appraisal Judgment.145 To be clear, factual allegations related to SourceHOV Holdings’ or the SourceHOV Subsidiaries’ third-party creditors are not in the Complaint, and for now at least, my analysis is confined to the “four corners” of that pleading.146
Other claims or remedies at law or equity. As for the existence of other claims or remedies, it does not appear that other remedies exist to serve the ultimate purpose the reverse veil-piercing claim is meant to serve here: to enforce the Charging Order held against SourceHOV Holdings. While certain jurisdictions consider the availability of “conversion, fraudulent conveyance of assets, respondeat superior and agency law” as relevant when considering this factor, no such argument has been developed here apart from a reference to the existence of such remedies in other jurisdictions.147 In any event, it is not clear at this nascent stage of the proceedings that enforcement of the properly placed Charging Order can be achieved through means other than reverse veil-piercing. With that said, it may well be that Defendants will be able to demonstrate that traditional judgment collection measures are adequate and that reverse piercing, therefore, would be unnecessarily extreme and inappropriate.148 But, for now, I see no reason to dismiss the claim on the basis that some other (as yet to be identified) means to collect the Appraisal Judgment
3. The Charging Order Does Not Prohibit Reverse Veil-Piercing
This construction makes perfect sense; each of the enumerated remedies are other means by which to force the judgment debtor to pay a creditor‘s judgment and, thus, would be displaced by the exclusive statutory remedy of the charging order. The reverse veil-piercing claim, as asserted here, does not rest on or invoke a remedy other than the charging order; it, instead, seeks a judicially sanctioned expansion of the entities against whom the Charging Order may be enforced. In other words, if the court determines that the SourceHOV Subsidiaries fall under the purview of the Charging Order, then Plaintiffs’ only remedy against those entities would still be enforcement of the Charging Order. Any attempt to pursue separate legal or equitable claims, or to seek attachment, garnishment or foreclosure against any one of those entities would be barred by statute.
The implication of a successful reverse veil-piercing claim here, as pled, is that the SourceHOV Subsidiaries are alter egos of SourceHOV Holdings and that “the ultimate part[ies] in interest, the [subsidiaries], [should] be regarded in law and fact
E. Plaintiffs’ Unjust Enrichment Claim Fails to State a Claim
Unjust enrichment is defined as “the unjust retention of a benefit to the loss of another, or the retention of money or property of another against the fundamental principles of justice or equity and good conscience.”156 Plaintiffs allege Exela was enriched by obtaining all of SourceHOV Holdings assets without paying full compensation by virtue of the failure to pay for Plaintiffs’ dissenting shares.157 They further allege SourceHOV Holdings’ failure to pay the approximately $57 million Appraisal Judgment resulted in an impoverishment to Plaintiffs because that was money owed to them as the fair value of the property that has been taken from them.158
For its part, Exela argues that it was not enriched, but rather impoverished, as a result of the Merger, the Appraisal Action and the Appraisal Judgment.159 More relevant here, Exela also argues that Plaintiffs unjust enrichment claim fails because they have an adequate (and exclusive) remedy in the form of the Charging Order against SourceHOV Holdings.160 On this latter point, I agree.
Plaintiffs cite Mehta v. Smurfit-Stone Container Corp. in support of their unjust enrichment claim.161 There, a shareholder who notified the company it would seek statutory appraisal of its shares in dissent of a merger ultimately failed to perfect its appraisal rights in the statutorily required 120-day period.162 Notwithstanding the failure to seek appraisal, Rock-Ten withheld the merger consideration from the plaintiff, arguing the stockholder made its election and yet failed to execute on its appraisal right through no fault of the company.163 The court held the denial of merger consideration to the plaintiffs amounted to an enrichment of Rock-Ten because it received the full benefit of its bargain by merging with Smurfit-Stone, yet had not paid the full price it agreed to pay (by withholding consideration to the dissenting shareholders).164
Unlike in Mehta, where the plaintiff might not have had any legal
Moreover, the charging order statute declares that the charging order is the judgment creditor‘s exclusive remedy under the circumstances.166 The unjust enrichment claim is not merely an action to expand the Charging Order‘s application to other entities, as is the case with the veil-piercing claims; it is a claim that, if successful, will side-step the Charging Order completely as a means to obtain a new judgment on a new claim. The “exclusive remedy” language of the statute prevents that result. Accordingly, Plaintiffs’ unjust enrichment claim must be dismissed.
III. CONCLUSION
For the foregoing reasons, the Motion to Dismiss is GRANTED as to Count I but DENIED as to Count II.
IT IS SO ORDERED.