Fourth Circuit Considers Reverse Piercing, Charging Orders, and Jurisdictional Challenges in Pilfered Cable Case

Sky Cable v. Coley (http://www.ca4.uscourts.gov/opinions/161920.P.pdf) examines the interplay between reverse piercing the corporate veil, the exclusivity of the charging order remedy, and jurisdiction over an unserved (with process) LLC based on its member’s acts.

In 2011, the plaintiff cable distributor sued two LLCs affiliated with an individual defendant (“Individual Defendant”) who was secretly supplying cable TV to over 2,000 rooms and pocketing the revenue.

After unsuccessfully trying to collect on a $2.3M judgment, plaintiff later moved to amend the judgment to include three LLCs connected to the Individual Defendant under a reverse veil-piercing theory. The Individual Defendant and one of the LLCs appealed the District Court order that broadened the scope of the judgment.

Affirming, the Fourth Circuit, applying Delaware law, found that the District Court properly reverse-pierced the Individual Defendant to reach LLC assets.

‘Reverse’ Veil Piercing

Unlike traditional veil piercing, which permits a court to hold an individual  shareholder personally liable for a corporate judgment, reverse piercing attaches liability to the entity for a judgment against a controlling individual. [10, 11]

Reverse piercing is especially apt in the one-member LLC context as there is no concern about prejudicing the rights of others LLC members if the LLC veil is pierced.

In predicting that a Delaware court would recognize reverse piercing, the Court held that if Delaware courts immunized an LLC from liability for a member’s debts, LLC members could hide assets with impunity to shirk creditors. [18, 19]

Charging Order Exclusivity?

The Court also rejected the Individual Defendant’s argument that Delaware’s charging statute, 6 Del. Code s. 18-703 was the judgment creditor’s exclusive remedy against an LLC member.

Delaware’s charging statute specifies that attachment, garnishment and foreclosure “or other legal or equitable remedies” are not available to the judgment creditor of an LLC member.

However, the Court found that piercing “is not the type of remedy that the [charging statute] was designed to prohibit” since the piercing remedy differs substantively from the creditor remedies mentioned in the charging statute.  The Court found that unlike common law creditor actions aimed at seizing a debtor’s property – piercing (or reverse-piercing) challenges the legitimacy of the LLC entity itself. As a result, the Court found that the plaintiff wasn’t confined to a charging order against the Individual Defendant’s LLC distributions.

The Court further held that applying Delaware’s charging law in a manner that precludes reverse piercing would impede Delaware’s interest in preventing its state-chartered corporate entities from being used as “vehicles for fraud”
by debtors trying to escape its debts. [20-22]

Alter Ego Finding

The Court also agreed with the lower court’s finding that the LLC judgment debtor was the Individual Defendant’s alter ego.  In Delaware, a creditor can establish does not have to show actual fraud. Instead, it (the creditor) can establish alter ego liability by demonstrating a “mingling of the operations of the entity and its owner plus an ‘overall element of injustice or unfairness.” [24-25]

Here, the evidence in the record established that the Individual Defendant and his three LLCs operated as a single economic unit.  The Court also noted the Individual Defendant’s failure to observe basic corporate formalities, lack of accounting records and obvious commingling of funds as alter ego signposts.

The most egregious commingling examples cited by the court included one LLC paying another entity’s taxes, insurance and mortgage obligations. The Court found it suspicious (to say the least) that the individual Defendant took mortgage interest deductions on his personal tax returns when an LLC was ostensibly paying a separate LLC’s mortgage.

Still more alter ego evidence lay in Defendant’s reporting an LLC’s profit and loss on his individual return. Defendant also could not explain at his deposition what amounts he received as income from the various LLCs.

Can LLC Member’s Post-Judgment Acts Subject LLC to Jurisdiction?

The Court also affirmed the District Court’s exercise of jurisdiction over the LLC judgment debtor based on the Individual Defendant’s acts even though the LLC was never served with process in the underlying suit.

Normally, service of summons and the operative pleading on a defendant is a precondition to a court’s exercise of personal jurisdiction over him. However, a court has “vicarious jurisdiction” over an individual where his corporate alter ego is properly before the court.  In such a case, an individual’s jurisdictional contacts are imputed to the alter ego entity.

The reverse can be true, too: where an LLC’s lone member is already before the Court, there is no concern that the LLC receive independent notice (through service of summons, e.g.) of the litigation. (This is because there are no other members to give due process protections to.)

Applying these rules, the Fourth Circuit found jurisdiction over the LLC was proper since the Individual Defendant appeared and participated in post-judgment proceedings. [30-36]

Afterwords:

Sky Cable presents a thorough discussion of the genesis and evolution of reverse veil-piercing and a creditor’s dogged and creative efforts to reach assets of a single-member LLC.

Among other things, the case makes clear that where an LLC is so dominated and controlled by one of its members at both the financial and business policy levels, the LLC and member will be considered alter egos of each other.

Another case lesson is that a judgment creditor of an LLC member won’t be limited to a charging order where the creditor seeks to challenge the LLC’s legitimacy; through either a traditional piercing or non-traditional reverse-piercing remedy.

Faulty Service on LLC Defendant Dooms Administrative Agency’s Unpaid Wages Claim Versus Security Company

The Illinois Department of Labor’s (DOL) decision to send a notice of hearing to a limited liability company and its sole member to the member’s personal post office (p.o.) box (and not to the LLC’s registered agent) came back to haunt the agency in People of the State of Illinois v. Wilson, 2018 IL App (1st) 171614-U.

Reversing summary judgment for the DOL in its lawsuit to enforce an unpaid wages default judgment, the First District austerely applies the Illinois LLC Act’s (805 ILCS 180/1-1 et seq.) service of process requirements and voided the judgment for improper service.

Key Chronology:

February 2013: the DOL filed a complaint for violation of the Illinois Wage Payment and Collection Act (the Wage Act) against the LLC security firm and its member (the “LLC Member”);

January 2015: the DOL sends a notice of hearing by regular mail to both defendants to the LLC Member’s personal p.o. box;

March 2015: Defendants fail to appear at the hearing (the “2015 Hearing”) and DOC defaults the defendants;

June 2015: Defendants fail to pay the default amount and DOL enters judgment that tacks on additional fees and penalties;

February 2016: DOL files suit in Illinois Chancery Court to enforce the June 2015 administrative judgment;

March 2016, May 2016: Defendants respectively appear through counsel and move to dismiss the case for improper service of the 2015 Hearing notice;

June – July 2016: DOL concedes that service was deficient on the LLC defendant (the security company) and voluntarily dismisses the LLC as party defendant;

May 2017: DOL’s motion for summary judgment granted;

June 2017: LLC Member appeals.

The Analysis

The main issue on appeal was whether the DOL gave proper notice of the 2015 Hearing. It did not.

Under the law, lack of jurisdiction may be raised at any time; even past the 35-day window to challenge an agency’s decision under the Illinois Administrative Review Law, 735 ILCS 5/3-103.

Section 50 of the LLC Act provides that an LLC must be served (1) via its registered agent or (2) the Secretary of State under limited circumstances.

Secretary of State service on an LLC is proper where (1) the LLC fails to appoint or maintain a registered agent in Illinois; (2) the LLC’s registered agent cannot be found with reasonable diligence at either the LLC’s registered office or its principal place of business; OR (3) when the LLC has been dissolved, the conditions of (1) and (2) above exist, and suit is brought within 5 years after issuance of a certificate of dissolution or filing of a judgment of dissolution. 805 ILCS 180/1-50(a), (b)(1-3).

Here, the DOL mailed notice of the 2015 Hearing to the wrong party: it only notified the LLC Member. It did not serve the notice on the LLC’s registered agent or through the Secretary of State. As a result, the LLC was not properly served in the underlying wage proceeding.

The DOL argued that since the LLC Member was also sued as an individual “employer” under Sections 2 and 13 of the Act, service of the 2015 Hearing on the LLC Member was valid.

The Court disagreed. Under Sections 2 and 13 of the Act, an employer can be liable for its own violations and acts committed by its agents and corporate officers or agents can be liable where they “knowingly permit” an employer to violate the Act.

Corporate officers who have “operational control” of a business are deemed employers under the Act. However, an individual’s status as a lone member of an entity – like the LLC Member – is not enough to subject the member to personal liability.

Instead, there must be evidence the member permitted the corporate employer to violate the Act by not paying the compensation due the employee. Otherwise, the Court held, every company decision-maker would be liable for a company’s failure to pay an employee’s wages. [⁋⁋ 49-50]

And since the DOL hearing officer never made any specific findings that the LLC Member knowingly permitted the security company to violate the Act, there wasn’t enough evidence to sustain the trial court’s summary judgment for the DOL. [⁋ 51]

Afterwords:

Wilson starkly illustrates that the LLC Act’s service of process strictures have teeth. If a litigant fails to serve an LLC’s registered agent or the Secretary of State, any judgment stemming from the invalid service is a nullity.

In hindsight, the DOL probably should have produced evidence at the 2015 Hearing that the LLC Member (a) had operational control over the security firm; and (b) personally participated in the firm’s decision not to pay the underlying claimant’s wages. Had it done so, it may have been able to salvage its case and show that p.o. box service on the LLC Member was sufficient to subject her to the DOL’s jurisdiction.

Nevada LLC Members’ Privilege to Tortiously Interfere with Business Relationships Has Limits – IL ND

When the former President of a lighting company started a competing venture, his former employer sued for damages under the Illinois Deceptive Trade Practices Act (IDTPA) and for breach of contract. The ex-President then countersued for unpaid commissions under the Illinois Wage Payment and Collection Act (IWPCA) and sued the individual members of the LLC plaintiff for tortious interference with advantageous business relationship. All parties moved to dismiss.

Green Light National, LLC v. Kent, 2018 WL 4384298, examines, among other things, the extra-territorial reach of the IWPCA and the scope of a corporate officer’s privilege to interfere with a rival’s business relationships.

An IDTPA plaintiff can only bring a claim where the wrongful conduct occurred “primarily and substantially in Illinois.” Factors include: (1) the place of plaintiff’s residence, (2) where the misrepresentation was made, (3) where the damage occurred, and (4) whether the plaintiff communicated with the defendant in Illinois.

Here, the court found factors (1) and (3) pointed toward Illinois as the locus of the challenged conduct. Plaintiff alleged the defendants used plaintiff’s lighting installations on the competitor’s website. And since plaintiff was an Illinois corporate entity, it was likely that plaintiff sustained damage in Illinois.  This made the case different from others where the lone connection to Illinois was a nationwide website. On the current record, the court wasn’t able to determine whether factors (2) and (4) weighed towards a finding that defendants’ misconduct happened in Illinois. As a result, the Court held that the plaintiff alleged a sufficient IDTPA claim to survive defendants’ motion to dismiss.

Next, the court sustained plaintiff’s breach of employment contract claim. The defendants moved to dismiss this claim on the basis that a 2013 Employment Agreement was superseded by a 2015 Operating Agreement which documented plaintiffs’ corporate restructuring. Under Illinois law, an earlier contract is superseded by a later contract where (1) both contracts deal with the same subject matter, (2) two contracts contain inconsistencies which evince the conclusion that the parties intended for the second contract to control their agreement and vitiate the former contract, and (3) the later contract reveal no intention of the parties to incorporate the terms of the earlier contract.

There were too many facial dissimilarities between the 2013 and 2015 documents for the court to definitively find that the former agreement merged into the latter one.

Turning to the defendant’s counterclaims, the Court sustained the tortious interference claim against two of the LLC members. In Illinois, corporate officers are protected from personal liability for acts committed on behalf of the corporation. Corporate officers and directors are privileged to use their business judgment in carrying out corporate business. So long as a corporate officer is acting in furtherance of a corporation’s legitimate business interest, the officer is shielded from individual liability. The same rule that protects corporate officers for decisions made on behalf of their company applies with equal force to LLC member decisions made for the LLC.

This LLC member privilege to interfere isn’t inviolable though.  Where the member acts maliciously – meaning intentionally and without justification – he abuses his qualified privilege. Here, the defendant alleged two LLC members made knowingly false statements about the defendant. These allegations, if true, were enough to make out a tortious interference with business relationships claim. The

The Court then denied the plaintiff’s motion to dismiss defendant’s IWPCA claim. The plaintiff argued that since defendant was not an Illinois resident, he couldn’t sue under the IWPCA since that statute lacks extraterritorial reach. The Court rejected this argument as Illinois law allows non-residents to sue under the IWPCA where they perform work in Illinois for an Illinois-based employer. The counter-plaintiff’s allegations that he made approximately 15 trips to Chicago over several months to perform work for the defendant was enough – at the motion to dismiss stage – to provide a hook for an IWPCA claim.

Afterwords:

1/ Where a later contract involves the same subject matter as an earlier contract and there are facial inconsistencies between them, a Court will likely find the later agreement supersedes the earlier one;

2/ Corporate officers (and LLC members) are immune from suit when taking action to pursue a legitimate business interest of the corporate entity. The privilege is lost though where a corporate officer engages in intentional and unjustified conduct;

3/ A non-resident can sue under the IWPCA where he/she alleges work was performed in Illinois for an Illinois employer.