On May 25, 2021, Vice Chancellor Joseph R. Slights III of the Delaware Court of Chancery partially denied a motion to dismiss claims brought by dissenting stockholder plaintiffs in a post-merger action to enforce an appraisal judgment. Manichaean Capital, LLC v. Exela Technologies Inc.
, C.A. No. 2020-0601-JRS (Del. Ch. May 25, 2021). The Court found that plaintiffs had adequately pleaded facts to allow a reasonable inference that the acquirer diverted funds from the acquiree’s subsidiaries in order to deprive the acquiree of funds to satisfy plaintiffs’ appraisal judgment. In what it called a “matter of first impression,” the Court held that plaintiffs’ allegations were sufficient to support “reverse veil-piercing” and permit execution of the judgment against the subsidiaries, as well as “traditional veil-piercing” as against the acquirer.
Plaintiffs were former stockholders of the acquiree, who withheld their consent to the merger and pursued their statutory appraisal rights in a separate appraisal action. In that case, the Delaware Court of Chancery utilized a discounted cash flow analysis to determine fair value and awarded an appraisal judgment reflecting a value in excess of the merger price per share. As we discussed in a prior post
, the appraisal judgment was affirmed by the Delaware Supreme Court.
However, mere weeks before the Court of Chancery issued its appraisal decision, the acquirer allegedly entered into an accounts receivable securitization facility with the acquiree’s subsidiaries to channel funds of the acquiree’s subsidiaries to the acquirer. Plaintiffs alleged that, because the acquiree is only a holding company with no direct operating assets, the alleged diversion of funds from its solvent subsidiaries in a manner that “bypass[ed]” the acquiree rendered it undercapitalized and unable to satisfy plaintiffs’ appraisal judgment. Plaintiffs thus sought to enforce the appraisal judgment against the acquirer and the subsidiaries.
The Court explained the concept of “reverse veil-piercing” as “the imposition of liability on a business organization for the liabilities of its owners.” The Court concluded that, although Delaware law “embraces and will protect corporate separateness,” a “carefully circumscribed reverse veil‑piercing rule” is appropriate where the corporate form is used “as a means to facilitate fraud or injustice.” However, the Court emphasized that “reverse veil-piercing should be sanctioned only in the most exceptional circumstances.” Indeed, the Court elaborated, “[o]nly 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.”
Accordingly, the Court set out a framework for considering a claim for reverse veil-piercing. In this regard, the Court explained that the “starting place” is the “traditional” veil-piercing factors, including “insolvency, undercapitalization, commingling of…funds, the absence of corporate formalities, and whether the subsidiary is simply a facade for the owner,” as well as whether the corporate form is being used to perpetuate fraud or injustice. Here, according to the Court, the complaint pleaded facts that the acquiree was insolvent and undercapitalized, that corporate formalities had not been maintained, and that the subsidiaries were allegedly being used to perpetuate fraud against a judgment creditor of their parent.
The Court explained that the assessment should then turn to additional factors, including: (i) the potential for the impairment of the expectations of other owners; (ii) the exercise of dominion and control by the parent over the subsidiary and the degree to which that caused the alleged injury; (iii) the extent to which the reverse veil-piercing would serve or impair the “public convenience”; (iv) the extent of the alleged wrongful conduct; (v) whether plaintiffs have themselves engaged in any wrongful conduct; (vi) whether there is any basis to infer that reverse veil-piercing will result in harm to innocent third-party creditors; and (vii) the availability of other remedies. The Court found that — at the pleading stage — consideration of these additional factors also favored the availability of reverse veil-piercing.