Court of Chancery Outlines Rule for Outsider Reverse Veil-Piercing

This case law summary was prepared by Ryan Paulish.

In Manichaean Capital, LLC v. Exela Technologies, Inc., the Delaware Court of Chancery outlined a rule that will apply only to "outsider" reverse veil-piercing.[1] Vice Chancellor Slights determined that a reverse veil-piercing rule deter wrongdoers from using the corporate form as a means to facilitate fraud or injustice.[2]


The plaintiff, former stockholders of SourceHOV Holdings, Inc., ("SourceHOV Holdings") dissented when presented with a decision of the SourceHOV Holdings board of directors to merge with Exela Technologies, Inc.[3] As a result, plaintiffs pursued their appraisal rights.[4]

Defendant, Exela, sits atop a family of "resident and non-resident direct and indirect subsidiaries."[5] The subsidiaries include: (1) Ex-Sigma LLC, a Delaware LLC formed to combine SourceHOV Holdings in the merger; (2) SourceHOV Holdings, the surviving entity in the merger; (3) SourceHOV, LLC, an entity directly below SourceHOV Holdings in which SourceHOV Holdings maintains a 100% membership interest; and (4) a number a subsidiary LLCs, which are referred to as SourceHOV Subsidiaries.[6]

In the appraisal litigation, the court adopted plaintiffs' fair value evidence, which appraised the value of their shares of SourceHOV Holdings at $4,591 per share.[7] As a result, plaintiffs'' stake equaled $57,684,471, which was significantly above the consideration they would have received in the merger.[8] Subsequently, plaintiffs filed a Motion for Charging Order against SourceHOV Holding's membership interest in SourceHOV, LLC.[9] The Motion was granted and mandated that "any 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]."[10]

Weeks before the court's decision in the Appraisal Action, Exela, through its subsidiaries, entered into a $160 million account receivable securitization facility ("A/R Facility").[11] In order to facilitate the transaction, Exela created two entities, Exela Receivables Holdco LLC ("Receivables Holdco") and Exela Receivables I LLC ("Receivables I").[12] Under the First Tier Purchase Agreement, thirteen of the SourceHOV Subsidiaries sold their accounts receivable to Receivables Holdco.[13] Under the Second Tier Purchase Agreement, Receivables Holdco sold those receivables to Receivables I. Then, Receivables I pledged the receivables as collateral for loans and letters of credit to be issued to Receivables I. As a result, the A/R Facility permitted value once held by the SouceHOV Subsidiaries to be held by Exela's indirect subsidiary, thereby allowing a diversion of funds around SourceHOV Holdings and directly to Exela.


After a discussion of traditional veil piercing, the court turned to considering reverse veil-piercing. There are two variants of reverse veil-piercing: insider and outsider reverse veil-piercing. This case only concerned outsider reverse veil-piercing (where "an outside third party, frequently a creditor, urges a court to render a company liable on a judgment against its member"),[14] because plaintiffs were creditors of SourceHOV Holdings (the single member and owner of SourceHOV LLC), which was in turn the single member and owner of the SourceHOV Subsidiaries. The plaintiffs sought to hold the subsidiaries liable for a judgment against the member.

After a summary of non-Delaware state court cases shutting down reverse veil-piercing claims for reasons of protecting the expectations of corporate creditors and shareholders, the court did not believe the reasons proffered warranted an outright rejection of reverse veil-piercing.[15] The court noted that the same considerations that justify traditional veil piercing are at work to justify a request for reverse veil-piercing. For example, in traditional veil-piercing, the court 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."[16] As a result, the court stated that "Delaware will not countenance the use of the corporate form as a means to facilitate fraud or injustice."[17]

In defining the rule for reverse veil-piercing, Vice Chancellor Slights noted that it should be sanctioned in only the most "exceptional circumstances," since the claims, if granted, can threaten innocent third-party creditors and shareholders.[18] When beginning review for a reverse veil-piercing claim, the courts will consider the traditional veil piercing factors, such as: (1) insolvency; (2) undercapitalization; (3) comingling of corporate and personal funds; (4) the absence of corporate formalities; and (5) whether the subsidiary is a façade for the owner.[19] Then, the court will ask whether the owner is utilizing the corporate form to perpetuate fraud or injustice by looking at additional factors, such as: (1) the degree to which allowing a reverse piercing claim would impair the legitimate expectations of any adversely affected shareholders who are not responsible for the conduct of the insider that gave rise to the claim, and the degree to which allowing a reverse pierce would establish a precedent troubling shareholders generally; (2) the degree to which the corporate entity whose disregard is sought has exercised dominion and control over the insider who is subject to the claim by the party seeking the reverse pierce; (3) 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 that person's reasonable reliance upon a lack of separate entity status between the insider and the corporate entity; (4) the degree to which the public convenience would be served by allowing a reverse pierce; (5) the extent and severity of the wrongful conduct, if any, engaged in by the corporate entity whose disregard is sought by the insider; (6) the possibility that the person seeking the reverse pierce is himself guilty of wrongful conduct sufficient to bar him from obtaining equitable relief; (7) extent to which the reverse pierce will harm innocent third-party creditors of the entity plaintiff seeks to reach; and (8) the extent to which other claims or remedies are practically available to the creditor at law or in equity to recover the debt.[20]

After reviewing the complaint with the factors in mind, the court was satisfied that the case fit into one of the "exceptional circumstances" where a plaintiff has pled a basis for reverse veil-piercing. To start, the complaint pled a reasonably conceivable basis to conclude that corporate formalities were not maintained and that SourceHOV Holdings were insolvent and undercapitalized.[21]Also, it was reasonably pled that certain SourceHOV Subsidiaries were active participants in a potential fraudulent and unjust scheme in regards to the A/R Facility since the complaint alleges that manager of the SouceHOV Subsidiaries knew about SourceHOV Holdings' undercapitalization and knowing that the A/R Facility will divert proceeds meant for SourceHOV Holdings' creditors.[22]

In turning to the additional factors for reverse veil-piercing, the court was satisfied that they were met. For example, the complaint pled no basis to infer that other owners of SourceHOV Holdings or SourceHOV Subsidiaries will be adversely affected.[23] There was no basis to infer that reverse veil-piercing will cause harm to innocent third-party creditors.[24] There was an inference of dominion and control over SourceHOV Holdings that caused plaintiffs' injury.[25] It was found that reverse veil-piercing would serve the public convenience as expressed in Delaware's appraisal statute because it was alleged "Exela and SourceHOV have retained all of the benefits of the merger at issue in the Appraisal Action without paying compensation for plaintiff's dissenting shares and are using their corporate structure as a sham in an attempt to render SourceHOV judgment proof."[26] The wrongful conduct pled justified reverse piercing because Exela and SourceHOV Subsidiaries initiated a scheme to ensure that Exela retained significant value of plaintiffs' ownership in pre-merger SourceHOV Holdings without paying for that equity.[27] In addition, there was no basis to infer that plaintiffs engaged in any wrongful conduct that would disable them from calling upon equity to address their harm.[28] Finally, it did not appear that other remedies existed to serve the ultimate purpose the reverse veil-piercing claim was meant to serve—to enforce the Charging Order held against SourceHOV Holdings.[29]

Ultimately, the court denied the motion to dismiss regarding the veil-piercing claims.[30]

[1] 2021 WL 2104857, at *12.
[2] Id.
[3] Id. at *1.
[4] Id. at *3.
[5] Id.
[6] Id.
[7] Id.
[8] Id.
[9] Id. at *4.
[10] Id.
[11] Id.
[12] Id.
[13] Id.
[14] Id. at *9.
[15] Id. at *11.
[16] Id. at *12.
[17] Id.
[18] Id.
[19] Id. at *13.
[20] Id.
[21] Id. at *14.
[22] Id.
[23] Id.
[24] Id. at *15.
[25] Id.
[26] Id.
[27] Id.
[28] Id.
[29] Id. at *16.
[30] Id. at *18.