About three years ago, I posted a blog on situations where a single-member limited liability company might not provide all the liability avoidance protection to its owner that it supposedly offers (Single Member LLCs — Potential Problems). That blog discussion focused on the concept of a court permitting a judgment creditor to pierce through the debtor entity and reach the assets of the entity owner. That concept of “piercing the corporate veil” has long been available in the corporate world and has since expanded into the LLC arena as well.
An offshoot of that concept seems to be slowly gaining a foothold in certain scenarios and in somewhat limited circumstances and is called “reverse veil piercing.” There are a few states where this legal theory has gained traction, including our neighboring state of California. Under reverse veil piercing, the judgment creditor is permitted by the court to pierce through a debtor-who owns a limited liability company to reach the assets of the entity itself.
An egregious example of reverse veil piercing would be where an individual places all of his or her assets in one or more limited liability companies while retaining few assets in personal name, runs up significant debt in personal name and then tells creditors there are no personal assets available to pay creditors.
Under most state limited liability company statutes, a creditor of the LLC owner can only obtain a charging order against the LLC ownership interest and cannot reach the ownership interest itself (as contrasted with the corporate situation, where a creditor can execute on corporate shares owned by a person or entity), thereby putting a creditor of an LLC owner at a distinct disadvantage in trying to collect a debt where the debtor has committed a fraud or is acting in a financially dishonest or unfair manner to defeat or hinder creditors of the entity owner. Some courts are applying equitable remedies to permit creditors to expand the judgment against the LLC owner to the LLC entity itself so that the assets therein can be reached. This concept is more likely to be applied where there are not multiple, arms-length owners of the entity who could be negatively impacted should the entity veil be pierced.
This area of law is evolving, and it would not seem surprising to see it applied in Arizona at some point in the future. While I have not found any reported cases in Arizona, an individual or entity that sets up one or more “dummy” entities to effectively defeat or elude creditors could be in for a rude awakening at some point.