The Case Against Fiduciary Entity Veil Piercing

Mohsen Manesh is Associate Professor at University of Oregon School of Law. This post is based on a forthcoming article authored by Professor Manesh. This post is part of the Delaware law series; links to other posts in the series are available here.

When two of the nation’s leading business law jurists question a judge-made doctrine of a relatively recent vintage for giving rise “to a particularly odd pattern of routine veil piercing,” [1] one senses that a doctrinal change may be stirring. In this case, those two jurists are Delaware Chief Justice Leo Strine and Delaware Vice-Chancellor Travis Laster. And the legal doctrine the judicial pair decry is the one announced just 25 years ago in In re USACafes, L.P. [2]

In USACafes, the Delaware Chancery Court held that where the general partner of a limited partnership (“LP”) is itself a corporation—rather than a natural person—the directors of the corporate general partner owe a fiduciary duty directly to the limited partners of the LP. Because it was decided in the context of an LP—addressing who owes fiduciary duties to the limited partners of an LP—USACafes is often conceived of as a doctrine of LP law. But to marginalize USACafes as an LP law doctrine neglects its corporate law ramifications. USACafes is as much a corporate law doctrine, dictating to whom corporate directors owe a fiduciary duty. And this says nothing about USACafes’ application to corporate affiliates, controlling shareholders, LLCs, and other business arrangements. Indeed, stated generally, the doctrine of USACafes holds that whenever a business entity (a “fiduciary entity”) exercises control over and, therefore, stands in a fiduciary position to another business entity (the “beneficiary entity”), those persons exercising control, whether directly or indirectly, over the fiduciary entity (the “controller(s)”) owe a fiduciary duty to the beneficiary entity and its owners.

Accordingly, the Delaware Chancery Court has applied USACafes in a variety of contexts and through various multi-tiered, parent-subsidiary business structures involving corporations, general partnerships, LLCs, trusts, as well as LPs. Indeed, USACafes can be seen as a type of entity veil piercing, specifically in cases involving a fiduciary entity.

The expansive reach of USACafes into seemingly every branch of business entity law stems from the doctrine’s foundation in a broader equitable concept: that those vested with control over the property of another owe a fiduciary duty to act in the best interests of the property’s true owners. And viewed strictly from this singular perspective, USACafes is on seemingly sound doctrinal footing. But, viewed more broadly, USACafes creates problematic tensions with basic precepts of both law and equity. Therefore, I argue in a forthcoming article, when presented with the opportunity, the Delaware Supreme Court and courts elsewhere should reject its holding.

The problems of USACafes are many. For one, the doctrine contravenes the entity law principles of legal separateness and limited liability, imposing onto a fiduciary entity’s controllers the duties and liabilities that are formally owed by the fiduciary entity. Likewise, the doctrine conflicts with fundamental contract law principles, disregarding the bargained for agreement governing the beneficiary entity, in which the parties agreed that an entity, and not the entity’s controllers, would stand in the position of a fiduciary. Finally, the doctrine is discordant with established equitable principles, imposing onto controllers potentially irreconcilable fiduciary duties owed simultaneously to the separate owners of the fiduciary entity and beneficiary entity.

Add to these problems the fact that USACafes is an altogether unnecessary extension equity. Traditional veil piercing doctrine already enables courts to pierce an entity’s veil in cases of fraud or unjust abuse of the statutory privilege of limited liability. By focusing solely on control and dispensing of the requirement of fraud or other injustice, USACafes serves only to make veil piercing—a doctrine that is ordinarily, and appropriately, an extraordinary judicial remedy—perfunctory and routine for fiduciary entities. And it does so for the benefit of investors who are voluntary creditors of a fiduciary entity, with the opportunity to protect themselves ex ante through the terms of the agreement governing the beneficiary entity.

To be sure, the abandonment of USACafes would raise some interesting doctrinal questions that the courts would need to eventually address. For example, if USACafes is abandoned, then should plaintiffs be able to continue bringing USACafes-style claims against controllers under a theory that the controllers aided and abetted the fiduciary entity in breaching its fiduciary duties owed to the beneficiary entity? To take another example, where the controlling shareholder of a corporation is itself an entity, under what circumstances (if any) should the natural-person controllers of the controlling shareholder entity owe a fiduciary duty directly to the controlled corporation? To date, the existing Delaware corporate case law on this question is in conflict. [3]

Regardless of how the courts choose to address these questions, however, the problems for USACafes are the same. It is a needless doctrine that stands in conflict with other, more fundamental legal and equitable precepts. Despite its nearly quarter century vintage, the Delaware Supreme Court has never expressly embraced USACafes and, therefore, is not bound to it by principles of stare decisis. Accordingly, when presented with the opportunity, Delaware’s high court as well as courts of other jurisdictions should reject USACafes and instead accord the fiduciary entity with the separate legal dignity to which it is statutorily entitled. If the limited liability veil of a fiduciary entity is to be pierced, then it should be under the more rigorous legal standard that courts have traditionally applied in veil piercing cases.

The full article is available here.

Endnotes

1Leo E. Strine, Jr., & J. Travis Laster, The Siren Song of Unlimited Contractual Freedom in Research Handbook on Partnerships, LLCs and Alternative Forms of Business Organizations 21 (Robert W. Hillman & Mark J. Loewenstein eds., 2015)(go back)

2In re USACafes, L.P. Litig., 600 A.2d 43 (Del. Ch. 1991) (Allen, C.).(go back)

3Compare In re Primedia Inc. Derivative Litigation, 910 A.2d 248, 257-59 (2006) (Lamb, V.C.) (ruling that the controller of a controlling shareholder group, consisting of seven LPs, may also be liable as a controlling shareholder), and In re Ezcorp Inc. Consulting Agreement Deriv. Litig., 2016 WL 301245, *10 (Del. Ch. Jan. 25, 2016) (Laster, V.C.) (citing Primedia, among other precedents, to rule that the controller of controlling shareholder entity (an LP), may also be liable as a controlling shareholder), with Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 194 (Del. Ch. 2006) (Strine, V.C.) (ruling that the directors of a controlling shareholder, which is itself a corporation, do not owe a fiduciary duty to the controlled corporation).(go back)

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