Connecticut Supreme Court Rejects Use of “Reverse Veil Piercing” In Environmental Enforcement Action

In the usual veil piercing case, a plaintiff asks a court to disregard a corporate entity so the assets of the owner can be used to satisfy the liability of the entity. However, sometimes the plaintiff seeks to use corporate assets to satisfy the debts of a shareholder under a theory known as “reverse veil-piercing”. In the environmental context, this tactic has been used to hold a subsidiary liable for a parent corporation that has no assets or that has been burdened with debt, or to reach assets of an affiliated entity when the corporate responsible party is judgement-proof.

In Commissioner of Environmental Protection  v. State Five Industrial Park, Inc., 304 Conn. 128 (Conn 2012), the Connecticut Supreme Court had the opportunity to review the circumstances when reverse veil-piercing may be appropriate. In this case, the Connecticut Department of Environmental Protection (CTDEP), commenced an enforcement action Joseph J. Farriciell (Joseph) and the five corporations that he controlled and/or owned—Hamden Salvage, Inc., Tire Salvage, Inc., North Haven Tire Disposal, Inc., Quinnipiak Real Estate & Development Corporation and Hamden Sand &    Stone, Inc.(Hamden). The CTDEP alleged violations of solid waste laws as well as a 1998 consent order. Following a bench trial, Joseph and his corporations were ordered fund the closure of two illegal solid waste landfills, reimburse the CTDEP for past costs and pay approximately $3.8 million in civil penalties to the commissioner and the town. In 2004, an appeals court affirmed the judgment.

The defendants posted bonds and implement much of the remediation but failed to pay the civil penalties. In 2005, CTDEP commenced an action, alleging that Joseph’s wife ( Jean)  and State Five should be held liable for all of the obligations imposed upon Joseph and his corporations pursuant to the 2001 judgment.

The trial court ruled that State Five was the alter ego of Joseph Farricielli should be held liable for the obligations imposed by the 2001 judgment. The court trial found that Joseph transferred all of the stock of State Five to Recycling Enterprises (Recycling) which, in turn, was 80% owned by Jean with the remaining 20% owned by their two sons. The trial court also found that Joseph had quitclaimed real property to State Five to be used for rental income.

The trial court also noted that between 2001 to 2004, Recycling transferred ownership of all of State Five’s stock to a friend of Jean and Joseph, William J. LaVelle. The trial court found that Joseph had negotiated the transfer of stock to LaVelle, that it was not an authentic sale, and that Joseph and Jean retained control over State Five during the period of LaVelle’s ownership. Jean frequently was present at State Five’s offices and dealt with its tenants. Joseph maintained an office at State Five, sometimes received wages from the corporation and continued to deal with its tenants. He directed its bookkeeper and accountant as to how to characterize transactions, and he wrote correspondence on State Five’s behalf. Both Joseph and Jean continued to write checks from State Five’s checking account.

The trial court also observed that prior to 2001, State Five had operated profitable and did not have any debt. After the 2001 judgment, though, State Five began to take on substantial debt. Joseph caused Hamden to go out of business,  Jean and Joseph  caused State Five to assume the debt of Hamden that they had personally guaranteed without adequate consideration. Between 2001 and 2004, Joseph wrote personal checks transferring funds to State Five.

Between  2001 and 2006, the trial court found, State Five’s financial condition worsened. The firm became thinly capitalized and most of its debt did not relate to its business as a landlord. To keep State Five viable, the trial court said Jean contributed her own funds and borrowed funds from her mother. Additionally, she borrowed against her own property, property she owned jointly with Joseph, and put the proceeds into State Five.

Despite its poor financial condition, the trial court said State Five paid thousands of dollars of personal expenses for Jean and Joseph, including  Joseph’s legal expenses. The court said State Five’s accounting treatment of these personal expenses was improper and inconsistent, and lacked appropriate documentation. The court also found that although Joseph and Jean caused State Five to make payments to themselves or loans to family members, State Five did not make any payments due under the 2001 judgment.

The Supreme Court began its analysis noting that some jurisdictions have adopted reverse veil piercing as a logical corollary of traditional veil piercing since both theories are based on the same equitable goals. Both doctrines are only to be used under exceptional circumstances where the corporation is a mere shell, serving no legitimate purpose, and used primarily as an intermediary to perpetuate fraud or promote injustice.

However, the Court also observed that other courts recognized there are important differences between the concepts and have either limited or disallowed entirely reverse veil piercing. The Court highlighted three principal concerns about reverse veil piercing. First, the Court noted that reverse veil piercing bypasses normal judgment-collection procedures since corporate assets are attached directly for the benefit of the creditors of an individual and can prejudice creditors of the corporation who relied on the entity’s separate corporate existence when extending credit and understood the loans were to be secured by the corporate assets. Second, the Court said that non-culpable shareholders would be prejudiced if the corporation’s assets can be attached directly. In contrast, the court continued, only the assets of the particular shareholder or other insider who is determined to be the corporation’s alter ego are subject to the attachment. Finally, the court said corporate veil piercing is an equitable remedy, it should be granted only in the absence of adequate remedies at law.

Turning to the facts of the case, the Court then concluded that the trial court should not have applied reverse veil piercing because certain of the trial court’s critical factual findings were not supported by the evidentiary record. First, the court said, the plaintiffs had failed to demonstrate that the sons who held a 20% interest in State  Five participated in any wrongdoing in relation to State Five’s affairs. The court said there was no testimony or other evidence that tended to show that the sons were aware of and acquiesced to any of the conduct that the trial court found objectionable. The court said that the absence of the sons’ lack of absence of decision making could not serve as evidence that they were were complicit in Joseph’s activities. Because the plaintiffs did not establish that the sons were not innocent shareholders, it was improper for the trial court to apply reverse veil piercing without regard to whether their interests would be impacted.

Second, the court said the plaintiffs did not demonstrate that non-party creditors of State Five would not be harmed by making all of the corporation’s assets available to satisfy the 2001 judgment by way of a reverse veil pierce. The court said there was evidence that State Five had a $200K line of credit with a local bank that it had actively accessed, sometimes with balances that were close to the limit. The trial court determined that the bank would not be harmed by reverse veil piercing because the line of credit was secured with Jean’s personal assets and noted that a 2007 accounting ledger of State Five indicated that the line of credit had  been paid off. However, the Supreme Court  ruled that this finding was clearly erroneous because a lender in this context extends credit in reasonable reliance on the existence of both a viable borrower in possession of assets and the additional security provided by a secondary obliger.

The court said that to justify imposing the entire obligation of the 2001 judgment on State Five, the plaintiffs needed to show that Joseph exercised control over State Five to divert or secrete assets belonging to him personally or to his corporations that would otherwise have been available to satisfy that judgment, and that these maneuvers were the proximate cause of the plaintiffs’ inability to collect $3.8 million that it otherwise would have been able to recover. The court found that although there was evidence that Joseph transferred some assets from himself and his corporations to State Five, the trial court did not calculate the value of those transfers, and the evidence presented would not support a finding that their value came anywhere near to the  amount which the court ultimately held State Five liable. Additionally, although Joseph transferred rental income property to State Five for no consideration, this was done more than three years before the institution of the 1999 action and more than five years prior to the 2001 judgment that imposed the fines at issue. Given that circumstance, the court said it cannot be argued that the transfer was contrary to the plaintiffs’ legal rights and proximately caused their inability to collect on their judgment.

Finally, to the extent that Joseph caused State Five to use its own assets or those transferred to State Five by its majority owner to pay his personal expenses and the tax bill of one of his corporations, the Supreme Court found that these actions did not offend the plaintiffs’ collection rights nor cause them any detriment. Because neither Jean nor State Five were defendants in the 1999 action, and because Joseph has had no ownership interest in State Five since the late 1980s, the Court concluded the assets of Jean and State Five were not subject to the 2001 judgment. Accordingly, the Court held that while the use of those assets to pay Joseph’s personal expenses may have been offensive to State Five’s interests, the tactic was not the proximate cause of the plaintiff’s  inability to collect the judgment against Joseph. Indeed, the Court reasoned, payment of a judgment debtor’s expenses by non-liable third parties enhanced a creditor’s ability to collect from the judgment debtor.

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