In a recent decision in South College Street, LLC v. Ares Capital Corporation, Justice Schechter of the New York State Supreme Court, Commercial Division, dismissed petitioner’s New York Debtor and Creditor Law claims, which were premised on alter ego liability.[1]  The opinion addressed the types of allegations a plaintiff must make in order to successfully plead a veil-piercing claim.

The case involved South College Street, LLC, a company that purchased a property in North Carolina that was subject to a lease for Charlotte School of Law (“CSL”).  The lease was guaranteed by CSL’s parent company, InfiLaw Corporation (“InfiLaw”).

In October 2017, CSL stopped paying its rent, so plaintiff commenced a North Carolina action against CSL and InfiLaw to enforce the lease.  In that action, plaintiff obtained a judgment against CSL and InfiLaw, jointly and severally, for $24.55 million.

Plaintiff then commenced a New York lawsuit against Ares Capital Corporation (“Ares”), a creditor of InfiLaw and a company to which InfiLaw’s parent company, InfiLaw Holding, LLC (“InfiLaw Holding”), had conveyed certain payments.[2]  Specifically, plaintiff asserted New York Debtor and Creditor Law (“DCL”) claims,[3] arguing that “between June 2015 and August 2016, more than $32 million was fraudulently conveyed to Ares” and seeking to “enforce its judgment against [InfiLaw] by setting aside those conveyances.”[4]  Ares moved to dismiss plaintiff’s complaint.

In considering Ares’s motion to dismiss, the Court noted that although DCL claims can generally only be asserted by creditors of the transferor, DCL liability can extend to alter egos.  “Alter ego liability requires piercing the corporate veil, which is an exception to the presumption that corporate entities are distinct from their owners[.]”[5] As Justice Schechter explained, “[w]hether veil piercing is warranted, is governed by the law of the state of incorporation of the entities whose veils were sought to be pierced[.]”[6] Because InfiLaw and InfiLaw Holding are both incorporated in Delaware, the Court applied Delaware law. 

Under Delaware law, “to state a veil-piercing claim, the plaintiff must plead facts supporting an inference that the corporation, through its alter-ego, has created a sham entity designed to defraud investors and creditors[.]”[7] The Court remarked that it is “difficult” to meet this standard because a plaintiff must allege facts showing a parent company’s domination over its subsidiary, as well as facts demonstrating that the corporate structure itself was used to perpetuate a fraud.[8]

Justice Schechter concluded that plaintiff had not adequately alleged facts supporting a reasonable inference that the corporate structure of and InfiLaw and InfiLaw Holding was designed to defraud InfiLaw’s creditors.  Specifically, the Court found that “[w]hile plaintiff alleges that [Infilaw Holding] dominates and controls [Infilaw], that is not enough.”[9]  Instead, the Court reasoned, “plaintiff must plead, for instance, that the capital structure of [InfiLaw Holding] and [InfiLaw] was specially designed to ensure [InfiLaw]’s creditors would be left seeking to collect from an empty shell.”[10]

The Court further noted that “the fraud prong of a veil piercing claim must rely on something other than merits of the underlying claim on which alter ego liability is sought[.]”[11]  Thus, the Court concluded that plaintiff’s allegations supporting its DCL claims—that CSL was destined to fail because of InfiLaw’s underlying debt structure—were insufficient to plead alter ego liability.  Accordingly, the Court granted Ares’s motion to dismiss.