« More Evidence that a For-Cause Removal of CFPB Director Corday Would Be Pretextual | Main | Mr. Regling's "Alternative Facts" About the Greek Debt »

Veil Piercing When a Sovereign Owns the Shares; Venezuela Edition

posted by Mark Weidemaier

This is a joint post by Mark Weidemaier and Mitu Gulati.

At least in the short term, the odds of Venezuela continuing to service its mountain of external debt are looking slightly better, though long-term prospects remain bleak. State-owned oil company PDVSA may be even worse off. A default or restructuring by one or both borrowers will raise issues that are typically peripheral in a sovereign debt crisis. If Argentina's pari passu saga tested the willingness of courts to approve novel injunctions, Venezuela's debt crisis will test the willingness of courts to disregard the legal fiction that corporations are separate legal "persons." That fiction means that a corporation's shareholders are not liable for corporate debts (or vice versa), unless a creditor can "pierce the corporate veil"--i.e., prove the shareholder abused the corporate form to engage in "fraud or inequitable conduct."

Consider at least two ways veil piercing issues might arise. First, Venezuela's economy depends heavily on oil exports managed by PDVSA and its subsidiaries, but assets related to these sales may belong to legally separate entities. PDVSA likely has few US assets, aside from shares in a holding company whose remote subsidiaries include CITGO Petroleum. Although we have limited information about PDVSA's operations, accounts receivable for US oil sales likely belong to a Venezuelan subsidiary. As an initial matter, bond creditors can try to attach these receivables, because the subsidiary has guaranteed PDVSA's bonds. Creditors without such a guarantee, however, cannot attach receivables without piercing the veil between these entities. Moreover, PDVSA's right to exploit Venezuelan oil reserves exists by the government's say-so. If the government were to transfer that right to a new entity, even bond creditors would have to persuade a court to let them pursue claims against the new entity's assets. Veil piercing is one of several theories they might invoke to do this.

As a second example, consider whether PDVSA creditors might like to hold Venezuela responsible for PDVSA's debts. Piercing the corporate veil between PDVSA and its government owner could help creditors avoid being bound by the result of a PDVSA bankruptcy. Moreover, while most Venezuelan bonds have CACs, PDVSA's creditors are not bound by these clauses; they could not be compelled to participate in a Venezuelan restructuring either. To be sure, creditors like these would be hard-pressed to find attachable Venezuelan assets. They could, however, disrupt the country's future access to capital and commercial markets by threatening to seize loan proceeds or other assets. 

For the most part, US courts resolve questions like these by simply borrowing the rules from corporate law. To us, this is odd. For one thing, the usual reasons for limiting a shareholder's liability for corporate debts don't seem very relevant when the shareholder is a foreign government. Among other reasons, because a foreign sovereign is entitled to sovereign immunity, it does not need to rely as heavily on corporate law principles to protect its assets. Moreover, many of the standard justifications for limited liability, such as ensuring liquid markets for corporate shares, have little relevance to entities like PDVSA.

Given the significance of oil exports to the Venezuelan economy, and the many entities involved in these trades, the Venezuelan debt crisis may require courts to think more deeply about veil piercing questions. (This article describes some of the basic facts.) One intriguing question is whether PDVSA's bond creditors can pierce the corporate veil separating PDVSA from Venezuela given the extensive disclosures in PDVSA's offering documents about the relationship between the company and its sole shareholder. Those disclosures make clear the country controls PDVSA, requires it to provide gas at subsidized domestic prices and to contribute to a variety of social funds, and in other respects uses PDVSA as a government cash machine. In the ordinary corporate context, a creditor might seize on facts like these to try to pierce the corporate veil. In the context of a state-owned entity, it isn't clear to us that such facts should matter at all, and that seems especially true when the facts are disclosed in advance to voluntary corporate creditors. But we will see. To return to the example of Argentina: courts have sometimes gone to great lengths to make foreign sovereigns come to terms with their remaining creditors.


While the legal doctrine surrounding sovereign veil-piercing is still developing, there is some precedent that provides insight into the current position of Venezuela. On the one hand, Federal Courts have consistently recognized the corporate doctrine in instances where “(1) a corporate entity is so extensively controlled by its owner that a relationship of principal and agent is created or (2) when recognition of the separate corporate form would work fraud or injustice.” First Nat’l City Bank v. Banco Para El Comercio Exterior de Cuba, 462 U.S. 611, 629 (2d Cir. 1984) (holding that “a foreign state instrumentality is answerable just as its sovereign parent would be if the foreign state has abused the corporate form, or where recognizing the instrumentality’s separate, status works as fraud or injustice”). On the other hand, every court that applies this doctrine continues to state that this is a fact circumstance analysis and the ultimate test is based on equitable principles. The Supreme Court has stated that there is a presumption that these instrumentalities are independent, but it can be overcome in circumstances where equitable principles weigh in favor of treating the independent entity as a sovereign nation itself.
Here, the determination of when to pierce the corporate veil is going to be in great part factual. PDVSA is a wholly subsidiary of Venezuela, which weighs in favor of veil piercing, as Venezuela has complete dominion over company. Additionally, Venezuela coordinates, monitors and controls all operations relating to hydrocarbons, suggesting that Venezuela is involved in the day-to-day operations of the company. On the other hand, the investors of PDVSA had clear disclosure in the bond of the fact that this was a wholly-owned subsidiary and that they were investing in the entity itself and not the government. While disclosure is important, fraud is not required. If you can demonstrate extensive dominion this appears to satisfy the first prong of the sovereign veil piercing test.

PDVSA's bondholders will not be the first of Venezuela's creditors to try to pierce the corporate veil of a domestic entity to reach the country's assets. In Transamerica Leasing, Inc. v. La Republica de Venezuela, 200 F.3d 843 (DC Cir. 2000), a creditor of state-owned Compañia Anonima Venezolana de Navegación (CAVN) brought suit against Venezuela to find that the country was liable for CAVN's debts. In that case, Venezuela "(1) owned a majority of CAVN's stock; (2) appointed the Board of Directors and the Chairman of the Board and President; (3) was involved in CAVN's “day-to-day” operations by overseeing the restructuring of CAVN's intermodal operations and approving the sale of three of CAVN's vessels; and (4) aided CAVN financially by allowing [a government-run fund] to enter into a trust agreement with CAVN; while (5) the President of CAVN, with apparent authority to bind Venezuela, assured one of the plaintiffs that the Government would support CAVN." Nonetheless, the DC Circuit found these facts were not enough to establish the amount of control necessary to overcome the presumption of independence of State instrumentalities.

Venezuela's relationship with PDVSA seems to follow along the same lines as its relationship with CAVN. Therefore, similar facts alone probably will not be enough to justify piercing PDVSA's corporate veil. Also, when it comes to PDSVA bonds, the extent of disclosures in the prospectus would make veil piercing even more difficult. While Venezuela in effect controlled the company through the board of directors, the question is whether this control was so extensive as to make PDSVA an extension of the state instead of a separately run entity overseen by the government. In order to overcome the presumption of separateness, we would need to show that Venezuela intervened in PDSVA affairs much more extensively than the legal framework would allow or much more than was disclosed in the prospectus.

In any case, while piercing the corporate veil can ensure that Venezuela's assets are fair game, we are somewhat skeptical that these creditors will have the same power as Argentina's holdout creditors to disrupt a future restructuring. The pari passu clause in the PDVSA bonds only ensures that each series will maintain the same ranking as "all other senior unsecured obligations of the Issuer [PDVSA] and the Guarantor [PDVSA's subsidiary]." It seems unlikely that a Court interpreting the meaning of this clause will find that it ensures that PDVSA's bonds shall have the same ranking as Venezuela's own bonds, since the contract defines the Issuer and the Guarantor restrictively. Piercing the corporate veil of a State instrumentality is an equitable remedy, and any Court would be significantly expanding the existing doctrine if they used it to change contract interpretation rules to expand the scope of the underlining pari passu clause. Nonetheless, if the Court takes a result-oriented approach to the case, PDVSA bondholders might be able to get a similar injunction to the one granted in NML v. Argentina, thereby preventing Venezuela from servicing its own bondholders without also reaching a deal with PDVSA's bondholders.

First National City Bank v Banco Para el Comercio Exterior de Cuba (Bancec) established that veil piercing can be used to establish joint liability if the entity is an ‘alter ego’ of a foreign government, or if failing to consider them jointly liable would lead to fraud or injustice.

Interestingly, many of the factors from Bancec for the first question seem to be unimportant in the instant case – given that it is fairly known that Venezuela exercised a good amount of control in a wide variety of aspects; with PDVSA being treated as a cash cow for the government, employee hiring being extremely political, massive donations being given to the government’s social and political projects, and its right to appoint PDVSA’s Board of Directors. As such, the court may find its decision hinging upon whether there is enough evidence to support that Venezuela was involved in day-to-day operations rather than generally in control. At least from the outside looking in, the vast extent of the control being exercised over every aspect of PDVSA makes it possible the court concludes there is a sufficient basis for a finding of day to day control.

As to the second, more interesting question, the fact that the contracts contained extensive disclosures as to PDVSA’s intricate relationship with Venezuela seems quite clear insofar the injustice/fraud inquiry. It will be difficult for investors to argue that Venezuela misled them barring any sort of additional findings indicating shady behavior not encompassed by the agreements. The exact relation these disclosures have with the control inquiry is tough to say. Investors seemed to be able to weigh the attendant risks of making this particular investment.

American courts have repeatedly emphasized the non-mechanical nature of the veil piercing inquiry at issue. It’s certainly possible given the fact that the oil assets in question are extremely valuable that the court chooses to consider this general sort of control as enough and prevent the possibility that Venezuela and PDVSA escape in any manner the enforcement of the claims against them. But it seems equally possible, if not more so, that a court will see this not as an injustice perpetrated by PDVSA or Venezuela, but as a situation where investors that made a poor and somewhat risky bet scramble to unfairly recoup potential losses on a decision made with what appears to be sufficient prior information.

The major reasons for respecting the separate judicial status between a foreign government and its instrumentality seem to be different from the purpose of limiting shareholders' liability in the corporate law context (such as facilitating innovation and ensuring liquid markets). That is, the U.S. courts presume the legally separate status in terms of "due respect for the actions taken by foreign sovereigns" and "principles of comity between nations" (Bancec), so that the foreign courts would not casually disregard the separation between the U.S. government and its instrumentalities. Even though foreign governments have the protection of sovereign immunity, it does not make the limited liability protection unnecessary because there should be a substantial difference between (a) legally not incurring liabilities and (b) incurring liabilities but being able to protect itself or its assets from foreign jurisdiction.

The U.S. courts would ignore such separate status if it is necessary "to avoid the injustice that would result from permitting a foreign state to reap the benefits of our courts while avoiding the obligations of international law." Bancec. In this regard, courts established largely two (or three) types of exceptions for the presumption of separate judicial status, that is, "agent-principal" (or "alter ego") exception and "fraud and injustice" exception.

With regard to the "agent-principal (alter ego)" exception, the court would pay much attention to (a) whether the government controls or is involved in the instrumentality's day-to-day operation or routine business decisions (Transamerica Leasing v. Venezuela; BCI Aircraft v. Ghana; Seijas v. Argentina) and (b) whether the assets and liabilities of the government and its instrumentality is commingled (Kensington v. Congo). In the precedent cases, the courts held that 100% ownership and appointment of directors are insufficient (Transamerica Leasing v. Venezuela); and government officials' serving as the board of directors is also insufficient (BCI Aircraft v. Ghana). In addition, the courts held that instrumentalities of states regularly carry out the states' policies without becoming an alter ego of the state (Seijas v. Argentina) but found an "alter ego" status when the instrumentality's assets and liabilities are so commingled with government's ones that accounting firm declined to render a fairness opinion. Kensington v. Congo). From these precedents, its seems that the courts rigidly apply the "agent-principal (alter-ego)" exception and pierce the veil only when (a) the control exercised by the government is so excessive that the instrumentality can be regarded as agent of the government, or (b) the assets and liabilities of the instrumentality are so entangled with the government's one that the entities can be regarded as one entity.

In this regard, the prior disclosure of the facts that would support the finding of “agent-principal (alter ego)” status would not, at least theoretically, affect this analysis because, as long as the actual authority (not apparent authority) is concerned, the principal should be liable for its agent’s acts regardless of whether those facts are disclosed in advance or not. Personally, such conclusion seems a bit strange from the perspective of original purpose of veil piercing in sovereign context (to avoid the injustice, as discussed above) or of the function of the equity relief. While I did not find any supporting precedents, I believe that, given the “extensive disclosures” in the offering circular, it is the bondholders’ fault to have refrained from requiring the guaranty

Here, it seems difficult or at least premature for me to support "agent-principal (alter ego") exception only with the information I have checked so far. As the precedents shows, Venezuela's 100% ownership in PDVSA, Venezuela's appointment of board of directors of PDVSA, and Venezuelan ministers' representation in the board of PDVSA are insufficient to find agent-principal relationship. In addition, PDVSA's contributions for social development and to FONDEN, PDVSA's selling of products at the price designated by Venezuela, and PDVSA's acquisitions and transfers of certain assets as instructed by the government could be insufficient to find alter ego status, because such transactions were properly addressed in PDVSA's financial statements and KPMG issued an unqualified fairness opinion (which shows that PDVSA supported carrying out of social policies but did not commingled its assets with government's ones). Having said that, subject to further research and fact findings, there still could be a chance to argue that Venezuela's involvement in PDVSA and the entanglement between Venezuela and PDVSA are more excessive than those found in the precedents where the veil piercing claim was declined. For example, while price controlling is typically a sovereign's right, designation of the price for each transaction, if any, could be regarded as an involvement in the day-to-day business. In addition, while the details of the transaction is unavailable, PDVSA's supply of oils and other products to perform Venezuela's obligation under the agreement executed by Venezuela (apparently with China) is suggestive that PDVSA works as agent or alter ego of Venezuela.

With regard to the "fraud and injustice" exception, the court would see whether the government abused a corporate form. For example, in Bridas v. Turkmenistan, the court held that “intentionally bleeding a subsidiary to thwart creditors is a classic ground for piercing the corporate veil.” In this regard, prior disclosure would affect the analysis, because the fact that investors are given an opportunity to make an informed judgement would prevent themselves from insisting abuse, fraud or injustice committed by the government.

Here, I did not find any facts so far that support Venezuela’s abuse of corporate form. The most recent offering circular indicates an interesting fact that CAMIMPEG, a Venezuelan company which has “the purpose of undertaking all lawful activities concerning oil services, gas and mining” and provide services to PDVSA in connection with the maintenance of oil wells and drilling rigs, has been established by Ministry of Popular Power for the Defense. I did not find the details of this transaction so far but, if some assets were transferred from PDVSA to CAMIMPEG in a manner detrimental to the financial status of PDVSA, it may be construed as “intentional bleeding” of PDVSA. In addition, while I have not found any precedents referring to this point so far, I’m interested in how the “fraud and injustice” exception is applied in the case where the owner of a corporation is also insolvent. In such case, the disadvantage caused by piercing veil would not finally be incurred by the owner itself, but the creditors of the owner would inflict the losses. Taking into consideration the fact that at least the bondholders of PDVSA should have enjoyed higher interest rate and yield to maturity as a return for taking greater risks as suggested in the offering circular, it would be unfair to put them in the same position as (if reverse veil piercing also apply) or in more favorable position than (if reverse veil piercing does not apply) the bondholders of Venezuela, who received lower return that PDVSA’s creditors. The situation is more similar to “substantive consolidation” under the bankruptcy law than to ordinary veil piercing case, in that the creditors of one entity benefit at the sacrifice of the other entity’s creditors and, thus, the factors to be considered in applying this exception could be different from usual veil piercing situation.

Building on the new rules of the sovereign debt game laid out by Argentina it could be argued that courts are now considering sovereign debt through the lens of contract law. In NML v. Argentina, 699 F.3d 246 (2d Cir. 2012), the Court took an extreme form over substance approach, focusing on the boiler plate language of the Pari Passu clause and made it an equal treatment provision so that Argentina could not subordinate its defaulted sovereign debt bond payments compared to the restructured sovereign debt. Prior to this ruling, the Pari Passu clause did not do much work in bonds.

So now with this new contracts focus in mind, if the PDVSA bonds disclosed in their offering documents the connections between Venezuela and PDSVA, then creditors should be concerned about all the traditional contract arguments stacking up against them. For example, from the ex-ante perspective, the creditors knew what they were purchasing as all of the risks were disclosed to them before they bought the bonds and they had the standard legal “duty to read”. Assuming they read, they knew what they were purchasing and the risks involved, and it was just unfortunate for the bondholders that the risks became reality. Now ex-post why should these creditors be treated equally to the Venezuela bondholders? What about "Caveat Emptor?" Why should we allow the PDVSA creditors to have access to the same pool of assets as the Venezuela creditors by piercing the corporate veil? They did not buy the same bonds, they knew what they had bargained for ex-ante, so why treat them the same ex-post?

When thinking about the possibility of sovereign veil piercing in this context, it might be instructive to focus on the aspect or aspects of veil piercing that could make the strongest case for overcoming a presumption of independence. In this case, creditors will most likely point to the type of state involvement or level of control. As the blog and preceding comments make clear through citation of precedent, overcoming this presumption presents a challenge for the creditors. But, this is not a foregone conclusion. A court may well find that Venezuela's involvement in PDVSA is unprecedented if creditors are able to find something that distinguishes PDVSA's relationship with Venezuela from seemingly analogous relationships in past cases. Just as the court in NML v. Argentina was able to work around the FSIA to grant an injunction against a sovereign, it is conceivable that, despite past decisions to the contrary, the court would use a similar rationale to justify its decision. While these two cases involve different enforcement mechanisms, they both deal with the same overarching concern for sovereign immunity. The question is whether creditors can make a strong enough case, given the facts surrounding Venezuela's undeniably pervasive involvement in PDVSA.

Furthermore, there are a couple more points worth thinking about. One is that CITGO notes offerings stated explicitly that Venezuela is not liable for CITGO’s debts. The same was not included in PDVSA bonds. The obvious question is why. Another point relates to disclosure. PDVSS disclosed its relationship with Venezuela in the bond offerings, including the level of “control,” an example of which is PDVSA’s obligation to contribute to social funds and programs. [As a sidenote, the amount of contribution might be a key factor in determining “control of PDVSA activities.” Creditors would have a very strong case if the amount of contribution of PDVSA was inversely related to the economic conditions in Venezuela: i.e contributions increased when the economy was slowing down. The strength of the creditors’ argument varies based on the formula used to determine these contributions.] Some say that given the above disclosure, piercing the veil will be difficult. Disclosure is used to allocate risks involved in a contract. But, at an extreme case, if a corporation disclosed that it was using the corporate form for its own benefit and to perpetrate fraud, this would not absolve it of liability. The fact that disclosure took place does not necessarily absolve the sovereign from liability if fraud/injustice is found to have been committed.

it is worth noting, not from a legal but from a market perspective, that the yield provided by PDVsa and Venezuela sovereign bonds is essentially identical: just look to the prices of PDVsa 2022 and Venezuela 2022, two bonds with equal coupon and usually trading at very similar prices.
Rightly or wrongly, the market estimates the risk of the oil company and of its sovereign owner to be one and the same.

The comments to this entry are closed.


Current Guests

Follow Us On Twitter

Like Us on Facebook

  • Like Us on Facebook

    By "Liking" us on Facebook, you will receive excerpts of our posts in your Facebook news feed. (If you change your mind, you can undo it later.) Note that this is different than "Liking" our Facebook page, although a "Like" in either place will get you Credit Slips post on your Facebook news feed.



  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless ([email protected]) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.