Confusion in Venezuela; Alter Egos in Delaware

Confusion reigns. Venezuela might plan to default, but maybe it's just pretending so it can buy bonds back on the cheap. Then again, it could be a "giant money laundering operation." If there are restructuring talks, U.S. investors can attend, and listen. Except that the talks will likely be hosted by a drug "kingpin," and investors can't have any "transactions or dealings, directly or indirectly" with that person. And don't ask whether PDVSA's late(ish?) payment was a credit event, or what the CDS payout will be on bonds that have experienced a credit event despite having been paid in full.

Thankfully, the law is clear, right? Here's PDVSA motion to dismiss the lawsuit Crystallex has filed in federal court in Delaware, alleging that PDVSA is Venezuela's alter ego and seeking to enforce an arbitration award against the government by attaching PDVSA's equity stake in the ultimate U.S. parent of CITGO. Here's a summary of the arguments the parties have made thus far. The case matters, first, because if successful Crystallex will sever PDVSA's indirect ownership stake in CITGO. It also matters because, as we've discussed here repeatedly, any debt restructuring will implicate questions of alter ego liability. For instance, many restructuring proposals begin by urging Venezuela to withdraw PDVSA's right to exploit oil reserves, so as to better insulate oil-related assets from creditors. This short article explains some of the issues of alter ego liability raised by these and other proposals.

Actually, the law is a bit of a mess. In the normal corporate context, elaborate, multi-factor tests determine whether a corporation's liabilities can be imputed to other entities or to shareholders. Many of the factors seem entirely unrelated to the purposes underlying the rule of limited liability--which include encouraging investment (by shareholders) and enabling access to credit (for corporations). For instance, a corporation would have difficulty borrowing if lenders had to worry that a shareholder's creditors would make claims against firm assets. (That's exactly what Crystallex wants to do here.) A good reason to disregard the separate legal status of a corporation is because failing to do so will undermine important policies underlying other laws, such as those governing creditor priorities. For example, it makes sense to pierce the corporate veil when a shareholder strips the corporation of assets needed to pay creditors, because the shareholder is trying to invert the normal priority scheme, in which shareholders are last in line. Multi-factor tests aren't very helpful in making these kinds of judgments.

These tests make even less sense when applied to corporations owned by foreign governments. In this context, the important underlying policies are set by the law of foreign sovereign immunity. There's an argument that courts should more readily pierce the corporate veil (i.e., impute corporate liabilities to a government shareholder) when it appears the government has removed substantial assets from the corporation. In such cases, the government's actions circumvent a fundamental bargain struck by the law of sovereign immunity: That foreign governments and their entities can access U.S. commercial markets, but only by placing at risk commercial assets related to these activities. Stripping a state-owned corporation of its assets, while relying on the entity protections offered by the corporate form, is contrary to this bargain. For what it's worth, I'll add that the consequences of veil piercing are often not that extreme, because the law of sovereign immunity will continue to protect the government's non-commercial assets (and even, in many cases, commercial assets without a nexus to the liability-generating activity).

Crystallex, however, isn't trying to pierce the corporate veil. It wants to impute the government's liabilities to PDVSA. Here, there's reason for caution. For one thing, state-owned corporations, like other corporations, need access to credit on reasonable terms. Considerations of comity (and the desire to protect U.S. businesses operating abroad) likewise suggest that courts should proceed cautiously.

In general, my view is that a finding of alter ego liability is most appropriate when the government uses the corporation to shelter assets that the law of foreign sovereign immunity would otherwise have made available to the government's own creditors. Thus far, however, Crystallex's case against PDVSA has turned largely on generic allegations of government control. To be sure, there's extensive evidence that Venezuela has interfered with, and even dominated, PDVSA. What's unclear is just how this domination harmed Crystallex. The most relevant evidence Crystallex cites is that Venezuela transferred the mining interests expropriated from Crystallex to PDVSA, for no consideration. Like much the government does these days, that's bad, in some broader sense. But Crystallex does not explain how the transfer materially worsened its position as a creditor of the government. Without such a showing, the case for alter ego liability seems thin to me. Crystallex has a reply brief due on November 22. Perhaps we'll see more of its argument there.