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Implications of the Third Circuit’s Crystallex Decision

posted by Mark Weidemaier

Mark Weidemaier & Mitu Gulati

On Wednesday, the Third Circuit granted Venezuela a victory in its ongoing settled-but-not-settled litigation with Crystallex. The case deals with a limited issue: Whether Delaware law imposes liability for the fraudulent transfer of an asset on an entity that is not itself a debtor.  We want to use this post to speculate a bit about the implications the decision may have for the bigger Venezuelan debt drama. If the new decision is important, it is because it signals something about the receptivity of US courts toward claims that Venezuela, PDVSA, and perhaps US entities like CITGO are “alter egos.” We disagree a bit about that question. But first, some background on this aspect of the Crystallex case.

Crystallex holds a judgment against Venezuela for over $1 billion and has been looking for ways to collect. The case is in an odd limbo, in that there has been a settlement, which Venezuela does not appear to be paying. (Perhaps it’s sending Crystallex chocolates.) Plus, the settlement calls for payment in installments, and Venezuela may stop paying even if it pays now. In any event, many of Crystallex’s legal theories can be replicated by other creditors, especially the claim that PDVSA is Venezuela’s alter ego. If successful, that claim would allow Crystallex to seize PDVSA’s assets (if not protected by sovereign immunity). In the U.S., those assets consist of shares in PDV Holding, the ultimate parent company of CITGO Petroleum.

Before the settlement-not-a-settlement, Venezuela proclaimed that it had no intention to pay Crystallex and similar creditors with judgments against the government. Because it’s a sovereign government, Venezuela’s assets are protected (but not absolutely) by sovereign immunity. Its assets are also protected by the corporate form, because assets held by state-controlled entities like PDVSA, and ultimately CITGO, belong to those entities, not to the government itself. If a creditor succeeds on an alter ego theory, these legal barriers between entities dissolve.

In any event, Venezuela was concerned that its creditors, or creditors of PDVSA, would go after CITGO. So it decided to extract as much wealth from CITGO as possible. According to Crystallex (though few dispute this), Venezuela did this by causing CITGO to issue $2.8 billion in bonds and then to pay the proceeds out as a dividend.

The Third Circuit’s decision deals only with PDVH’s liability to Crystallex under Delaware law. Upset that Venezuela had siphoned wealth from CITGO, Crystallex alleged that the dividend payment was a fraudulent transfer under Delaware law. In a purely formal sense, of course, the transfer was almost exactly the opposite of a typical fraudulent transfer, in that it involved a transfer of assets to the debtor from a non-debtor. But of course, the practical effect was to stiff the government’s creditors. That’s because they have no practical ability to recover money held by Venezuela. Their only realistic hope is to seize assets held by other entities in the U.S. And that, again, requires them to prove that these entities are Venezuela’s alter egos or otherwise liable for its debts.

Although the district judge had ruled in Crystallex’s favor, the Third Circuit, by a 2 to 1 vote, reversed. The majority held that a non-debtor can’t be liable for a fraudulent transfer under Delaware law. PDV Holding is a non-debtor precisely because no court has found it to be Venezuela’s alter ego; in fact, Crystallex didn’t allege (much less prove) the contrary. The dissent would have affirmed the district court, on the theory that a non-debtor’s transfer of property at the direction of a debtor (Venezuela) violated Delaware law.  

What does all this mean for future alter ego or veil piercing cases? Here, we disagree a bit. In a nutshell, Mitu wonders if the Third Circuit decision might be a signal that veil piercing claims face a tough uphill climb under Delaware law. Delaware, as the court points out in its decision, is a jurisdiction that takes corporate formalities seriously. And certainly Venezuela’s conduct was shady here; all judges seem to acknowledge that it essentially directed these transfers. If that isn’t enough to impute liability to a legally-separate entity, future litigants will need to come up with something even stronger. He agrees (with Mark!) that veil piercing and similar theories should work differently in the sovereign context. 

Mark thinks that's just nuts. No, actually he shares the view that creditors will have a hard time convincing courts to disregard the separate legal status of the U.S. entities (though an easier time with respect to PDVSA). But he doesn’t read very much into the Third Circuit’s decision. Without credible alter ego allegations against PDVH, the Third Circuit would have to expansively interpret Delaware fraudulent transfer law, which plays a key role in all kinds of cases, usually not involving sovereign governments.

In any event, it is odd that a case that has ostensibly been settled continues to produce new law and to be actively litigated. Which brings us back to a question that we and others have asked before: What exactly is the point of this settlement?


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