The Far-Reaching and Unintended Consequences of the State Corporation Commission’s Newly Granted Authority to Void Transactions Between Entities That Are “Substantially the Same” Pursuant to H.B. 2102 (2013)

In 2013, Virginia's General Assembly enacted House Bill 2102 ('HB 2102') which amended Virginia Code Section 8.9A-516. This bill has the potential to significantly alter secured transactions under the Uniform Commercial Code as in effect in Virginia ('UCC'). The amended statute authorizes the State Corporation Commission ('SCC') to determine, in its own discretion, whether an initial financing statement 'indicates that the debtor and the secured party are substantially the same person' and to remove that record from the index if the SCC makes such a determination.[1] The SCC is also authorized to remove a financing statement and have it considered retroactively void and ineffective if the filing office 'becomes aware that a record may have been wrongfully filed because it should have been rejected' because the debtor and the secured party are substantially the same person.[2]

One of the reasons that this provision is particularly troubling is that the SCC is afforded broad discretion to determine whether a debtor and secured party are 'substantially the same person.' To make such a determination, the SCC 'may review the record and relevant circumstances.'[3] An affidavit or other formal notice to the SCC from a competing creditor's legal counsel would appear to put the SCC on notice of such relevant circumstances. Even if the SCC issues a conservative interpretation of its discretionary power, the SCC in Virginia is quite independent and new SCC Commissioners could change the policy.[1] Va. Code Ann. § 8.9A-516(b)(8) now provides: (8) in the case of an initial financing statement or amendment communicated to the office of the State Corporation Commission, it appears to such office that the record: (A) is not created pursuant to this title; (B) is presented for filing for an improper purpose, such as to hinder, harass, or otherwise wrongfully interfere with a person or promote or conduct an illegitimate object or purpose; (C) is materially false or fraudulent; or (D) indicates that the debtor and the secured party are substantially the same person or that an individual debtor is a transmitting utility.[2] Va. Code Ann. § 8.9A-516(c)(3).[3] Id.

Given the potential breadth of the bill, business entities must now consider the risk that the SCC has the authority to consider (i) separate entities that are owned by the same person or persons or (ii) an entity which owns, or is owned by, another entity as 'substantially the same persons.' If so, the law now appears to give the SCC the authority to void a security interest in which those persons or entities are the debtor and secured party, even if the entities rigorously adhered to corporate formalities.

Even more troubling, the General Assembly neither defines 'substantially the same person' nor offers any guidance with regard to applying this standard. Though the ordinary meaning[1] and courts' interpretations of 'substantially the same'[2] indicate that two persons are substantially the same when they have the same essential features, it is not clear what features the SCC could consider 'essential' to a person.

Given this uncertainty, the application of corporate successor liability or corporate veil piercing principles might guide the SCC in determining what features are essential, and therefore which persons are substantially the same as one another.

The extent to which HB 2102 authorizes the SCC to disregard the distinctiveness of corporate entities is unprecedented because the language of the bill focuses on the extent of two entities' sameness alone and does not by its language require a showing of fraud or injustice, as in cases considering successor liability or piercing of the corporate veil. The statutorily required SCC's analysis ends with substantial sameness and nothing in the statute requires—or even authorizes—the SCC to consider other factors, such as the presence, or absence, of fraud or injustice. Accordingly, this section authorizes the SCC to void innocuous transactions that occur at arm's-length and do not indicate fraud or injustice based solely on the 'substantial sameness' of the creditor and debtor.

If the SCC or Virginia courts look to corporate successor liability jurisprudence when interpreting the phrase 'substantially the same,' they could focus on corporate formalities and look for organizational continuity.[3] On the other hand, the SCC could disregard corporate formalities and look to other factors like continuity in production, whether the entities manufacture the same products,[4] or whether the successor corporation completely assumed all of the assets and liabilities of its predecessor.[5] It is worth noting that Virginia's successor liability jurisprudence contains an arm's-length transaction exception: an entity is not liable as the successor to another corporation when the purchase of all the corporation's assets is a 'bona fide, arm's-length transaction.'[6] Thus, though selling and purchasing entities may have common officers, directors, and stockholders, a court will not hold the purchasing entity liable for the debts of the selling entity if the purchase was an arm's-length transaction.

The SCC may also borrow from corporate veil piercing jurisprudence to interpret the phrase 'substantially the same person' because by piercing the corporate veil, courts treat shareholders and corporations—entities which are legally distinct—as effectively the same person. Virginia courts have found that piercing the corporate veil is only justified 'when the unity of interest and ownership is such that the separate personalities of the corporation and the individual no longer exist and to adhere to that separateness would work an injustice.'[7] In other words, a plaintiff must show that the corporation is the 'alter ego, alias, stooge, or dummy' of the shareholders and that 'the corporation was a device or sham used to disguise wrongs, obscure fraud, or conceal crime.'[8] If the SCC applies the principles courts use to determine whether a corporation is the alter ego of its shareholders, the range of potential filings the SCC will void depends on how the SCC considers corporate formalities. If the SCC follows the lead of at least one Virginia court, it could find that an entity and its wholly owned subsidiary are substantially the same despite their adherence to corporate formalities.[9]

There are various options the General Assembly could take to remedy this problem. The General Assembly could simply remove the 'substantially the same person' language from subsection 516(b)(8)(D) altogether, which would then authorize the SCC to void filing statements that fall within current subsections 516(b)(8)(A)-(C), as well as those that indicate that an individual debtor is a transmitting utility. Such an amendment would accord with Virginia's traditional corporate liability jurisprudence and would still authorize the SCC to void filing statements that are fraudulent, materially false, or filed for an improper purpose.

In the alternative, the General Assembly could limit the SCC's authority by amending Section 8.9A-516(b)(8)(D) to include either an arm's-length transaction exception or injustice element. By including a bona fide, arm's-length transaction exception, the SCC would not be able to void legitimate transactions where a creditor and debtor may be substantially the same person, yet have engaged in a transaction with terms comparable to those which two substantially dissimilar persons would have reached.[10] Similarly, the General Assembly could add to Section 8.9A-516(b)(8)(D) a requirement that the SCC find that adherence to corporate distinctions would result in injustice.[11] By adopting either solution, the General Assembly would provide the SCC with an established reference point for interpreting those amended provisions: Virginia's corporate successor liability jurisprudence or veil piercing jurisprudence.

Finally, the General Assembly could simply combine subsection (D) with other subsections by changing the word 'or' to 'and' in subsection (C). Such an amendment would authorize the SCC to void filing statements only when it finds that the statement meets at least one criteria from current Sections 8.9A-516(b)(8)(A), (B), and (C) and also meets Section 8.9A-516(b)(8)(D). This would narrow the section's applicability by ensuring that the SCC could only void statements that are least likely to be part of legitimate transactions.[12]

The SCC might narrowly construe the phrase 'substantially the same person'; however, ultimately, the issue is not what the SCC will actually do by rule or regulation. Rather, it is what authority the General Assembly has now granted to the SCC and its impact on the business climate in Virginia. Until the General Assembly amends Section 8.9A-516(b)(8)(D), businesses cannot solely rely on corporate formalities to avoid the potential risk of having the SCC render their security interests void.

[1] Va. Code Ann. § 8.9A-516(b)(8) now provides: '(8) in the case of an initial financing statement or amendment communicated to the office of the State Corporation Commission, it appears to such office that the record: (A) is not created pursuant to this title; (B) is presented for filing for an improper purpose, such as to hinder, harass, or otherwise wrongfully interfere with a person or promote or conduct an illegitimate object or purpose; (C) is materially false or fraudulent; or (D) indicates that the debtor and the secured party are substantially the same person or that an individual debtor is a transmitting utility.'

[2] Va. Code Ann. § 8.9A-516(c)(3).

[3] Id.

[4] Webster's Third New International Dictionary 2280 (1966) (defining 'substantially' as 'in a substantial matter manner: so as to be substantial' and defining 'substantial' as 'important, essential').

[5] See, e.g., Bank of Chatham v. Arendall, 178 Va. 183, 190, 16, S.E. 2d 352, 355 (1941) (defining substantial as 'important; essential; material').

[6] Fish v. Amsted Indus., Inc., 376 N.W.2d 820, 824%u201125 (Wisc. 1985) (refusing 'to allow the successor corporation to escape liability when in substance the successor corporation was the same entity as the predecessor').

[7] See, e.g., Tift v. Forage King Indus., Inc., 322 N.W.2d 14, 17-19 (Wisc. 1982) (finding the corporation had 'substantially the same identity although transformed by merger, consolidation, etc.' as the sole proprietorship because the corporation had acquired all the assets of the business that the individuals had formed, had engaged in 'essentially the same manufacturing operation' as the prior business, and manufactured the same product as well).

[8] Clardy v. Sanders, 551 So. 2d 1057, 1058 (Ala. 1989) (finding that the successor corporation to the interests and liability of a sole proprietorship were substantially the same despite the difference in corporate formalities).

[9] Kaiser Found. Health Plan v. Clary & Moore, P.C., 123 F.3d 201, 205 (4th Cir. 1997); Harris v. T.I., Inc., 243 Va. 63, 70, 413 S.E.2d 605, 609 (1992).

[10] O'Hazza v. Exec. Credit Corp., 246 Va. 111, 115, 431 S.E.2d 318, 320-21 (1993) (citation omitted).

[11] Cheatle v. Rudd's Swimming Pool Supply Co., 234 Va. 207, 212, 360 S.E.2d 828, 831 (1987) (citation omitted).

[12] See Newport News Holdings Corp. v. Virtual City Vision, 650 F.3d 423, 429 (4th Cir. 2011); Dana v. 313 Freemason, 266 Va. 491, 587 S.E.2d 548 (2003).

[13] Section 8.9A-516(b)(8)(D) might be amended to read: 'indicates that the debtor and the secured party are substantially the same person or that an individual debtor is a transmitting utility, unless the filing resulted from an arm's-length transaction.' If the General Assembly wished to limit the application of an arm's-length transaction exception, it might place the burden of proof on the debtor and secured party. Such an amendment might read: 'indicates that the debtor and secured party are substantially the same person or that an individual debtor is a transmitting utility, unless the debtor and secured party demonstrate that the filing resulted from an arm's-length transaction.'

[14] The General Assembly might amend § 8.9A-516(b)(8)(D) to read: 'indicates that the debtor and the secured party are substantially the same person and that adherence to corporate distinctions between the debtor and secured party would work an injustice. . . . '

[15] Such an amendment might read: '(8) in the case of an initial financing statement or amendment communicated to the office of the State Corporation Commission, it appears to such office that the record: (A) (i) is not created pursuant to this title; (ii) is presented for filing for an improper purpose, such as to hinder, harass, or otherwise wrongfully interfere with a person or promote or conduct an illegitimate object or purpose; or (iii) is materially false or fraudulent; and (B) indicates that the debtor and the secured party are substantially the same person or that an individual debtor is a transmitting utility.'


The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2017.

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