Preparing for Questions About CUSO Separateness

By Brian Lauer

There are many reasons why a credit union would invest in a Credit Union Service Organization (CUSO) instead of providing the same services directly through the credit union. These reasons may be that the CUSO is a collaboration of several CUSOs to create economies of scale, that it would be too cost prohibitive to initiate the service from the ground up, or that a credit union would not be permitted to perform the service itself like insurance services. One enticing reason to invest in a CUSO is to shield the credit union from the liability associated with the services by moving operations into a CUSO.

This shield has also become important recently because the National Credit Union Administration (NCUA) is questioning the sufficiency of this limitation by stating that CUSOs are creating systemic risk to the credit union industry.  However, the only way CUSOs can cause systemic risk to credit unions is if a credit union investor does not maintain this shield and opens itself up to the liabilities of the CUSO.  As you can see in Part 712 of the NCUA regulations, this means ensuring that the CUSO is a separate entity from the credit union in the eyes of the legal system preventing third party creditors from attaching the obligations of the CUSO to its credit union owners. If a CUSO does not maintain this separateness, a court may grant a creditor this ability, which is often called “piercing the corporate veil.” The decision to pierce the corporate veil by a court is not black and white. Instead, a judge or jury will look at many factors and weigh each of those factors to determine if the veil should be pierced. Although this doctrine is driven by state law and may be slightly different from state to state, the factors used by the courts in most states are substantially similar. 

Before we discuss the factors generally analyzed by the courts, it is important to note why a creditor would feel it necessary to pierce the corporate veil, and as usual, it all comes down to money. Generally, a creditor of the CUSO will seek payment directly from the CUSO for the CUSO’s obligations, but what if the CUSO cannot meet its obligations (i.e. it does not have the money)? A creditor may look through the CUSO to its owners with the objective of getting paid. So, even though a credit union may invest in a CUSO to shield the credit union from the liability of a particular service, a third party creditor of the CUSO may try to break down that barrier to get paid, and as I have said, if it appears to a court that the CUSO is not a separate entity from its owners, the court may not honor this limitation of liability.

This is why one of the most important factors analyzed by a court is capitalization of the CUSO.
A CUSO must be adequately capitalized to meet the reasonably foreseeable obligations of the services provided by such CUSO. This takes the form of both capital infusion and reasonable errors and omissions and/or general liability insurance. If a creditor is trying to pierce the corporate veil, my first guess would be that the entity was not capitalized and insured to meet the present obligations upon it. However, the creditor must show that these obligations were reasonably foreseeable and not extraordinary. Simply not having the capital or insurance to pay every single third party claim is not enough to pierce the veil. It must be shown that the third party claim is a reasonable byproduct of conducting the business of the CUSO. It is also important to note that this is just one factor considered by a court and that not having adequate capital and insurance alone may not be enough to pierce the veil. Obviously, there are many instances where companies become insolvent and this alone is not a license to dig into the pockets of its owners.

The remaining factors deal mostly with the operations of the CUSO. Essentially, the question is whether the CUSO is formally operating as a separate entity. Your CUSO must keep accurate books and records which should include meeting minutes and resolutions of the Board. Furthermore, the CUSO must have a distinct governing body that can be comprised of employees of the credit union, but must act on their own accord. It is also important that the management of the CUSO not be controlled by a majority of the board of directors of the credit union because this gives the impression that the CUSO is merely a department of the credit union. The CUSO’s funds should not be intermingled with the credit union’s funds or misappropriated by an owner. Although this seems like common sense, this may be an issue with CUSOs owned solely by one credit union. You must ensure that the CUSO and credit union have separate operating accounts and that any exchange of funds between the two is formalized in writing and for fair consideration.  Similarly, the CUSO should have separate policies and procedures.  These can emulate those of a credit union but should be formally adopted by the Board of the CUSO.

As you can see, many of these corporate formalities can be handled through good books and records documenting the operations of the CUSO. There is also one document that relates specifically to examinations and corporate separateness that is incredibly important. For every CUSO investment, the NCUA requires the investor credit union to obtain an attorney opinion letter stating that the CUSO is a separate entity. To draft such a letter, the attorney will review the CUSOs books and records to ensure that the company is maintaining the corporate shield.  For examination purposes, this is very important to have on file, but I think it is also important to think about in this current climate. Many companies and credit unions are having trouble, and many creditors are less and less likely to write down losses. This is leading to a lot more litigation, and that litigation is definitely touching the credit union world. You should take the time to think about these issues so that you feel more comfortable with your CUSO and the limitation of liability I am sure the credit union believes it has.
Brian G. Lauer is a partner with Messick & Weber PC in Media, PA. He can be reached at 610- 891-9000 or blauer@cusolaw.com

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