The Washington LLC Act prohibits an insolvent LLC from making a distribution to a member. RCW 25.15.235(1). Either type of insolvency will do – the LLC is unable to pay its debts as they come due in the usual course of business, or the LLC’s liabilities exceed the fair value of its assets. Furthermore, a member who receives such an unlawful distribution and who knows at the time that the LLC is insolvent, “shall be liable to [the] limited liability company for the amount of the distribution.” RCW 25.15.235(2).
How does this rule play out when a third party makes a claim against the LLC? I had always assumed that in this scenario a court would allow an LLC’s creditor to assert the claim against the distribution-receiving member as well, probably by piercing the LLC’s veil. But the analysis of the Washington Court of Appeals in a recent case turned out to be a little more complex.
In Shinstine/Assoc. LLC v. South-N-Erectors, LLC, No. 39277-1-II, 2010 Wash. App. LEXIS 1976 (Wash. Ct. App. Aug. 31, 2010) (unpublished), the defendant LLC stipulated to a judgment in favor of the plaintiff Shinstine for $127,850.58. Shinstine also sought to hold the LLC’s sole member, Roger Hicks, personally liable for Shinstine’s judgment against the LLC. Shinstine claimed the LLC made an improper distribution to Hicks that rendered the LLC insolvent and therefore violated RCW 25.15.235. The trial court agreed and pierced the LLC’s veil, holding Hicks personally liable for Shinstine’s judgment against the LLC.
The Court of Appeals began its analysis with the proposition that generally LLC members and managers are not personally liable for the LLC’s obligations. RCW 25.15.125(1). The Act provides an exception, however: “Members of a limited liability company shall be personally liable for any act, debt, obligation, or liability of the limited liability company to the extent that shareholders of a Washington business corporation would be liable in analogous circumstances.” RCW 25.15.060.
The Shinstine court looked to a case that involved an unlawful corporate distribution, Block v. Olympic Health Spa, Inc., 24 Wn. App. 938, 604 P.2d 1317 (1979), rev. denied, 93 Wn.2d 1025 (1980). In Block, the court had held that an insolvent corporation’s distribution to its sole stockholder and president, who was well aware of the company’s insolvency, did not require piercing the corporation’s veil. Block, 24 Wn. App. at 950. (The corporate rule when a shareholder knowingly receives an unlawful distribution from an insolvent corporation is similar to the LLC rule: the shareholder is liable for return of the distribution to the corporation. RCW 23B.08.310.)
The court in Block refused to pierce the veil because to do so would have allowed the plaintiff to secure a preference over the other creditors of the corporation. Block, 24 Wn. App at 950. The Block court’s reasoning was persuasive to the Shinstine court: “To hold otherwise would permit creditors to get a preference over other creditors otherwise prohibited by law.” Shinstine, 2010 Wash. App. LEXIS 1976 at *12-13. The Shinstine court applied the Block rule and reached the same result on the same reasoning – it held that the LLC’s veil would not be pierced to allow Shinstine’s claim to reach Hicks.
Was Shinstine left with no recourse? Apparently not. The court stated in a footnote:
Shinstine was not without remedy. Without disregard Shinstine could have had a receiver appointed pursuant to RCW 7.60.025(1)(c), which permits any party to request appointment of a receiver after a judgment in order to give effect to the judgment. The receiver could have sought reimbursement from Hicks or South-N-Erectors’ behalf if the distribution was in violation of RCW 25.15.235(1), and then pay those funds to Shinstine.
Id. at *13 n.5. My litigation colleagues tell me that receivers indeed can be appointed under this statute, for this purpose, but counsel for the plaintiff must go to court and make the necessary showing for appointment of the receiver. Doable, but not simple.