Another State Pierces the Veil to Reach Managers
Courts will “pierce the corporate veil” to allow creditors of an LLC to assert claims against the LLC’s owners, in a proper case. Marc Ward recently discussed just such an LLC veil-piercing case, in which the U.S. District Court for the Eastern District of Michigan upheld an LLC creditor’s claim against the single member of the LLC.
There are far fewer cases where the LLC’s veil is pierced to allow an LLC’s creditors to reach a non-member manager or officer of the LLC. I recently discussed such a case from Colorado, in which the court held that a manager could be held personally liable for the LLC’s breach of contract even though the manager was not a member, here. Sheffield Servs. Co. v. Trowbridge,No. 08CA0059, 2009 WL 1477003 (Colo. App. May 28, 2009).
Now another state court has held that an LLC’s claimants can pierce the veil and assert their claims against those involved in the management and operation of the LLC, even if the managers are not members. Equity Trust Co. v. Cole, 766 N.W.2d 334 (Minn. Ct. App. 2009).
Equity Trust was a consolidation of eight lawsuits. One hundred and seventy-eight plaintiffs sued a myriad of corporations, LLCs and individuals on theories of breach of fiduciary duty, breach of contract, misrepresentation, conspiracy, civil theft, and violations of the Minnesota Consumer Fraud Act and the Minnesota Securities Act. The plaintiffs alleged a large-scale real estate investment fraud scheme, orchestrated by the individual defendants. Default judgments were entered against the entities, and the plaintiffs sought to pierce the veil and hold the individual defendants personally responsible for the default judgments.
The court’s veil-piercing analysis considered the corporations and LLCs together, without distinguishing one type of entity from the other. The court did not discuss Minnesota’s LLC Act, but its analysis was consistent with the statute. The Act applies the corporate rules on veil piercing to LLCs: “The case law that states the conditions and circumstances under which the corporate veil of a corporation may be pierced under Minnesota law also applies to limited liability companies.” Minn. Stat. § 322B.303 (2008).
The court first applied an alter-ego analysis and found many of the alter-ego factors to be present, including insufficient capitalization, failure to observe entity formalities, insolvency at the time of the transactions, siphoning of funds by those owning or controlling the entity, and the absence of corporate records. Equity Trust,766 N.W.2d at 339. The court then examined the second prong of the test, whether piercing the veil is necessary to avoid injustice or fundamental unfairness. This prong was easily satisfied, “[c]onsidering that the entities were operated in furtherance of a large-scale real estate fraud scheme.” Id. at 340, 341.
The individual defendants argued that the corporate and LLC veils should not be pierced because the individuals were not shareholders or members of the entities. The court held to the contrary: “If veil piercing were solely dependent on a party’s ownership interest in an entity, unscrupulous parties could avoid personal liability under the doctrine by simply acting in a capacity that does not involve ownership.” Id. at 339.
Equity Trust, like Sheffield, involved non-members who dominated and controlled the LLCs, disregarded the LLCs, and used LLC funds for their own individual purposes. In both cases the courts held that in those circumstances equity would intervene and pierce the veil to avoid injustice or fundamental unfairness.
What can managers and owners of an LLC do to forestall the LLC’s creditors from piercing the veil and reaching the assets of the owners and managers? In short, follow the golden rule: If you don’t want the LLC to be disregarded, don’t disregard it yourself. Some specifics are:
- Observe the state LLC filing requirements. These usually include the initial certificate of formation, an annual report, keeping an up-to-date agent for service of process, and paying the state’s annual fee. In most states, failure to comply will ultimately result in the dissolution and termination of the LLC.
- Have a written operating agreement and comply with its requirements for meetings, approvals and other formalities.
- Keep adequate business and accounting records.
- Maintain the records required by the state’s LLC Act. For example, Washington requires that an LLC maintain at its principal place of business the following:
(a) A current and a past list of each member and manager;
(b) A copy of its certificate of formation and all amendments thereto;
(c) A copy of its current operating agreement and all amendments, and a copy of any prior agreements;
(d) Unless contained in its certificate of formation or operating agreement, a written statement of:
(i) The amount of cash and a description of the agreed value of the other property or services contributed or promised by each member;
(ii) The requirements for any additional contributions agreed to be made by each member; and
(iii) Any right of any member to receive distributions which include a return of all or any part of the member’s contribution.
(e) A copy of the LLC’s federal, state, and local tax returns and reports, if any, for the three most recent years; and
(f) A copy of any financial statements of the LLC for the three most recent years.
- Adequately capitalize the LLC. (The courts recite this factor, but unless the Company is grossly undercapitalized or the LLC Act’s limits on distributions are violated, it should not normally have much weight in contract cases, since creditors can adjust credit terms when extending credit. It may be given more weight when tort claims are involved.)
- Keep separate bank accounts for the LLC. Do not commingle personal funds and LLC funds.
