Piercing the Veil vs. Direct Member Liability in Connecticut
Claimants against LLCs often go beyond the LLC and seek recovery from individual members or managers of the LLC. They do that because in many cases, to quote Willie Sutton, that’s where the money is. The LLC may not be able to satisfy a claim, but a member or manager who turns out to be liable on the claim may have deeper resources to satisfy the claimant.
Under the state LLC statutes, a member or manager is not liable for the debts of the LLC simply by virtue of being a member or manager, but sometimes the circumstances can result in personal liability for a member or manager. Two recent Connecticut cases dealt with attempts to reach LLC members and managers.
Piercing the Veil. Last month the Connecticut Court of Appeals decided Breen v. Judge, 124 Conn. App 147, 2010 Conn. App. LEXIS 420 (Sept. 28, 2010). In 2006 Breen obtained a judgment against Patriot Truck Equipment, LLC for money loaned to the LLC. In 2007 Breen sued Judge, the managing member of the LLC, on grounds that the corporate veil of the LLC should be pierced in order to hold Judge personally liable for the LLC’s debt. The trial court denied the veil-piercing claim, and Breen appealed.
Usually an LLC is treated as a separate legal person, and its debts are separate from the debts of its members or managers. Piercing the veil is an exception that ignores the legal distinction between the LLC and its members or managers, with the result that a manager or member may be held liable for the debts of the LLC.
Connecticut law allows an LLC’s veil to be pierced under either the “instrumentality test” or the “identity test.” To pierce the veil under the instrumentality test, the plaintiff must show that (1) the defendant completely dominated the LLC’s finances, policies, and business practices, (2) the defendant used that control to commit fraud, waste or a dishonest or unjust act, or to violate a legal duty, and (3) the defendant’s conduct caused the injury or loss complained of. Breen, 2010 Conn. App. LEXIS 420, at * 7-8.
The court listed ten factors relevant to whether an entity is dominated or controlled, and reviewed the relevant factors considered by the trial court. At all times Judge was no more than a 50% owner of the LLC. The LLC was a properly formed company doing business in Connecticut. The LLC followed the various entity-related formalities, such as keeping separate books, filing company tax returns, and filing dissolution documents when it dissolved. The LLC operated a truck-outfitting business with increasing sales for each of its first three years, although it ultimately failed. Based on those factors the court found that neither the instrumentality test nor the control test was satisfied, and therefore affirmed the trial court’s decision not to pierce the LLC’s veil.
Breen is a good example of what an LLC and its members and managers should do to avoid a pierced veil and personal liability for the LLC’s debts. It’s not rocket science: have a legitimate business, properly form the LLC, keep books and records, file tax returns, don’t use the LLC’s bank account as the member’s personal checkbook, and so on.
Tort Claims. Piercing the veil is not the only way a creditor can reach the members or managers of an LLC. The Connecticut Supreme Court in August decided a case where the plaintiff raised tort claims against an LLC member: Sturm v. Harb Dev., LLC, 298 Conn. 124, 2010 WL 3306933 (Aug. 31, 2010). (A tort is an actionable, civil wrong, such as negligently or intentionally causing harm to someone. Examples include negligently causing an auto accident, fraud, and breach of a fiduciary duty. A party injured by a tort may be able to recover damages from the tortfeasor if requirements such as causation and proof of damages are satisfied.)
Harb Development, LLC built a home for Mr. and Mrs. Sturm. The Sturms were unhappy with the result and sued both the LLC and John Harb, a member of the LLC. The Sturms asserted violations of the Connecticut Unfair Trade Practices Act, negligence in the construction of their home, violations of the Connecticut New Home Construction Contractors Act, and fraudulent and negligent misrepresentation.
Harb asserted that the Sturms’ claims against him arose from his membership and management of the LLC and were fundamentally the same as their claims against the LLC. Harb pointed to Conn. Gen. Stat. § 34-133(a), which provides that an LLC member or manager is not liable for the LLC’s debts “solely by reason of being a member or manager.” He argued that therefore the Sturms were required to plead facts adequate to pierce the LLC’s veil in order to state a valid claim, and that they had failed to do so. The trial court agreed and dismissed all claims against Harb in his individual capacity. Harb, 298 Conn. at 129.
The Sturms emphasized on appeal that their claims against Harb were tort claims based on his own actions, that he was personally liable in tort despite being a member or manager of the LLC, and that therefore it was not necessary to pierce the veil to establish his personal liability.
The Supreme Court reviewed the well-trodden case law on the tort liability of an LLC member or manager. Members and managers are not personally liable for the LLC’s torts merely because of their status as a member or manager. But if they commit or participate in the tort, or direct the LLC’s tortious act, they will be liable even if the LLC is also liable. Id. at 132-33. Nowhere in the prior cases was the injured party required to show that the LLC’s veil should be pierced in order to allow recovery against a manager or member who personally participated in or directed the LLC’s tortious act.
The court found Harb’s reliance on Conn. Gen. Stat. § 34-133(a) to be unfounded. The Connecticut LLC Act only excludes liability for the LLC’s debts “solely by reason of being a member or manager.” Conn. Gen. Stat. § 34-133(a) (emphasis added). The court concluded that the statute was not intended to preclude the common-law, individual liability of members or managers who participate in wrongful conduct, and that therefore the trial court improperly denied the claims against Harb for the plaintiffs’ failure to plead the elements of a veil-piercing claim. Harb, 298 Conn. at 137-38.
Harb’s attempt to transmute the Sturms’ tort claim against him into a veil-piercing claim was imaginative, although ultimately unsuccessful. This tactic likely reflects a recognition that piercing the veil is difficult and less predictable than proving a tort claim. As the Breen court said, “Ordinarily the corporate veil is pierced only under exceptional circumstances.” Breen, 2010 Conn. App. LEXIS 420, at *9 (quoting Naples v. Keystone Bldg. & Dev. Corp., 295 Conn. 214, 233, 990 A.2d 326 (2010)). Not only are exceptional circumstances usually required, but predicting the outcome of a veil-piercing case is challenging. As Peter Oh recently indicated in the abstract to a research paper, here, “Exactly when the veil of limited liability can and will be circumvented to reach into a shareholder’s own assets has befuddled courts, litigants, and scholars alike.”
LLC Manager Is Personally Liable for LLC's Failure to Pay State Agency, Without Piercing the Veil
The sole manager of a Michigan limited liability company has been held potentially liable for the LLC’s failure to pay assessments due under the Michigan Agricultural Commodities Marketing Act (ACMA). Dep’t of Agric. v. Appletree Mktg., L.L.C., No. 137552, 2010 WL 841173 (Mich. Mar. 10, 2010). The case illustrates that an LLC’s liability shield is not absolute – an LLC manager can be personally liable for some types of nonpayment by the LLC.
The ACMA established the Michigan Apple Committee to carry out marketing programs funded by assessments on apple distributors. Distributors are required to deduct a portion of the purchase prices they pay to apple producers, and to hold the funds in trust and remit them to the Committee. Mich. Comp. Laws § 290.651 et seq.
Appletree Marketing, L.L.C. withheld the required amounts from its payments to apple producers in 2004 and 2005, but failed to remit those amounts to the state. The LLC instead used the funds to pay other debts, and later became insolvent and defunct. The state sued the LLC and Steven Kropf, the LLC’s manager, to recover the unpaid assessments.
The trial court entered judgment against the LLC for the unpaid amounts, but dismissed the state’s claim against Kropf on grounds that the state’s ACMA remedy against the LLC was exclusive. Michigan’s Supreme Court reversed, holding that the ACMA explicitly preserved all other lawful remedies, including claims for common law conversion and statutory conversion. The court then examined the issue of Kropf’s potential personal liability.
Under the ACWA, the funds withheld by the LLC were held intrust for the Committee. When the LLC used those funds for other purposes, it asserted dominion and control over the Committee’s money and therefore committed the tort of conversion.
To decide whether the state could pursue claims for common law and statutory conversion against Kropf, the court looked to existing Michigan law:
Michigan law has long provided that corporate officials may be held personally liable for their individual tortious acts done in the course of business, regardless of whether they were acting for their personal benefit or the corporation’s benefit.
Appletree, 2010 WL 841173, at *7. Corporate officers may be held individually liable when they cause the corporation to act unlawfully. Id.
Kropf participated in the tort by causing the LLC to divert the Committee’s funds to other purposes. Although the prior case law involved officers of corporations, the court applied those cases to the LLC’s manager without discussion, apparently by analogy.
The court made clear that this was not a case of piercing the veil of the LLC. “However, we have never required that a plaintiff pierce the corporate veil in order to hold corporate officials liable for their own tortious misconduct, and thus it is unnecessary to pierce the corporate veil in this case.” Id.
The court concluded that Kropf could be personally liable if the facts established the necessary participation: “There is no question that, if the facts prove either common law or statutory conversion, Kropf can be held personally liable and may not hide behind the corporate form in order to prevent liability for his active participation in the tort.” Id. Because the claim against Kropf had been dismissed on summary judgment, the court remanded the claim against Kropf back to the trial court for further proceedings.
Business people use limited liability companies to shield themselves from personal liability for the companies’ debts and obligations. But the shield is not impenetrable, as Appletree shows.
Normally an LLC manager is not personally liable merely because the manager caused the LLC to breach a contract; breach of contract is not a tort. The contract, however, can establish a relationship where the conduct constituting breach of contract also constitutes a tort.
Assume the parties agree that an LLC will receive property and hold it in trust, or hold it as a bailee. If the LLC misappropriates the property and refuses to return it to the other party, it has probably committed the tort of conversion. Then, the LLC manager who caused the LLC to convert the property will be personally liable for the tort.
Tort remedies can sting. For example, under Michigan’s conversion statute, a person damaged because of another’s theft, embezzlement or conversion may recover three times the amount of actual damages plus costs and reasonable attorneys’ fees. Mich. Comp. Laws § 600.2919a.
Appletree involved an intentional tort by the LLC, but claims against managers can also occur in negligence cases. Sometimes injured parties claim that an LLC manager’s inadequate supervision and management resulted in the company’s negligent injury to the plaintiff. The law is less clear here, although in many of these cases courts do hold managers liable for acts and omissions related to supervision and management. But that’s a discussion for another day.
