Piercing the veil is a long-standing equitable remedy that can allow a claimant against a corporation to also assert the claim against a shareholder, under limited circumstances that usually involve some degree of wrongdoing or abuse of the corporate form. With the advent of LLCs, most states have also applied their existing law about veil piercing to LLCs. State laws about veil piercing vary quite a bit from state to state, and anomalous decisions crop up from time to time.
An outlier decision on veil-piercing was handed down earlier this year by the Massachusetts Appellate Division, in Kosanovich v. 80 Worcester Street Associates, LLC, No. 201201 CV 001748, 2014 WL 2565959 (Mass. App. Div. May 28, 2014). The court pierced the veil of a single-member LLC based on only one factor: the LLC’s failure to maintain business records.
Background. Milan Kosanovich entered into a purchase agreement to buy a condominium from 80 Worcester Street Associates, LLC (WSA). Jeffrey Feuerman was WSA’s manager and sole member, and signed the purchase agreement and a supplemental contract on behalf of WSA. One of the agreements required WSA to repair any defects in the condominium for up to one year after closing.
During the following year Kosanovich complained of numerous defects, and Feuerman responded to some but not all of the complaints. Kosanovich was not satisfied and later sued WSA and Feuerman for breach of contract, breach of an implied warranty of habitability, and violations of the Massachusetts Consumer Protection Act. A jury was waived, and at trial the judge ruled in favor of Kosanovich on his claims for breach of contract and breach of an implied warranty of habitability, and awarded him $9,000 in damages. The judge pierced WSA’s LLC veil and found Feuerman personally liable for the damages award. Id. at *2.
Appellate Division. The court first reviewed the basic veil-piercing rule: the corporate or LLC veil should only be pierced in rare situations, and only “for the defeat of fraud or wrong, or the remedying of injustice.” Id. at *2 (quoting Hanson v. Bradley, 10 N.E.2d 259, 264 (Mass. 1937)). The court should examine 12 factors in light of all the circumstances to determine if veil piercing is justified:
(1) common ownership,
(2) pervasive control,
(3) confused intermingling of business assets,
(4) thin capitalization,
(5) nonobservance of corporate formalities,
(6) absence of corporate or LLC records,
(7) no payment of dividends or distributions,
(8) insolvency at the time of the litigated transaction,
(9) siphoning away of corporation’s funds by dominant shareholder or member,
(10) nonfunctioning of managers, or officers and directors,
(11) use of the corporation or LLC for transactions of the dominant shareholders or members, and
(12) use of the corporation or LLC in promoting fraud.
Feuerman did not dispute that he had sole ownership and pervasive control of WSA, which according to the court is not enough to pierce the veil, standing alone. But the trial judge had also found that WSA’s records did not exist or were improperly kept. The only document submitted by Feuerman at trial was WSA’s certificate of formation. Feuerman admitted that he ran the business out of his house and his car and that he had no bookkeeping records, tax records or returns, checkbook, or records of payments to subcontractors. As he said, “it was a bit informal.” Id.
That was enough to pierce the veil, said the court. “Feuerman’s failure to maintain or produce records hindered the court’s ability to establish the twelve factors, including intermingling of assets, thin capitalization, and insolvency…. Feuerman’s failure to maintain business records coupled with his sole ownership and pervasive control of WSA supported the [trial] judge’s decision to pierce the corporate veil.” Id. at *3.
Comment. The court’s decision seems inconsistent with the basic rules the court itself cited. As the court said, piercing the veil is intended to remedy fraud, wrong, or injustice. But there was no evidence of any of those. One would have thought the burden of proof would have been on the party claiming that the LLC’s veil should be pierced. The court’s reliance on Feuerman’s inadequate record-keeping effectively placed on his shoulders the burden to prove that he was innocent of violating any of the other 12 factors.
Lawyers of course routinely advise their clients to adhere to the various formalities of running a business in the form of a corporation or LLC, and to maintain and keep adequate business and organizational records. This decision drastically underscores the need to follow the formalities and keep good records.