Tuesday, October 15, 2013

You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One

Early this month, the United States District Court for the Middle District of Pennsylvania decided Gentex Corp. v. Abbott, Civ. A. No. 3:12-CV-02549,  (M.D.Pa. 10-10-2013).  The outcome of the case is not really objectionable (to me), but some of the language in the opinion is. As with many courts, this court conflates LLCs and corporations, which is just wrong.  The court repeatedly applies “corporate” law principles to an LLC, without distinguishing the application.  This is a common practice, and one that I think does a disservice to the evolution of the law applying to both corporations and LLCs.

I noted this in a Harvard Business Law Review Online article a while back:

Many courts thus seem to view LLCs as close cousins to corporations, and many even appear to view LLCs as subset or specialized types of corporations. A May 2011 search of Westlaw’s “ALLCASES” database provides 2,773 documents with the phrase “limited liability corporation,” yet most (if not all) such cases were actually referring to LLCs—limited liability companies. As such, it is not surprising that courts have often failed to treat LLCs as alternative entities unto themselves. It may be that some courts didn’t even appreciate that fact. (footnotes omitted).

To be clear, though, Pennsylvania law applies equitable concepts, such as piercing the corporate veil, to LLCs.  Still, courts should not discuss LLCs as though they are the same as corporations or improper outcomes are likely to follow.  When dealing with LLCs, the concept should be referred to as “piercing the LLC veil” or “piercing the veil of limited liability.”  Instead, though, courts tend to discuss LLCs and corporations as equivalents, which is simply not accurate.

By way of example, the Gentex court states:

Helicopterhelmet.com's principal place of business is in South Carolina, while Helicopter Helmet, LLC is a Delaware corporation with its principal place of business also in South Carolina.

 Gentex Corp. v. Abbott, 3:12-CV-02549, 2013 WL 5596307 (M.D. Pa. Oct. 10, 2013) (emphasis added).  It is not!  It is a Delaware LLC!

Further, the court says:

 From the record, it does not appear that Helicopter Helmet LLC was anything less than a bona fide independent corporate entity, or that Plaintiff intends to allege as much. 

Id. (emphasis added).  Again – no.  An LLC is NOT a corporate entity.  It is as, Larry Ribstein liked to say, an uncorporation.  In fact, I would argue that Pennsylvania law, in Title 15, is called Corporations and Unincorporated Associations for a reason. Chapter 89 of that title is called Limited Liability Companies.

In fairness to Judge Brann, who wrote the Gentex opinion, Pennsylvania courts have merged the concepts of LLC and corporate veil piercing in other cases, even when discussing the differences between the two.  In Wamsley v. Ehmann, C.A. No. 1845 EDA 2009 (Pa. Super. Ct. Feb. 28, 2012), summarized nicely here, the court explained:

These factors [for determining whether to pierce the veil] include but are not limited to: (1) undercapitalization; (2) failure to adhere to corporate formalities; (3) substantial intermingling of corporate and personal affairs; and (4) use of the corporate form to  perpetrate fraud. [citing Village at Camelback Property Owners Assn. Inc.] . . .

Certain corporate formalities may be relaxed or inapplicable to limited liability corporations and closely held companies. Advanced Telephone Systems, Inc., supra at 1272. An LLC does not need to adhere to the same type of formalities as a corporation. Id. (finding lack of financial statements, bank accounts, exclusive office space, and tax returns was not evidence of failure to adhere to corporate formalities because entity was LLC with limited scope). In fact, the appropriate formalities for an LLC “are few” and, depending on the purpose of the LLC, it may not need to be capitalized at all. Id. Moreover, not all corporate formalities are created equal. Id. at 1279. To justify piercing the corporate veil, the lack of formalities must lead to some serious misuse of the corporate form. Id. 

Okay, got that?  The rules that apply to corporations apply to LLCs.  Except when they don’t because LLCs are sometimes different.  To justify piercing the “corporate veil,” then, an LLC must have seriously misused the corporate form, even though an LLC is a distinct form from the corporation. This is not especially helpful, I am afraid. 

Veil piercing is difficult enough to plan around, and the seemingly random nature of veil piercing is often noted (with some, such as Prof. Bainbridge, arguing that we should do away with it altogether).  There has not been much of a move to abolish veil piercing, and there hasn't even been much progress to make the standards for veil piercing more clear. Still, given the prevalence of LLCs, it’s high time courts at least help LLC veil piercing law evolve into murky standards specifically designed for LLCs.  That doesn’t seem like too much to ask.  

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Comments

I cite to hundreds of veil piercing cases in my LLC treatise and, although few or none call LLCs corporations, most or all apply corporate principles to LLCs. Some statutes (eg, Colorado) do so as well. I am not convinced that there is an LLC-specific problem that requires LLC-specific solutions. Other than perhaps loosening the rules concerning single member LLCs (and the like) formed for asset protection purposes only, but that is a different question. Bill

Posted by: Bill Callison | Oct 16, 2013 8:37:38 AM

I don't mean to overstate the problem, yet I do think that, at a minimum, there should be LLC-specific rules relating to the "failure to adhere to corporate formalities" prong of any LLC veil-piercing tests. Providing a potential cause of action based on failure to follow corporate formalities in an LLC is, to me, inconsistent with the general concept of LLCs. Even if there are minimum formalities an LLC must follow, it seems clear to me they different than those required of a corporation, and that much, at least, should be clear.

Posted by: Joshua Fershee | Oct 21, 2013 5:53:49 AM

I suppose I can understand what you mean about how LLCs should be treated versus corporations. LLCs aren't meant to be treated under the same rules as corporations. Doing so seems more restrictive than the LLCs should have to commit to. My impression of LLCs is that they are formed significantly smaller than an average corporation. As a result, there doesn't really need to be 'veil piercing' on the magnitude of a corporation because it's overkill for an LLC. As you said, there should be rules set on a level appropriate for LLCs, not corporations. Doing so seems fair for everyone involved in the ownership and management of such companies.

Posted by: Tonya Eley | Nov 1, 2013 5:09:25 PM

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