Tuesday, May 13, 2014

More LLC Veil Piercing Forced into State Statutes

The Supreme Court of Appeals of West Virginia recently had the opportunity to address the role (if any) of veil piercing in West Virginia LLCs.  The state statute is silent on the subject, but the court determined veil piercing was there, anyway.  It was close, though, as the West Virginia Circuit Court took on the following question with the corresponding answer: 

Does West Virginia's version of the Uniform Limited Liability Company Act, codified at W. Va. Code § 31B el seq., afford complete protection to members of a limited liability company against a plaintiff seeking to pierce the corporate veil?

ANSWER: YES

 Kubican v. The Tavern, LLC, 2012 WL 8523515 (W.Va.Cir.Ct.)

Under West Virginia LLC law:

[T]he debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, are solely the debts, obligations and liabilities of the company. A member or manager is not personally liable for a debt, obligation or liability of the company solely by reason of being or acting as a member or manager. . . . The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.

 W. Va. Code § 31B-3-303 [1996].

 The Supreme Court of Appeals of West Virginia recently took the certified question and disagreed, determining that veil piercing is permitted in LLCs in the state. Kubican v. The Tavern, LLC, 752 S.E.2d 299, 313 (W. Va. 2013) (pdf here). There are legitimate arguments on both sides of this issue, so it was proper for the court to answer the question.  The reasoning behind the court’s decision, though, is not very satisfiying. 

The Supreme Court explained, in the syllabus, the law on veil piercing for corporations, as follows:

[T]o ‘pierce the corporate veil’ in order to hold the shareholder(s) actively participating in the operation of the business personally liable ..., there is normally a two-prong test: (1) there must be such unity of interest and ownership that the separate personalities of the corporation and of the individual shareholder(s) no longer exist (a disregard of formalities requirement) and (2) an inequitable result would occur if the acts are treated as those of the corporation alone (a fairness requirement).” Syllabus point 3, in part, Laya v. Erin Homes, Inc., 177 W.Va. 343, 352 S.E.2d 93 (1986).

 For LLCs, the court eliminates the “disregard of formalities requirement” in part one, but kept the rest of the corporate veil-piercing test the same.  The court provided:

 To pierce the veil of a limited liability company in order to impose personal liability on its member(s) or manager(s), it must be established that (1) there exists such unity of interest and ownership that the separate personalities of the business and of the individual member(s) or managers(s) no longer exist and (2) fraud, injustice, or an inequitable result would occur if the veil is not pierced.

The problem, of course, is that part one of the LLC test is the same as that of the corporate veil piercing test, minus the explanation that part one is “the disregard of formalities requirement.”  The court is comfortable saying that the veil piercing test: 

is a fact driven analysis that must be applied on a case-by-case basis, and, pursuant to W.Va. Code § 31B–3–303(b) (1996) (Repl. Vol. 2009), the failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business may not be a ground for imposing personal liability on the member(s) or manager(s) of the company.

However, now that the “unity of interest and ownership” test no longer looks at corporate formalities and looks simply to other factors to make the determination.  The court notes the nineteen factors that can be used in corporate veil-piercing cases, like undercapitalization, commingling of funds, etc., and explains that similar considerations may apply for LLCs. The court is right to point out that other states have made the same determination on similar statutes, but that doesn’t clearly make those decisions correct. See, e.g., Bainbridge, Abolishing LLC Veil Piercing (pdf here).  In addition, West Virginia’s veil-piercing test under Laya stated more clearly than other states have that corporate formalities are the main issue for the unity of interest test. 

Courts continue to look to veil piercing to rectify harms such as commingling of funds or using entity funds for personal endeavors.  This does not inherently warrant veil piercing. Instead, courts can find such uses of funds fraudulent transfers or improper uses of entity funds that the member needs to pay back. That is not veil piercing; that is simply requiring the member to put back in the entity that which was wrongfully withdrawn. 

Further, there are other arguments that can be made to hold LLC members liable for the entity’s debts. If the members pay directly the bills for the entity, it may be that the members have become guarantors for the entity.  In the Kubican case, the allegation was that the members used the entity credit cards for things like visits to the chiropractor, dinners, and even a trip to Myrtle Beach.  Again, though, if true, all of those funds should be returned to the entity to pay any claims the plaintiff is awarded from the LLC, but it does not need to be that the limited liability veil must be disregarded in full. 

It is at least an open question whether the West Virginia legislature intended to preserve veil piercing for LLCs. The often cited Flahive case in Wyoming determined it was a mere oversight of that state’s legislature to provide veil piercing in the LLC context expressly.  Since then, though, states have shown they know how to include LLC veil piercing by statute (see, e.g., Minnesota: Minn. Stat. § 322B.303(2) (2003) & North Dakota: N.D. Cent. Code § 10-32-29(3)).  If the legislature determines that veil piercing is proper in LLCs, then so be it. Until then, though, courts should ensure entity funds are available for entity debts, but they should also be far more willing to follow the statute as written and respect the unique nature of LLCs

http://lawprofessors.typepad.com/business_law/2014/05/more-llc-veil-piercing-forced-into-state-statutes.html

Business Associations, Corporations, Joshua P. Fershee, LLCs | Permalink

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