Tuesday, March 21, 2017

Abolishing Veil Piercing Is for Legislatures, Not Courts

I write often about how courts often incorrectly treat LLCs as corporations.  Last week, I reported on a case about a court that misstated, in my view, the state of the law regarding LLCs and veil piercing.  When I do so, I often get comments about how veil piercing should go away. Prof. Bainbridge replies similarly here

I am on record as being open to the elimination of veil piercing (I am actually, at least in theory, working on an article tentatively called Abolishing Veil Piercing Without Abolishing Equity), and I am especially open to the idea of abolishing veil piercing with regard to contract-based claims.  (Texas largely does this by requiring "actual fraud" for cases arising out of contract. For a great explanation of Texas law on the subject, please see Elizabeth Miller's detailed description here.)

Several courts over the years, most notably the Wyoming court in Flahive, have extended the concept of veil piercing to LLCs, even where a statute did not explicitly provide the concept of veil piercing. Although I think these courts got it wrong, now that concept of veil piercing is well established for corporations and LLCs in virtually all (if not all) U.S. jurisdictions, I think any rollback must properly be done by statute. 

In the past, I have been critical of courts like the one in Flahive, because I agree with Prof. Bainbridge and others who argue that veil piercing, when not expressly stated, may well have not been intended.  Minnesota, for example, has at least made the concept clear. Minnesota LLC law provides: 

322B.303 PERSONAL LIABILITY OF MEMBERS AS MEMBERS.

Subdivision 1. Limited liability rule. 

Subject to subdivision 2, a member, governor, manager, or other agent of a limited liability company is not, merely on account of this status, personally liable for the acts, debts, liabilities, or obligations of the limited liability company.

Subd. 2. Piercing the veil.

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.  . . . .

Like most states, Minnesota courts are willing to pierce the corporate veil where (1) an entity ignores corporate formalities and serves as the alter ego of a shareholder and (2) enforcing the liability limitations of the corporate form leads to injustice or is fundamentally unfair. I have often used this example of how a state should, if they want to have LLC veil piercing, proceed. That is, although I would not advocate for doing so, if a state is going to have veil piercing of LLCs, it should be expressly stated. The statute may be flawed in concept, but that's a call for the legislature.  

The Minnesota statute is well crafted to achieve its apparent goals, in that it makes clear that one can, in fact, be "personally liable for the acts, debts, liabilities, or obligations of the limited liability company" merely on account of being a member of an LLC.  That is, the general rule is that members are not liable for the LLC's debts, but where an LLC veil is pierced, all members become personally liable for the debts, regardless of the their actions.  In Minnesota, this includes "corporate formalities" as a factor for corporate veil piercing and thus it applies to LLCs, even though LLCs have few, if any, statutory formalities (and many states disclaim formalities as an obligation to maintain limited liability for an LLC).  

This seems wrong to me, especially the part about making those who did not participate in the bad behavior potentially liable and adding a corporate-formalities requirement to an entity that is not supposed to have them.  As Prof. Bainbridge argues in Abolishing Veil Piercing,  "Abolishing veil piercing would refocus judicial analysis on the appropriate question-did the defendant-shareholder do anything for which he or she should be held directly liable."  I agree.  

Still, because veil-piercing of entities is well-settled law, I don't think judges have latitude to eliminate it. Judges must focus on proper limitations and clarity of the law that is still subject to interpretation (or plainly inconsistent with the law), where possible.  At this point, abolishing veil piercing must be done by statute. Maybe some bold legislators will heed the call.

http://lawprofessors.typepad.com/business_law/2017/03/abolishing-veil-piercing-is-for-legislatures-not-courts.html

Corporate Personality, Corporations, Joshua P. Fershee, LLCs | Permalink

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