Tuesday, March 14, 2017

Perpetuating the Hot Mess of LLC Veil Piercing Law

A new case, out just yesterday from the Southern District of Ohio, makes a mess of LLC veil piercing law. It appears that the legal basis put forth by the court in granting a motion to dismiss a veil piercing claim was probably right, but the statement of veil piercing law was not quite there.  

The case is ACKISON SURVEYING, LLC, Plaintiff, v. FOCUS FIBER SOLUTIONS, LLC, et al., Defendants., No. 2:15-CV-2044, 2017 WL 958620, at *1 (S.D. Ohio Mar. 13, 2017).  Here are the parties: the defendant is FTE Networks, Inc. (FTE), which filed a motion to dismiss claiming a failure to state a claim. FTE is the parent company of another defendant, Focus Fiber Solutions, LLC (Focus). The plaintiff, Ackison Surveying, LLC (Ackison) filed  a number of claims against Focus, added an alter ego/veil piercing claim against FTE. Thus, Ackison is, among other things, seeking to pierce the veil of an LLC (Focus). Focus appears to be a Pennsylvania LLC, based on a search here.

Pennsylvania law provides the liability cannot be imposed on a member of an LLC for failing to observe formalities. The law states: 

The failure of a limited liability partnership, limited partnership, limited liability limited partnership, electing partnership or limited liability company to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground for imposing liability on a partner, member or manager of the entity for a debt, obligation or other liability of the entity.
15 Pa. Stat. and Consol. Stat. § 8106 (2017). 
 
However, the S.D. Ohio court states that a threshold question of whether an LLC's veil can be pierced includes an assessment of the following factors: 
(1) grossly inadequate capitalization,
(2) failure to observe corporate formalities,
(3) insolvency of the debtor corporation at the time the debt is incurred,
(4) [the parent] holding [itself] out as personally liable for certain corporate obligations,
(5) diversion of funds or other property of the company property [ ],
(6) absence of corporate records, and (7) the fact that the corporation was a mere facade for the operations of the [parent company].
ACKISON SURVEYING, LLC, Plaintiff, v. FOCUS FIBER SOLUTIONS, LLC, et al., Defendants., No. 2:15-CV-2044, 2017 WL 958620, at *3 (S.D. Ohio Mar. 13, 2017) (alterations in original). 
 
The opinion ultimately find that the complaint made only legal conclusions and failed to provide any facts to support the allegations of the LLC as an alter ego of its parent corporation, and further determined that a proposed amended claim was equally lacking.  As such, the court dismissed FTE from the case.  This conclusion appears correct, but it still suggests that, in another case, one could support a veil piercing claim against an LLC by showing that the LLC's "failure to observe corporate formalities," formalities it may have no legal obligation to follow.  
 
This remains my crusade. When courts get cases like this, they should (at a minimum) provide a clear veil piercing law for LLCs that accounts for the differences between LLCs and corporations.  I keep saying it, again and again, and I will keep beating the drum. If state law allows for LLC veil piercing, then fine, but get the law right. LLCs and corporations provide limited liability for their residual interest holders, but they are not the same entity. You Can’t Pierce the Corporate Veil of an LLC Because It Doesn't Have One, but the LLC does have a limited liability veil.  In cases such as these, courts should take the time make the law clearer so that future courts can stop applying the incorrect standards.  And lawyers bringing such cases could help, too, by framing their claims and responses appropriately.  Please.  

http://lawprofessors.typepad.com/business_law/2017/03/perpetuating-the-hot-mess-of-llc-veil-piercing-law.html

Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink

Comments

Hi Josh,

The real answer here is not just to drop failure to observe corporate formalities from the piercing an LLC list, but also to drop this irrelevant factor from piercing the corporate veil lists altogether.

Posted by: Franklin Gevurtz | Mar 14, 2017 8:08:36 PM

Thanks for the comment. I am inclined to agree, but I can see some courts getting squeamish about changing the law (legislators should do that). But, at least where state laws like Pennsylvania make clear liability is not to be imposed on LLC members for an entity not following formalities, there should be no stare decisis problem. But yes.

Posted by: Joshua Fershee | Mar 15, 2017 5:21:30 AM

I do not know whether my comment posted or I deleted, so here may be redundancy.
One wonders whether the litigators raised the protective statute. Pa law seems clear, as stated in legis history: Corporate formalities reflect statutory mandates. Formalities in the governance of limited partnerships, in contrast, derive for the most part from the agreement among the partners. From a policy perspective, disregarding formalities adopted by agreement differs substantially from disregarding formalities imposed by law. Under this section, disregard of formalities will never be a factor in piercing the veil of an unincorporated entity even if there are other factors that support piercing the veil of the entity.
Also, bear in mind that this was a motion to dismiss, and did not go deeply into substantive law. Decision seems more or less a cut and paste job.
Other states, incl Colo, say not "in itself" a basis for piercing, and IMHO could couple with other factors in piercing case. I doubt courts will ever give much clarity. I have many pages of piercing cites in my LLC book, and I doubt any are models for clarity. Equity and clarity may not mix too well.

Posted by: Bill Callison | Mar 15, 2017 8:58:19 AM

Bill, thanks for reposting. I did not get two of them, so I am glad to have your input. I agree with the concern that "[e]quity and clarity may not mix too well." As such, veil piecing law is like to remain murky, which is one of the problems I have with it generally. However, for courts not to remove the factor of "corporate formalities" for LLCs, especially in the face of a statutory intent not allow liability on such a basis, seems contrary to equitable principles. Thanks for the thoughts.

Posted by: Joshua Fershee | Mar 15, 2017 9:20:24 AM

I agree with you re formalities. My point was only that I do not think this court went to substantive law since it was on motion to dismiss and dismissal was granted. FWIW I may try to push for tighter version of Colo LLC Act when next we amend it.

Posted by: Bill Callison | Mar 21, 2017 9:27:00 AM

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