Tuesday, August 29, 2017

More Corporate LLCs and Phantom Veil Piercing

And so it continues:

In a recent case in the United States District Court, District of Columbia, a court messes up the entity (referring to one of the parties as “Howard Town Center Developer, LLC, is a limited liability corporation (‘LLC’)") and also does a fine job of improperly stating (or really, failing to state) the law for veil piercing. 

I took the initiative to pull the initial complaint and the answer to see if either of the parties were responsible for calling the LLC a corporation. Both sides properly referred to the LLC as a “limited liability company,” so it appears the corporation reference is a court-created issue.

In the case, a property developer brought action to require a university landowner to reinstate a ground lease and development agreement between developer and university, after the university sent notices of termination. The University counterclaimed to recover unpaid rent. The court determined, among other things, that the university was entitled to the damages it sought of $1,475,000 for unpaid rents and to attorney fees related to the developer's breach of a ground lease and development agreement. But the opinion doesn’t stop there.

It is quite clear that the developer LLC does not have the funds to pay the judgment, so the question of whether the LLC’s veil could be pierced was also raised.  The court, I think properly, determined that “a targeted asset or individual must be named before veil-piercing may be considered.” Howard Town Ctr. Developer, LLC v. Howard U., CV 1075 (BAH), 2017 WL 3493081, at *56 (D.D.C. Aug. 14, 2017). The court continued: “The University should not lament, nor the Developer celebrate, that conclusion, however, on the erroneous assumption that the University has waived its right to veil-piercing in this matter.” Id.  

The court then determined that, because of “considerations of justice and equity,” the university could later seek a veil-piercing action if it were unable to satisfy its judgment. “Any such action will be fairly straightforward given the instant decision, including the Court's observations regarding the inadequacy of the Developer's capitalization . . . and the University may then be entitled to the additional discovery it presently seeks.” Id.

 Wow.  That’s some heavy dicta.  First, the court never states what the rule is for veil piercing an LLC, so it is a pretty bold assertion to say veil-piercing will be “straightforward.” Is the sole test adequate capitalization? What does that mean?  And what is that test? Well, the court gives us an explanation in footnote 22:

The Developer's status as an inadequately capitalized shell company is an ongoing demonstration of bad faith. LLCs are a legitimate corporate form, and the societal benefits of such entities are significant. Dickson testified that the use of such entities in transactions like this one is “typical[ ],” explaining that “single-asset entities are established as borrowers” so that “the borrower[ ] contains one asset,” the advantage from a “liability standpoint” being that “on a transaction of this size, the asset couldn't be pulled into bankruptcy.” Trial Tr. Day 7 AM at 49:25–50:7. Yet, even a single-asset entity must be capitalized to the extent necessary to satisfy its obligations to the project it was created to support. See Lawlor v. District of Columbia, 758 A.2d 964, 975 (D.C. 2000) (noting inadequate capitalization as factor in determining whether a given entity's corporate form should be respected). Consequently, abuse of the corporate form to render a company judgment-proof is impermissible and reflects bad faith.

Um, no.  First, the LLC is not a corporate form. And an entity not being able to pay its debts is not, in and of itself, a showing of bad faith.  Otherwise, what’s the point of limited liability? The court seems to think that being judgment proof because of a lack of funds is not allowed. But it is specifically allowed. If there is fraud or deception, that is not allowed. But an inability to pay the bills is not, alone, at all improper.  It is unfortunate, and perhaps awful, but it is not improper. 

Ultimately, it may be that veil piercing could be justified under DC law, but first, we’d need to know what that law is.  And it should be clear that it is LLC-veil-piercing law that is to be applied, and not the “corporate” veil piercing this court has apparently relied upon.  Once again, I will repeat my call for courts to state specifically the law (and the test) they are applying in LLC-veil-piercing cases, explain why the factors of the test are appropriate in the LLC setting, and then apply that test. 

Instead, the court suggests that veil piercing is essentially inevitable, which could have a strong role in forcing a settlement. This language amounts to phantom veil piercing.  The court never stated a veil-piercing test, never ran the test, and yet, there it is: the specter of a pierced limited liability veil. 

The court seemed frustrated with the developer, and that may be well founded.  Maybe the developer committed fraud. Maybe the developer and other representatives made binding promises that should make them all guarantors. The case also suggests that there may be an argument for enterprise liability among some of the entities mentioned.  And those are all issues that should have been considered.  But none of them are veil piercing claims, and if the court is going to go down that road, the court needs to be more precise to ensure justice and equity prevail.  

http://lawprofessors.typepad.com/business_law/2017/08/more-corporate-llcs-and-phantom-veil-piercing.html

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

Comments

Yes, this case is unsettling in a number of respects, including either the judge's or the law clerk's inattention to detail. Moreover, surely DC has a fine LLC statute that just might be worth consulting in the context of the relationship of the members of the LLC to the LLC's debts or, procedurally, whether a member and the LLC can even be parties in the same third-party lawsuit. Certainly many LLCs that may be great business citizens start out with an office that is a checkbook on the hood of a car and a bank account funded with the minimum required to open an account. Undercapitalization at any particular stage, absent fraud, is largely dispositive of nothing.

Posted by: Craig Sparks | Aug 30, 2017 8:39:07 AM

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