Tuesday, March 29, 2016
Wyoming has added two new sections to its Code Section 17-29-304, which is related to veil piercing of a Wyoming LLC. The additions are a response of a court decision from last year, Green Hunter Energy, Inc. v. Western Ecosystems Technology, Inc., No. S-14-0036, 2014 WL 5794332 (Wyoming Nov. 7, 2014), which is summarized nicely here. The first added section provides:
(c) for purposes of imposing liability on any member or manager of a limited liability company for the debts, obligations or other liabilities of the company, a court shall consider only the following factors no one (1) of which, except fraud, is sufficient to impose liability:(i) Fraud;(ii) Inadequate capitalization;(iii) Failure to observe company formalities as required by law; and(iv) Intermingling of assets, business operations and finances of the company and the members to such an extent that there is no distinction between them.
Although some might view this as a significant change to the veil piercing of a Wyoming LLC, this largely confirms and clarifies the law prior to GreenHunter. The rule from that case was set forth as follows:
The veil of a limited liability company may be pierced under exceptional circumstances when: (1) the limited liability company is not only owned, influenced and governed by its members, but the required separateness has ceased to exist due to misuse of the limited liability company; and (2) the facts are such that an adherence to the fiction of its separate existence would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity.
GreenHunter Energy, Inc. v. W. Ecosystems Tech., Inc., 2014 WY 144, ¶ 27, 337 P.3d 454, 462 (Wyo. 2014).
The GreenHunter court provided the above rule, then stated that several factors could be considered in assessing whether both prongs of the test were met. These factors included fraud, inadequate capitalization, and intermingling of assets. "No single category, except fraud, alone justifies a decision to disregard the veil of limited liability; rather, there must be some combination of them, and of course an injustice or unfairness must always be proven." GreenHunter Energy, 2014 WY 144, ¶ 34, 337 P.3d at 464.
This amendment, in fact, adds another factor courts can consider in LLC veil piercing: "Failure to observe company formalities as required by law." As such, this law clarifies the state LLC law, which is an improvement over the prior iteration, in my view. I do have a concern that some courts might miss that the need for "company formalities" as a potential factor for veil piercing is limited only to the formalities that are "required by law," which also means very few such formalities. "Company formalities" are not "corporate formalities," and I hope courts remember this.
In addition, the Wyoming legislature added:
(d) In any analysis conducted under subsection (c) of this section, a court shall not consider factors intrinsic to the character and operation of a limited liability company, whether a single or multiple member limited liability company. Factors intrinsic to the character and operation of a limited liability company include but are not limited to:(i) The ability to elect treatment as a disregarded or pass-through entity for tax purposes;(ii) Flexible operation or organization including the failure to observe any particular formality relating to the exercise of the company’s powers or management of its activities;(iii) The exercise of ownership, influence and governance by a member or manager;(iv) The protection of members’ and managers’ personal assets from the obligations and acts of the limited liability company.
This section is, to me, spot on. GreenHunter did not disabuse the notion of using tax classification as a factor in veil piercing analysis, and that was wrong. Tax status is irrelevant to limited liability (a general partnership is a pass-through entity) and using any factors of an LLC acting like an LLC is inherently flawed.
Overall, if the state is going to allow veil piercing of LLCs, then I support a more clear statute. This is an improvement over the original statute, which did not include veil piercing, but Wyoming courts allowed it anyway. Still, the better read on GreenHunter, is not really veil piercing, it would have been some version of enterprise liability, though I know some people think it has to be veil piercing when the entities in questions are vertically related, and reserve enterprise liability for horizontal relationships. I don't agree, but that's for another post.
[H/T: Kentucky Business Entity Law]