One of the most common issues I see in my practice is small business owners who are facing litigation against their LLCs and who assume that, because they set up an LLC, their personal assets are automatically protected. Unfortunately, that is not always the case. There are exceptions to the limited liability offered by an LLC or even an “S corp” that every small business owner should know about. Following a few basic steps and understanding the theories courts use to impose personal liability could help maintain the distinction between you, as an owner of the LLC, and the LLC itself. In the long run, this could help you avoid personal liability for activities conducted in the name of the LLC.
An LLC is recognized by the courts as a distinct entity, separate and apart from the members who comprise the ownership. The courts, however, have developed a theory, commonly referred to as “piercing the corporate veil,” to impose liability on individual members when the owners of an LLC appear to be using the LLC solely as a means to avoid personal liability or operating the LLC as a shell company. For example, in ORX Resources, Inc. v. MBW Exploration, L.L.C.,[1] the court ruled that a member of an LLC was personally liable for the debts of an LLC because the member “operated [the LLC] as his alter ego” based on the fact that the LLC was not yet in existence when certain contracts were signed on its behalf, that it never had a bank account, and that debts of the LLC were paid by the member individually and by another LLC controlled by the member.
The court noted that while members of an LLC are generally not personally liable for the debts of the LLC, third parties can bring claims against members and managers individually in certain situations, such as when fraud is present. Courts in Louisiana analyze the following factors to determine if a member of an LLC may be held liable for the debts and obligations of the LLC under an alter ego/veil piercing theory:
· Was there commingling of corporate and shareholder funds;
· Did the LLC fail to follow statutory formalities for incorporating or organizing and transacting corporate affairs
· Was the LLC undercapitalized
· Did the LLC have separate bank accounts and bookkeeping records
· Did the LLC hold regular corporate meetings.
The court in ORX wrote that “one of the primary components which justifies piercing the veil is often present: to prevent the use of the corporate form in the defrauding of creditors.” The member who was sued in ORX basically operated the LLC as a shell entity and, according to the court, “tried to avoid paying a legitimate debt of the LLC.” After reviewing the facts of that case, the court ruled that the corporate veil of the LLC could be pierced and that the member was personally liable for the debts of the LLC.
There are some simple and basic lessons a small business owner can take away from the ORX case. First, always treat the LLC (or other corporate entity) as just that – a separate entity, with its own bank accounts, insurance, records and dealings. Commingling of personal and corporate funds is one of the most common ways small business owners unintentionally expose themselves to personal liability.
Second, follow basic corporate formalities: file the necessary documents with the Secretary of State, obtain the required occupational and professional licenses, if applicable, and hold regular owner/shareholder meetings, keeping minutes of the meetings and preparing short corporate resolutions or member consent documents for decisions made on behalf of the company. Third, when transacting business on behalf of the LLC, always indicate that you are doing so solely in your capacity as a member or manager of the LLC.
Failing to do so blurs the line between you and the company and could be used against you on an alter ego/veil piercing claim. Following these easy steps won’t guarantee that you won’t get sued one day, but you’ll be much better prepared and more protected if it does happen.
An LLC is recognized by the courts as a distinct entity, separate and apart from the members who comprise the ownership. The courts, however, have developed a theory, commonly referred to as “piercing the corporate veil,” to impose liability on individual members when the owners of an LLC appear to be using the LLC solely as a means to avoid personal liability or operating the LLC as a shell company. For example, in ORX Resources, Inc. v. MBW Exploration, L.L.C.,[1] the court ruled that a member of an LLC was personally liable for the debts of an LLC because the member “operated [the LLC] as his alter ego” based on the fact that the LLC was not yet in existence when certain contracts were signed on its behalf, that it never had a bank account, and that debts of the LLC were paid by the member individually and by another LLC controlled by the member.
The court noted that while members of an LLC are generally not personally liable for the debts of the LLC, third parties can bring claims against members and managers individually in certain situations, such as when fraud is present. Courts in Louisiana analyze the following factors to determine if a member of an LLC may be held liable for the debts and obligations of the LLC under an alter ego/veil piercing theory:
· Was there commingling of corporate and shareholder funds;
· Did the LLC fail to follow statutory formalities for incorporating or organizing and transacting corporate affairs
· Was the LLC undercapitalized
· Did the LLC have separate bank accounts and bookkeeping records
· Did the LLC hold regular corporate meetings.
The court in ORX wrote that “one of the primary components which justifies piercing the veil is often present: to prevent the use of the corporate form in the defrauding of creditors.” The member who was sued in ORX basically operated the LLC as a shell entity and, according to the court, “tried to avoid paying a legitimate debt of the LLC.” After reviewing the facts of that case, the court ruled that the corporate veil of the LLC could be pierced and that the member was personally liable for the debts of the LLC.
There are some simple and basic lessons a small business owner can take away from the ORX case. First, always treat the LLC (or other corporate entity) as just that – a separate entity, with its own bank accounts, insurance, records and dealings. Commingling of personal and corporate funds is one of the most common ways small business owners unintentionally expose themselves to personal liability.
Second, follow basic corporate formalities: file the necessary documents with the Secretary of State, obtain the required occupational and professional licenses, if applicable, and hold regular owner/shareholder meetings, keeping minutes of the meetings and preparing short corporate resolutions or member consent documents for decisions made on behalf of the company. Third, when transacting business on behalf of the LLC, always indicate that you are doing so solely in your capacity as a member or manager of the LLC.
Failing to do so blurs the line between you and the company and could be used against you on an alter ego/veil piercing claim. Following these easy steps won’t guarantee that you won’t get sued one day, but you’ll be much better prepared and more protected if it does happen.
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