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As discussed in our previous post, LLCs are statutorily designed to protect its members from personal liability for the business entity’s debts and obligations. So long as the LLC has been properly formed and properly maintained, that protection will remain in place. But when not properly formed or maintained, it is possible to pierce the LLC’s protective veil and go after its member’s personal assets to satisfy a business debt or obligation.
Primary Factor—Number of Members
One factor that may lead to an LLC being more vulnerable to piercing is its number of members. There are single-member LLCs and multi-member LLCs formed according to state law.
While limited liability protection is the default position for both single-member and multi-member LLCs, single-member LLCs may be more susceptible to piercing because courts are more likely to find that the entity and the single owner are not really separate, thereby making the single owner personally liable for the business’s debts and obligations. Some state courts set aside limited liability protection for single-member LLCs, applying the alter-ego theory for corporations. “Under the alter ego theory, courts disregard the corporate entity when there exists such unity between the corporation and individual that the corporation ceases to be separate and when holding only the corporation liable would promote injustice.” Mancorp, Inc. v. Culpepper, 802 S.W.2d 226, 228 (Tex. 1990), citing Castleberry v. Branscum, 721 S.W.2d 270, 272 (Tex. 1986). However, you do not run into this alter-ego issue with a multi-member LLC, where there are multiple owners with separate property interests in the entity.
Other states, Nevada and Wyoming for example, have passed legislation expressly maintaining limited liability protection, regardless if the LLC is a single-member or multi-member entity. These states require proof other than alter-ego (see “Other Factors—Members’ Acts or Omissions” below) before a court can set aside limited liability protection.
Other Factors—Members’ Acts or Omissions
Other factors that may result in piercing the limited liability veil of protection include:
- Fraud;
- Failure to observe corporate formalities, for example—failing to comply with the entity’s operating agreement, failing to file annual statement and pay state fees, etc. Note: Though not required by most states, it is highly recommended that your LLC have an operating agreement (a.k.a. company agreement in some states) and operate strictly according to its provisions;
- Inadequate capitalization;
- Illegality;
- Evasion of duty or obligation;
- Commingling of personal (or other business) assets and funds with the entity’s assets and funds;
- Tortious or criminal conduct; and
- One member (in a multi-member LLC) holding complete dominance and control over the entire entity.
If you own or operate an LLC and want to avoid having your company’s limited liability protection set aside, we recommend that you have qualified and experienced legal counsel review your company’s structure, operating agreement, policies and procedures, governance, and day-to-day operations.
To have Zhemian Ventures perform a thorough assessment of your LLC and design custom protocols and procedures for your company to mitigate against the risk of having your LLC protections voided, contact Martin Brown at m.a.brown@zhemian.com.
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