Business Law – Llcs, Corporations Subject To Same Veil Pierced Test
Although limited liability companies can be an attractive alternative to forming traditional corporations, whether or not an LLC is any more or less vulnerable to having its veil pierced in Pennsylvania remains a gray area in the law, court observers said.
Since the state General Assembly passed 15 Pa. CSA 8904 in 1994, courts have largely been applying the doctrine of piercing the corporate veil to LLCs. But, since LLCs are much more flexible than corporations and have fewer internal rules that must be followed, courts are now having to consider exactly how the corporate test should be applied to these more flexible entities.
According to McElroy, Deutsch, Mulvaney & Carpernter attorney Matthew A. Lipman, while some members of LLCs believe they do not need to follow the rules as strictly, a new body of law is forming, establishing that there is no greater protection for LLCs.
“The interplay is where LLCs generally don’t have as many requirements, so the question becomes, because LLCs have less requirements, whether an LLC must adhere to whatever the requirements are, or whether even adherence to LLC requirements are further relaxed,” Lipman said.
“There’s a new body of law coming out from the courts that holds that the requirements of an LLC and the law must be followed in order to enjoy the limited liability that comes with an LLC.”
Lipman and other court watchers agreed the test for piercing the veil of an LLC is set, but the gray area remains in the weight and consideration judges should be giving to each area of consideration.
According to Lipman and other court observers, a recent decision from Bucks County in a case he handled is a prime example of the courts applying the general principles of piercing the corporate veil to LLCs, and finding the rules must be followed.
Late last month, a Bucks County Court of Common Pleas judge awarded a packaging company more than $138,000 in restitution against a limited liability company, and allowed the plaintiffs to pierce the corporate veil to recoup the money. Judge Gary B. Gilman’s 66-page opinion and order in Power Line Packaging v. Hermes Calgon/THG Acquisition LLC was issued Sept. 30.
According to court documents, the dispute in the case centered on a packaging company’s reliance on the LLC’s representations that it had established purchasing agreements for a product line the packaging company was developing. However, soon after the purported purchasing agreement fell through, principals of the LLC withdrew funds.
While the LLC’s principals contended the funds were used to pay off necessary debts, Gilman said the principals had used the company to perpetrate fraud.
“Defendants have used the company to attempt to avoid making payment to Power Line, and are attempting to perpetrate fraud by asking the court to permit them to keep the money which was distributed to them rather than being used to pay Power Line,” Gilman said.
Gilman relied on the factors used to determine whether a corporate veil should be pierced, including if the company was undercapitalized, if the principals adhered to the corporate formalities, if dividends were paid, and whether or not the debtor corporation was insolvent.
According to Elizabeth Fenton of Saul Ewing, the cases and considerations are very fact-specific, and judges have a lot of discretion in deciding whether to pierce a company’s veil. Fenton said courts will also look into whether a dispute involves a tort or a contract, since contracts often include additional collateral, which could offer the company more protection.
Fenton also noted that the issue of how to treat an LLC differs around the country, and some states have gone back and forth on the issue of whether to treat LLCs the same as corporations when it comes to piercing the veil. In Delaware, she said, corporate veil issues can only be raised in the Court of Chancery, which is a specialized court of equity.
“Not only is it somewhat unclear in Pennsylvania, it’s also unclear elsewhere,” Fenton said.
One particular gray area courts must consider is the significance of an LLC’s formalities, and the importance that the principals followed all those rules, attorneys said.
On the one hand, since there are fewer and more relaxed rules for an LLC—for instance, in Pennsylvania, operating agreements do not need to be made in writing—it is easier to adhere to the company’s formalities. But on the other hand, with fewer rules it may be easier to argue the LLC is a mere alter ego of the company principals.
“To a certain extent, you’re starting from behind the 8-ball with an LLC, because there aren’t as many formalities,” said Buchanan Ingersoll & Rooney attorney Stanley Yorsz. “That’s why so many of these things come down to factual issues. Just because you don’t follow some formalities does not mean you’re not adhering to an LLC form, or a corporate form.”
McNees Wallace & Nurick attorney Vance E. Antonacci said that for several years, while LLCs were a relatively new entity in the business world, courts were more willing to think of LLCs as alter egos of principals, since there were fewer rules.
“LLCs are a relatively new form of entity when compared to a corporation,” Antonacci said, “It was an unknown because they’d never been tasted. People’s initial reaction was, “Less formalities, perhaps its easier to make the argument that they’re a sham.”
That thinking started to change once LLCs became more prevalent, Antonacci said.
Antonacci said the test when it comes to piercing the veil is now clear, and neither form appears to offer significantly more protection than the other. With either form, according to Antonacci, if a company makes sure to follow the rules, there is no significant risk to having its veil pierced.
With corporations, “maybe there’s more I’s to dot than there are in an LLC, but the case could be made that it’s harder to pierce the LLC,” Antonacci said.
Although the law is a little unclear as to how the corporate considerations are going to be applied to LLCs in litigation, Antonacci and Yorsz said that law is not so vague as to make it difficult when consulting with clients.
Yorsz and Antonacci agreed that when advising clients, protection of the principals against litigation is only a small factor in the larger consideration.
“You have to always balance the potential litigation risk with the corporate practicalities of what’s best for the client,” Yorsz said. “It can’t be completely driven by litigation possibilities.”
Attorneys said piercing the corporate veil is always difficult, and a plaintiff needs to have good facts to support the argument.
“If they treat funds as their own, it’s far less likely that the court will recognize a distinction between the principals of the company and the company,” Lipman said. It’s clear how to avoid litigation. What’s unclear is how egregious do the violations need to be in order to have the LLC pierced.”
Reference: Max Mitchell, Pennsylvania Law Weekly (October 20, 2015)
Filed Under: Business Law; LLCs & Corporations Veil-Piercing
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