This memorandum highlights some of the key considerations to keep in mind while conducting business as a limited liability company ("LLC"). Observance of these basic considerations, which are not exhaustive, will maximize the likelihood that you will enjoy the benefits that you intended and the purposes for which you formed the LLC.

I. Standing/Authority to Sue

In order for an LLC to enforce any claims it has in court, it must establish standing/authority to sue.1  To have standing in a particular state, the LLC must be registered to transact business in that state and do such things as are necessary to remain in good standing in that state (e.g., file an annual report and pay taxes).2 In some cases, courts have dismissed lawsuits where a company has failed to file an annual report.3  Additionally, failure to pay taxes will result in the company lacking good standing and therefore lacking capacity to sue.4 Therefore, to ensure that the LLC can enforce any claims it has in court, it should be registered to transact business in all states where it would potentially need to enforce such claims and should comply with all statutory requirements (e.g., filing annual reports and paying taxes).5

II. Nature of LLC; Mischaracterization of LLC

Sometimes, signatories for limited liability companies mistakenly sign contracts without using the "LLC" designation.6 In such cases, some courts will construe the company as a partnership instead of an LLC. This may result in personal liability for the members of the LLC, which effectively destroys any protection from liability that was intended by formation of the LLC. Therefore, contracts signed by the company should always include "LLC" or "Limited Liability Company" as appropriate.

III. Limited Liability of Members and Managers; Personal Liability under Agency or Other Law

As mentioned above, an LLC shields its members from liability for the company's obligations.7 However, there are circumstances in which members can be held personally liable for the LLC's obligations. Here are a few examples:

  1. If a member has an oral side agreement to reimburse the LLC for payments made on a note which he signed in his capacity as a member of the LLC, the individual may be held personally liable.8
  2. When signing contracts or other obligations, members should always include their title (e.g., Chief Executive Officer) and the LLC's name. This will ensure that any breach of contract claims against the member individually will be dismissed, especially when there is no evidence that the member intended to be personally liable.9 Any contractual obligations assumed by the LLC belong to the entity, not the individuals signing or the LLC's members.10 Individuals who sign a contract that indicates title but does not name the LLC can bind themselves (instead of the LLC) on the contract by virtue of the individual's failure to respond to a request for admissions.11 If the signature block of the contract states the name of the company without the "LLC" designation, a court might not find the person who signed it personally liable since the variance is slight.12 This finding would be further bolstered if there was no evidence that the other party to the contract was ever misled about the identity of the company and that it is an LLC.13 However, a person who knowingly omits "LLC" in the signature block is liable for any indebtedness, damage, or liability caused by the omission.14 Even when an individual signs a contract as president of the LLC, if the contract includes personal guarantee language, then a court may hold the individual personally liable.15 The bottom line: contracts should never include personal guarantee language and signature blocks should always include 1) the signing person's title and 2) the company's name, including the "LLC" designation.
  3. A member of an LLC who personally participates in tortious conduct (bad acts) of the company may be held personally liable for the consequences of their conduct.16 Members or managers may be personally liable if they, in their individual capacity, damage someone else's contractual or business relationships.17 As an example, if a member makes a down payment under a contract of the LLC to purchase real estate and uses a personal check which bounces, he is personally liable for the bad check.18 An agent or officer who participates in the commission of a tort is liable whether or not he is acting on behalf of another or the LLC.19 Even if officers and agents of the company are not participating "hands on" at every step, they may be held personally liable for violations.20 This liability is not based solely on their membership in the LLC. Rather, it is the fact that they are present and participating in the operations of the company while a violation is being committed (either by them or the company) that incurs the liability.21 The LLC's members are not, however, always liable for bad acts of another person associated with the company: if an employee commits a tort without approval or knowledge of the member, then the member may remain insulated by the LLC.22
  4. As for negligent conduct, a manager of an LLC may be held personally liable for approving, directing, actively participating in or cooperating in the company's negligent conduct.23
  5. An LLC's officers may be held personally liable if they are acting on behalf of the company and the company, through bad faith misrepresentation, breaches a contract.24

IV. Piercing the Veil

Generally, limited liability companies are treated as independent legal entities. Therefore, as noted previously, they shield members who have ownership interests in the company from being personally liable for the liabilities of the LLC. However, the legal concept of "piercing the corporate veil" is a determination where a member of the company is held personally liable for the company's liabilities.

For a party to successfully pierce the LLC veil, he or she will usually have to prove that the LLC ignored formalities and protocols, such as voting to approve major actions in a duly authorized meeting or otherwise failed to comply with the terms of the company's operating agreement.

A. Instrumentality Theory

There are few Delaware cases in which the veil has been pierced, though there are signs this trend may be changing and the law is less certain than before. However, in those few cases where the veil has been pierced, Delaware courts have adopted an "instrumentality" theory for piercing the veil. This occurs where a company is an extension of an individual, such as where an individual uses a company to make gifts to others or where a parent corporation holds itself out to the public as the owner-operator of a subsidiary motel. Under this approach, factors that may lead a court to pierce the veil include failure to follow formalities (comply with operating agreement requirements for approval by vote of transactions), overlapping ownership and management, common office space, lack of arms length dealing, preferences exercised in favor of family owned entities, unity of interest, lack of independence and injustice/inequity.25  Additionally, lack of sufficient funds for the company to operate is a basis to pierce the veil when coupled with evidence of an intent, at the time of funding, to avoid payment of future debts of the company.26

Satisfaction of only one or a few of these factors, however, will not necessarily result in piercing the veil. For example, some courts have stated that any lack of formalities must lead to some misuse of the LLC form to justify piercing.27 Additionally, even where some formalities are not strictly followed, evidence that other formalities were followed (e.g., filing papers, making loans, having a bank account and operating in the company's name) can help prevent an LLC's corporate veil from being pierced.28 Finally, one court has written that members of an LLC are not personally liable when they follow company rules, refrain from commingling personal funds with company funds, do not borrow or use company assets for their own purposes and do not exercise any greater control than any managing members of a company.29

B. Alter Ego Theory

Another approach to piercing the veil is the "alter ego" theory. This has been adopted by many states and occurs where a corporation (or LLC) is deemed merely a front for another entity. Delaware courts, as previously mentioned, adhere to the "instrumentality" theory of veil piercing, and thus have not expressly adopted the alter ego theory. However, one of the most authoritative passages on the alter ego theory was written by a Delaware judge applying a federal standard. She wrote that the alter ego analysis: 

  • includes whether the corporation was adequately [funded] for the corporate undertaking; whether the corporation was solvent; whether dividends were paid, corporate records kept, officers and directors functioned properly and other corporate formalities were observed; whether the dominant shareholder siphoned corporate funds; and whether, in general, the corporation simply functioned as a façade for the dominant shareholder ... [N]o single factor could justify a decision to disregard the corporate entity, but that some combination of them was required and that an overall element of injustice or unfairness must always be present, as well.30

Although Delaware Courts have not expressly adopted the alter ego theory, courts in other states have applied it to Delaware companies in actions pending in their jurisdictions. New York has adopted the alter ego theory. To establish alter ego liability, New York courts require evidence of 1) a single economic unit and 2) injustice.31 Courts have held that 30% ownership interest is insufficient to make a controlling decision (constituting a single economic unit) in a Delaware company.32

Some factors a court will consider in determining whether to pierce the veil, whether according to an instrumentality or alter ego theory are:

  1. Significant lack of funding for the LLC (requirements vary based on industry, location and specific circumstances);
  2. Failure to observe formalities in terms of behavior and documentation (regularly scheduled meetings, keeping notes of the meetings, recording votes, etc.);
  3. Commingling of assets of the LLC and of the member;
  4. Treatment by an individual of the assets of the company as his/her own;
  5. Failure to pay dividends/distributions;
  6. Siphoning of the company's funds by the dominant member(s);
  7. Non-functioning officers and/or directors;
  8. Concealment or misrepresentation of members;
  9. Absence or inaccuracy of financial records;
  10. Use of the LLC as a front for personal business of the dominant member(s) (alter ego theory);
  11. Failure to maintain arm's length relationships with related entities; or
  12. Manipulation of assets or liabilities to concentrate those assets or liabilities.

This list is not exhaustive, but is intended to give a general idea of the types of things to avoid. Not all factors have to be met and usually satisfaction of only one factor is not enough to pierce the veil, but this will depend on the circumstances and egregiousness of the conduct.

V. Fiduciary duties of members and managers

To prevent against self-dealing, the law imposes a duty of full candor and disclosure by the LLC members when the company takes actions.33 Members are required to maintain loyalty to the LLC and should refrain from taking part in transactions where a majority of the board is interested or lacks independence.34 The law has some measure of presumption, however, that actions by directors are valid. According to the business judgment rule, directors are presumed to act on an informed basis, in good faith and in the honest belief that the action taken is in the best interest of the company.35 Before making a business decision, directors must inform themselves of all reasonably available information.36 Finally, members and managers are not personally liable for breach of fiduciary duty to each other, the LLC or any party to the LLC operating agreement if such breach of fiduciary duty was based on a good faith reliance on the provisions of the LLC operating agreement (unless the LLC operating agreement specifically provides for such personal liability).37

Conclusion

While an LLC may provide many benefits, there are several guidelines that must be followed in order to receive those benefits. Filing annual reports, paying taxes on time, using proper signature blocks, keeping good notes of meetings, keeping personal money separate from the company's money and observing other formalities are some of the important things that must be done to ensure that the LLC operates properly and provides the desired benefits. This is just a guide. Observance of these basic considerations will maximize the likelihood that the benefits and purposes for which the LLC was formed will be realized. 

Footnotes

1.Morgan Howard (United States), LLC v. Lewis, No. FSTCV 054006343S, 2006 WL 2348892, at *2 (Conn. Super. July 14, 2006); See also, Zahrijczuk v. Branford Water Pollution Control Auth., No. CV116024727, 2012 WL 1511369, at *2 (Conn. Super. Apr. 10, 2012) (quoting Cmty. Brd. 7 v. Schaffer, 639 N.E.2d 1, 4 (N.Y. 1994)) ("Business corporations . . . are creatures of statute and, as such, require statutory authority to sue and be sued[.]").

2.Id.

3.SMLL, LLC v. Daly, 128 P.3d 266, 266 (Colo. App. June16, 2005).

4.Real Estate Network, LLC v. Gateway Ventures, LLC, No. 4:05-CV-422-CAS, 2005 WL 1668194, at *3 (E.D. Mo. July 12, 2005); See also, N.Y. Bus. Corp. Law § 1312(a) ("A foreign corporation doing business in this state without authority shall not maintain any action or special proceeding in this state unless and until such corporation has been authorized to do business in this state and it has paid to the state all fees and taxes imposed under the tax law or any related statute[.]").

5.Id. at *2; HMMH Holdings, LLC v. Hallenborg, No. CV065001446S, 2006 WL 2411476, at *1 (Conn. Super. Aug. 1, 2006); Eschelon Photography, LLC v. Dara Partners, L.P., No. 99968/05, 11 Misc.3d 1064(A), at *8 (N.Y. City Civ. Ct. Jan. 25, 2006).

6.Courthouse Corporate Ctr., LLC v. Schulman, 902 N.Y.S.2d 160, 161 (2010).

7.Lazard Debt Recovery GP, LLC v. Weinstock, 864 A.2d 955, 974 (Del. Ch. 2004).

8.See Belden v. Thorkildsen, 197 P.3d 148, 155 (Wyo. 2006) (holding that the appellee had not orally agreed to personally guaranty payment of the LLC's debt).

9.Thomas v. Hobbs, No. C.A. 04C-02-010 RFS, 2005 WL 1653947, at *1-2 (Del. Super. Feb 13, 2006).

10.Id. at *2.

11.Truck Am. Training, LLC v. City of Hillview, No. 2006-CA-000727-MR, 2007 WL 866694, at *2, *4 (Ky. App. Mar. 23, 2007).

12.Quebecor World (USA), Inc. v. Harsha Assocs., LLC, 455 F.Supp.2d 236, 242 (W.D.N.Y. 2006).

13.Id.

14.See infra note 24.

15.Creative Res. Mgmt., Inc. v. Soskin, No. 01A01-9808-CH-00016, 1998 WL 813420, at *2 (Tenn. Ct. App. Nov. 25, 1998).

16.McFarland v. Virginia Ret. Servs. Of Chesterfield, LLC, 477 F.Supp.2d 727, 740 (E.D.Va. 2007).

17.Brew City Redevelopment Grp., LLC v. Ferchill Grp., 297 Wis.2d 606, 626 (2006).

18.Nola Realty, LLC v. DM&M Holding, LLC, 33 A.D.3d 523, 526-27 (N.Y.A.D. 1st Dep't 2006).

19.Ventres v. Goodspeed Airport, LLC, 275 Conn. 105, 142 (2005).

20.MaryCLE, LLC v. First Choice Internet, Inc., 166. Md.App. 481, 530 (2006).

21.Estate of Sestito v. Silk, LLC, No. X04CV010103522S, 2004 WL 574517, at *3 (Conn. Super. Mar. 9, 2004).

22.Id. at 4.

23.Hoang v. Arbess, 80 P.3d 863, 868 (Colo. App. 2003).

24.Ledy v. Wilson, 831 N.Y.S.2d 61, 62 (N.Y.A.D. 1st Dep't 2007).

25.Tzovolos v. Wiseman, 16 A.3d 819, 842 (Conn. Super. 2006).

26.Milk v. Total Pay and HR Solutions, Inc., 634 S.E.2d 208, 212 (Ga. App. 2006).

27.Advanced Tel. Sys., Inc. v. Com-Net Prof'l Mobile Radio, LLC, 846 A.2d 1264, 1279 (Pa. Super. 2004).

28.F.G. Bruschweiler (Antiques) Ltd. v. GBA Great British Antiques, LLC, 860 So.2d 644, 651 (La. App. 5th Cir. 2003).

29.McGovern Capital, LLC v. Papic, No. CV020190931S, 2003 WL 21267436, at *3 (Conn. Super. May 21, 2003).

30.Harco Nat. Ins. Co. v. Green Farms, Inc., CIV. A. No. 1131, 1989 WL 110537, at *1039-40 (Del. Ch. Sept. 19, 1989).

31.NetJets Aviation, Inc. v. LHC Commc'ns, LLC, 537 F.3d 168, 176 (2d Cir. 2008).

32.Bronstein v. Crowell, Weedon & Co., No. B191738, 2007 WL 969559, at *9 (Cal. App. 2d Dist. April 3, 2007).

33.In re Bigmar, Inc., Section 225 Litigation, No. CIV.A.19289-NC, 2002 WL 550469, at *23 (Del. Ch. April 5, 2002).

34.Blackmore Partners, LP v. Link Energy, LLC, 864 A.2d 80, 81 (Del. Ch. 2004).

35.Minnesota Invco of RSA No. 7, Inc. v. Midwest Wireless Holdings, LLC, 903 A.2d 786, 797 (Del. Ch. 2006).

36.Id.

37.6 Del. C. § 18-1101(d).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.