We form LLCs because they protect our personal assets from the creditors of the company; however, there is a concept called “piercing the LLC veil” that you should be aware of. Piercing the LLC veil comes from the legal concept of piercing a corporate veil. Essentially, what it means is that you’ve been operating your company in a manner that removes your liability protection. For a great overview of liability protection, see our blog on the difference between LLCs and DBAs. We will explore how the LLC liability protection can be pierced.
Today, the North Carolina Court of Appeals decided the case Southern Shores Realty Services, Inc. v. William G. Miller, et all. In this case, the Miller family owned thirteen different LLCs. Each LLC owned a separate vacation property. William Miller managed each of these LLCs, though he wasn’t the sole manager. Each LLC separately contracted with Southern Shores Realty Services, Inc. (SSRS) to provide services to the LLC, primarily including seeking out and providing short term renters. As part of the contract, the Millers were obligated to let SSRS know if any of the properties were in foreclosure.
In 2009 and 2010, several of the properties entered foreclosure. Mr. Miller did not notify SSRS of the foreclosures. Instead, the foreclosures were discovered through a foreclosure subscription list that SSRS subscribed to. SSRS exercised their right to demand the deposits back from those properties and withhold any other payments. When the dust all settled, 11 of the 13 properties went through foreclosure and SSRS sued for over $74,000. As part of the lawsuit, they sued to hold William Miller personally responsible for the debts of each LLC. This is called “piercing the LLC veil” in this case. The defendants failed to show there were no facts supporting the claim for breach of contract, nor any for the piercing the LLC veil. The Court rejected the defendants’ arguments, and the defendants appealed.
Rules and Analysis of Piercing the LLC Veil
Under North Carolina law, the general rule is that in the ordinary course of business, a corporation is treated as distinct from its shareholders.
That said, “[C]ourts will disregard the corporate form or ‘pierce the corporate veil’ and extend liability for corporate obligations beyond the confines of a corporation’s separate entity, whenever necessary to prevent fraud or to achieve equity.” Glenn v. Wagner. As to whether this applies to LLCs is a matter the Court in this case addressed. They came up with the same analysis, but with only a few changes.
The elements of piercing the LLC veil starts with:
- Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and busienss practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and
- Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest and unjust act in contravention of plaintiff’s legal rights; and
- The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of.
- Inadequate capitalization;
- Non-compliance with corporate formalities;
- Complete domination and control of the corporation so that it has no independent identity; and/or
- Excessive fragmentation of a single enterprise into separate corporations.
For LLCs, this Court determined that Non-compliance with corporate formalities and mere management are not sufficient factors to contribute to the piercing of the LLC veil. The inadequate capitalization and excessive fragmentation are the main factors this court looked to.
The Court held that the 13 LLCs were inadequately capitalized, as they were in foreclosure, and they were excessively fragmented since there were 30-40 total. Therefore, excessive fragmentation and inadequate capitalization were the greater factors.
- Be sure to have money in your LLC to cover anticipated debts.
- Be careful of having too many LLCs or corporations in your business and liability protection strategy.
- Include other members in the management.