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Presenting a live 90-minute webinar with interactive Q&A

Piercing the LLC Veil: Avoiding

Member Liability for Business Debts Protecting the Limited Liability Benefits of LLCs Amid Evolving State Law

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, OCTOBER 13, 2015

Markus May, Esq., May Law Firm, Naperville, Ill.

Paul Porvaznik, Davis McGrath LLC, Chicago

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PIERCING THE LLC VEIL:

BEST PRACTICES TO AVOID

MEMBER LIABILITY FOR

BUSINESS DEBTS

October 13, 2015

Markus May is the principal attorney of May Law Firm Ltd. which serves business clients throughout the Chicago area. He is a client focused business attorney with knowledge in a broad range of industries. As a mergers and acquisitions attorney he has represented numerous clients with respect to business sales and purchases. Mr. May also acts as general outside business counsel to small midmarket companies where he helps them solve business related legal problems. As a transactional attorney he often drafts shareholder agreements, operating agreements, distribution and manufacturing agreements, leases, supplier agreements, customer agreements, and numerous other contracts and documents for businesses.

Mr. May has been the Chairman of the Business & Securities Law Section Council of the Illinois State Bar Association, Chairman of the Chicago Bar Association Business Law Committee, Chairman of the Chicago Bar Association Mergers and Acquisitions Sub-Committee, and Chairman of the DuPage County Bar Association Business Law Committee. He is a current newsletter editor for the Business & Securities Law Section Council of the Illinois State Bar Association and a former editor of the DuPage County Bar Brief. He currently is a member of the Chicago Bar Association Business Law Committee and M&A subcommittee and a past member of the American Bar Association Business Law Committee. As a member of the Institute of Illinois Business Law he helps draft Illinois statutes that impact businesses. Mr. May served on the Midwest Business Brokers and Intermediaries board of directors and chaired the MBBI Meetings Committee.

An accomplished author and speaker, Mr. May has published numerous legal and newspaper articles related to business law, including protecting business owners from personal liability, mergers and acquisitions, drag-along rights, and other topics. He appeared on two Illinois State Bar television programs where he taught viewers about finding a business to buy and the business buying process. He speaks frequently at seminars on business topics and graduated from the University of Colorado where he was a member of the law review.

Markus is married with two children, enjoys skiing, basketball, and racquetball and is involved with his church as a small group leader.

Markus May

May Law Firm ,Ltd.

400 E. Diehl Road, Suite 310

Naperville, IL 60563

630–864–1004

mmay@illinois-business-lawyer.com

Paul B. Porvaznik Davis McGrath LLC

Paul Porvaznik has practiced law since 1997, primarily in the areas of general civil litigation, mechanics liens, landlord-tenant law, collections, post-judgment enforcement and general business disputes. He has successfully prosecuted and defended both jury and bench trials in various State and Federal courts.

Paul contributes regularly to the Commercial Litigation and Lawyer’s Forum columns in the Chicago Daily Law Bulletin. Paul’s articles have also run in the Chicago Bar Association Record, the Illinois State Bar Association’s ISBA Journal and he has been published several times in The Computer & Internet Lawyer magazine.

Paul has authored and updated the Illinois Institute for Continuing Legal Education (IICLE) Quick Guide entitled Forcible Entry and Detainer Actions for the years 2012 and 2015.

Paul has also given presentations to the Chicago Bar Association Commercial Litigation Committee, the Illinois Creditors Bar Association, and a day-long Continuing Legal Education seminar on Piercing the Corporate Veil through the National Business Institute in Altoona, Wisconsin on a variety of commercial litigation topics.

Paul graduated from the DePaul College of Law in 1996 and obtained his undergraduate degree from Boston University in 1993.

pporvaznik@davismcgrath.com

Blog: http://paulporvaznik.com / Twitter: @Paul Porvaznik

312.332.1506

Limited Liability – or not?

• A limited liability company is a separate and

distinct legal entity from its owners and managers and from other companies with which it may be connected. Therefore these other people and entities are generally not liable for the company’s debts.

• However there are some instances where the company entity will be disregarded and the “corporate veil” can be pierced so the owner’s assets are at risk.

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Questions for Owners

• Why do (did) you want to form a corporation or LLC to

do business? • Do you like Personal Guarantees? Why not? • You are always personally responsible for your own

actions, but do you know that if you don’t run your business properly, you can be personally liable for the debts of the business even if it is properly registered with the Secretary of State?

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How to Present to Clients

Company Owners

Corporate Veil

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How to Present to Clients

Company Owners

Corporate Veil

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Who can be liable under the doctrine?

• Shareholders of companies.

• Parent Companies

• Sister Companies

• Non-Shareholders?

• Lenders?

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States that allow non-shareholder liability under piercing or alter-ego theory: Alabama, Alaska, Colorado, Connecticut, Delaware, Hawaii, Indiana, Louisiana, Mass., Minn., Montana, Nebraska, Nevada, New York

States that do not allow piercing against a non-shareholder: Maine, Maryland, North Carolina, Texas

Non-shareholder liability

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Non-shareholder liability

• Buckley v. Abuzir, 2014 IL App (1st) 2014 (dismissal of complaint reversed)

• Konrad Motor & Welder Service, Inc. v. Magnetech Industrial Services, Inc., 973 N.E.2d 1158, 1165 (Ind. Ct. App. 2012)

• Roohan v. First Guarantee Mortgage, LLC, 97 A.D.3d 891 (N.Y. App. Div. 2012)

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What about LLC’s?

• Statutorially provided for in • Cal. Corp. Code § 17703.04(b).

• Colorado C.R.S.A. § 7-80-107

• Florida 608.701

• Minnesota 322B.303(2)

• Washington State RCWA 25.15.060 (Effective until January 1, 2016)

• Wyoming § 17-29-304(b)

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What about LLC’s?

• However this is also an Equitable Doctrine…..created by courts

• Therefore – YES – Members of LLC’s can be liable under the Piercing the Corporate Veil Doctrine even absent a statute.

• If your state hasn’t yet – it will when a judge finds a case where they want to promote equity

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Reverse Piercing and Single Member LLC’s

• Subjects the entity to liability for the acts of its owners.

• May be used to make a subsidiary corporation liable for the actions of its parent entity when the use of the subsidiary entity by the parent entity is wrongful.

• Can’t be brought by the parent as a shield

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LLC Charging Order Confusion

• Cases such as Albright and Olmstead hold that the ownership interest of a single member LLC may be turned over to creditors – this is not veil piercing

• Multiple owner LLC’s the creditor is generally limited to receiving the distributional interest – and can be stuck with phantom income

• With a corporation the stock can be turned over to creditors whether single or multiple owners

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Series LLC’s

• Separate books and records should be maintained for each series;

• Creditors need to be made specifically aware of the separate existence of each series; and

• The assets of each must be unambiguously identified as belonging to that series.

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Who Can Bring a Piercing Claim

• An innocent third party creditor. • Not - - -

– Shareholders – Directors – Officers – Affiliates

Piercing the corporate veil is limited to protecting those who have relied on the existence of a distinct entity. A party should not be allowed to utilize the corporate form on one hand to protect itself from liability, and on the other hand to nullify the existence of the company to avoid reckoning with the obligations incurred by the corporation while it was a viable entity.

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IL Piercing the Veil Standard

A party seeking to pierce the corporate veil must generally make a substantial showing that

(1) there is such a unity of interest and ownership that the separate personality of the company no longer exists (e.g., that one party is the “Alter Ego” of the other), and

(2) circumstances exist so adherence to the fiction of a separate corporate existence would sanction a fraud, promote injustice, or promote inequitable consequences.

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Courts are Reluctant to Pierce But….

• They will if certain factors are met

• Each state creates its own factors

• Many of the factors are the same

• As this is an equitable remedy – courts can create additional factors as they see fit

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Factors

• Not just an academic exercise

• Guidelines for client on things to avoid or do in order to avoid a piercing claim

• Usually not just one factor is enough and courts will aggregate factors

• The following factors are in general order of importance

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Inadequate capitalization

• Poorly understood by courts – debt v. equity

• Usually Initial capitalization – avoid flimsy entities

– Illinois $1,000 is common – an insufficient amount

• Practice Pointer – start out with more equity

• Practice Pointer – keep a copy of the initial check

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Diversion of assets from the company by or to an owner or other person or entity to the detriment of creditors.

• If the company is doing poorly, don’t make preferential payments to shareholders.

• Where a company moved money to avoid a judgment to a sister company, the courts pierced the corporate veil.

• Don’t pay yourself a higher %age on debt owed than other creditors receive.

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Failure to maintain arm's-length relationships among related entities

• Don’t give preferential treatment to individuals or related entities. Two main areas: – Charge a fair market rental rate for leased real

estate.

– Pay a fair market interest rate on loans.

• Operating several businesses out of the same location is not enough.

• Using another company’s trademark is not enough to pierce.

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Commingling of funds

• Keep separate bank accounts.

• Don’t use company funds to pay personal expenses.

• Don’t transfer money to an individual account without proper resolutions.

• Practice Pointer: A centralized cash management system is not a commingling of funds.

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Nonpayment of “Dividends”

• Document how money flows to owners

• Guaranteed Payment or Owner Distribution for LLC taxed as partnership or sole proprietor

• Salary or Owner Distribution for LLC taxed as a corporation

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Non-Functioning Officers or Directors

• Be wary of improper minority and woman owned business designations

• Don’t appoint cousin Don or sister Suzy to a position without real authority and active involvement in the company

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Failure to Issue Ownership Interests

• Don’t need certificates

• Maintain an ownership ledger and notices of ownership interest

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Failure to observe “corporate” formalities

• Big factor for corps, but… many states don’t require this for LLC’s – but good practice in any event

• Company minutes

• Annual and other meetings

• Elect managers and officers

• Practice Pointer – don’t refer to your fellow owner as a “partner”

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Insolvency of the Debtor Company

• Duhhhhh….of course it is or we wouldn’t have a piercing claim

• Practice Pointer: if company is doing poorly , be extra careful where money goes, document all transactions, and especially avoid all preferential transfers (e.g. paying an owner loan before other creditors)

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The Catch-All

• Whether, in fact, the company is a mere facade for the operation of the dominant owner

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Second Prong – Sanction a Fraud or Promote Injustice

Whether there is an element of unfairness, something akin to fraud or deception, or the existence of a compelling public interest. If the company is organized and carries on its business without substantial capital in such a way that the company is likely to have no sufficient assets available to meet its debt, this is generally sufficient because it is inequitable that shareholders set up flimsy organizations to escape personal liability.

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Summary - Working with Clients

• Keep an eye open for factors

• Annually review factors and draw circles

• Pass out a company checklist

• Be careful allowing a default judgment to enter thinking this can be avoided by closing the company down

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LITIGATION TRENDS AND CONSIDERATIONS

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PIERCING PROS & CONS

• Additional Funds

Source

• Discovery to third

parties holding debtor

assets/property

• Settlement leverage

• Bankruptcy

• Out of Business

• Fishing expedition

• Judgment Amount Must

Be High

PROS CONS

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Situations Where Piercing Potentially Applies

Pre-judgment

• Pre-suit investigation shows lack of

separateness between LLC and the

dominant member or manager

• Piercing LLC to obtain jurisdiction over LLC

member

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Situations Where Piercing Potentially Applies

Post-judgment

• Can’t pierce in supplemental proceedings

• Must file new lawsuit

• Res judicata defense should fail

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“Back Door Piercing”(?) – Post-judgment

• Third-party citations on individuals who may have property or assets of the debtor.

• If “yes”, file motion for turnover order in the supplementary/post-judgment proceeding.

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Pleading

• Alternative pleading (735 ILCS 5/2-604, 613).

• Count I names LLC as defendant

• Count II names individual member(s) as defendant(s)

• Count II - same cause of action (breach of contract, e.g.), same facts, but additional allegations to show existence of piercing factors.

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Analysis of Claims

LLC Piercing Claims are Analyzed Under the Same Framework as Piercing of Regular Corporation

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Heightened pleading – Rule 8, 9

Yes - Superkite PTY Limited v. Glickman, 2014 WL 1202577 (N.D.Ill. 2014)

No - Landstar Inway v. Samrow, 181 Wash.App. 109 (2014)

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Heightened burden of proof

See In re: Opus East, LLC, 528 B.R. 30 (USBC Delaware 2015); Also, see Fontana v. TLD Builders, Inc., 362 Ill.App.3d 491, 500 (2nd Dist. 2005)

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Factors

• Factors are Considered in the Aggregate – Not in Isolation

• The more specifics, the better chance of surviving summary judgment or motion to dismiss

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Finding Order in the Morass: The Three Real

Justifications for Piercing the Corporate Veil, 100

Cornell L. Rev. 99 (2014);

http://scholarship.law.cornell.edu/clr/vol100/iss1/2

“The entire universe of piercing cases can be

explained as judicial efforts to remedy one of the

following three problems.” Id., p. 101.

MACEY & MITTS STUDY

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Macey & Mitts Study continued

1. Courts pierce the corporate veil as a tool of statutory application. That is, to bring corporate behavior into conformity with a particular statutory scheme. Courts will disregard the corporate form to accomplish a legislative goal as expressed in the statute;

2. Courts pierce in order to remedy what appears to be fraudulent conduct that does not satisfy the strict elements of common law fraud (see Greenhunter, e.g.);

3. Courts pierce to promote “bankruptcy values” – to prevent fraudulent conveyances and preferential transfers and to promote orderly disposition of debtor assets so that all creditors are treated equally.

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OTHER REMEDIES

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Fraudulent Transfer

• Uniform Fraudulent Transfer Act (UFTA) • 740 ILCS 160/1 et seq., 735 ILCS 5/2-

1402(c)(3)

• UFTA recognizes actual fraud and constructive fraud (UFTA §§5, 6)

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Successor Liability

• General Rule = No Successor Liability

• Unless (i) Merger, (ii) consolidation,

(iii) express or implied assumption,

(iv) fraud, (v) mere continuation

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Charging Order

• Exclusive remedy for a judgment creditor of an LLC member

• Creditor Must Look to Member’s distributional interest, monetize it and sell it.

• 810 ILCS 180/30/20

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Common Questions

• Why bother with an LLC?

• If I am a sole owner can an LLC help me?

• Should I bother with a subsidiary if the same people run both companies?

• Can I have a common cash management system?

• Does it matter what kind of underlying claim is brought to establish initial liability?

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Takeaway

My # 1 Takeaway or Action Point from this Presentation is:

___________________________________________________________________________________________________________________________________________________________________________________________________

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