Piercing the Shield: Exposing LLC Members to Personal Liability
The limited liability company (LLC) structure generally shields members of the LLC from personal liability for company debts. However, when members of an LLC abuse or ignore certain company formalities, a court may disregard the entity altogether, thereby exposing members to personal liability.
The Michigan Court of Appeals recently pierced the veil of an LLC and held its members personally liable for company debts. Florence Cement Co. v. Vettriano, No. 295090, 2011 WL 1681414 (Mich. App. May 3, 2011). In Florence Cement Co., the plaintiff cement company contracted with the defendant developer to perform concrete and asphalt work on the defendant developer’s development. However, the development was unsuccessful, and the defendants failed to pay the plaintiff the full amount owing for its work. The plaintiff then brought an action against the developer and its members to recover the outstanding balance due, alleging claims of alter ego and improper distributions, among others.
In Michigan, a court may piece the veil of an LLC where: (1) the company is the mere instrumentality of another individual or entity; (2) the company was used to commit a wrong or fraud; and (3) the plaintiff suffered an unjust injury or loss.
On appeal, the court in Florence Cement Co. determined that the trial court erred by not piercing the veil of the defendant LLC because the plaintiff had established all the above elements at trial. In support of its conclusion, the court cited the following facts:
The defendant members failed to treat the LLC as a separate entity and made no distinction between their personal debts and the debts of the company.
One member falsified a sworn statement regarding the outstanding debt owed the plaintiff, and the LLC made several distributions to its members while insolvent.
The plaintiff suffered a significant loss as a result of the individual defendants undercapitalizing the company and treating it as a mere instrumentality; specifically, the plaintiff did not receive the full amount due for its work on the development.
The court also held the defendant members jointly and severally liable for several improper distributions made while the defendant developer was insolvent, pursuant to the Michigan Limited Liability Company Act. However, the court explained that, under the Act, the members were liable to the company, not the plaintiff creditor; therefore, on remand, the trial court should order the individual defendants to refund the improper distributions to the LLC so that the company can satisfy its outstanding obligations to the plaintiff creditor.
While a court’s determination to disregard the limited liability shield turns on the specific facts of each case, there are certain precautions that an LLC and its members should take to protect themselves from such a claim. Conversely, piercing the veil may provide certain creditors with an adequate remedy against individual members who abuse or disregard LLC formalities. Individuals with further questions should contact a business attorney who has experience in these areas.