How To Avoid Veil (Liability Shield) Piercing of Limited Liability Companies (“LLCS”) – By Jeffrey R. Matsen

7:15 am Asset Protection, Business Planning, Business Succession Planning

Insights From A California Business Succession Planning Attorney Who Protects Your Future

One of the principal legal benefits for business owners and real estate investors in using LLCs to conduct their businesses and hold their real estate is the limited liability shield provided by LLC statutes to LLC members and managers. This shield protects the personal assets of these members and managers (e.g., their homes and savings) from being at risk for debts of the LLC and the business assets and real estate the LLC owns.

However, in certain circumstances the courts may “pierce the veil” of an LLC – that is, they may disregard this shield and may hold members and/or managers personally liability for claims against the LLC.

Thus, it is critically important for LLC managers (“manager” refers both to the managers of the manager-managed LLCs and to the members of member-managed LLCs) to take all reasonable measures to prevent LLC veil-piercing. The principal such measures are outlined below:

  1. LLC Managers Should Not Use the LLC to Commit Fraud or Other Serious Misconduct.

    The courts are unlikely to pierce LLC’s veil unless the members or manager of the LLC use it to commit fraud or other serious misconduct and then seek to rely on their limited liability shield to avoid personal liability for this misconduct. Thus, to avoid veil-piercing (and, obviously, for many other strong legal and ethical reasons), LLC members and managers should avoid all such misconduct.

  2. LLC MANAGERS SHOULD EXPRESSLY REFER TO THEIR LLC AS AN LLC.

    In general, whenever LLC managers make mention about their LLC to third parties verbally or in writing, they should expressly refer to it as an LLC. This practice is an effective means of telling third parties that they are dealing with the LLC, not with the LLC’s members and managers in their individual capacities, and that, accordingly, they may look only to the LLC and not to the members or managers for satisfaction of claims against the LLC.

    Thus, for example, members and mangers generally should ensure that the initials “LLC” or the like appear after the names of the LLC in its stationery and invoices, on business cards of its managers and employees and on other printed material prepared by the LLC and communicated to third parties. In addition, LLC members and managers should generally

    refer to their company in conversations with clients, suppliers, and others as “my LLC” rather than merely as “my company” or the like.

    However, LLC managers should feel free to depart from the above practices when marketing considerations or other common sense concerns dictate. For example, the initials “LLC” may sometimes appear odd and out-of-place on a street sign identifying a store that does business as an LLC or in a newspaper advertisement of the store.

  3. LLC MANAGERS SHOULD MAINTAIN SEPARATE BOOKS AND BANK ACCOUNTS FOR THEMSELVES IN THEIR INDIVIDUAL CAPACITIES AND FOR THE LLC.

    A basic rationale for the limited liability shield that LLCs afford to their members and managers is the legal separateness of LLC’s vis à vis their members and managers. Thus, to protect the shield, members and managers should take every reasonable means to implement and document this separateness. For example:

    1. They should keep separate books and bank accounts for, on the one hand, the personal affairs of members and managers, and on the other, the business and affairs of the LLC.
    2. They should not write checks from the LLC’s account for personal use, nor should they deposit money in that account, without making and maintaining written records of these transactions that reflect arm’s-length terms.
  4. LLC MANAGERS SHOULD ENSURE THAT AT THE TIME OF ITS FORMATION AND THEREAFTER, THE LLC IS ADEQUATELY CAPITALIZED.

    Some courts may question the propriety of the conduct of an LLC and may pierce its veil if the LLC lacks adequate capitalization – that is, if its aggregate equity contributions, business assets, cash flow, insurance, and other financial resources are inadequate to pay its debts when due. Thus, LLC managers should ensure that their LLCs are adequately capitalized.

  5. IN ACTING ON BEHALF OF THEIR LLC, LLC MANAGERS SHOULD AVOID ANY ACTION THAT MAY IMPLY TO THIRD PARTIES THAT THEY ARE ACTING ON THEIR OWN BEHALF.

    In acting on behalf of the LLC, managers should avoid any action that may imply to third parties that they are acting on their own behalf, and where appropriate, they should state explicitly that they are acting on behalf of the LLC. For example, LLC managers should sign LLC contracts and letters more or less as follows:

    XYZ, LLC
    By _________________________________________
    , Manager

  6. LLC MANAGERS SHOULD ENSURE THAT THEIR LLCs FOLLOW ALL APPLICABLE FORMALITIES IMPOSED BY THE RELEVANT LLC ACT.

    Unlike corporate legislation, LLC legislation typically imposes few if any statutory formalities on LLCs. For example, LLC legislation generally does not require LLCs to hold annual meeting of members, and no LLC status requires LLCs to issue certificates of membership to their members.

    However, to the extent that the LLC legislation under which an LLC is formed does impose formalities, members and managers should make sure that they comply with them and that they document this compliance.

    For example, some LLC status contain provisions requiring LLCs to maintain specified types of records (e.g., tax returns and member lists) at a specified LLC office. Members and managers of LLCs formed under such status should ensure compliance with these provisions.

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