How many law professors do you know whose bibliography includes titles like, “Agents of the Good, Servants of Evil: Harry Potter and the Law of Agency,” or “Eliminating Fiduciary Duty within Closely Held Businesses — Cardozo is Dead: We Have Killed Him”? I only know of one, and that’s Daniel S. Kleinberger (pictured), Emeritus Professor of Law at William Mitchell College of Law in St. Paul, Minnesota.
Amidst a spectacular career as teacher, prolific author and business law scholar, Professor Kleinberger also has played a leading role in state and national legislative drafting projects, writing the statutes that govern unincorporated business entities, including his service as co-reporter for and a principal drafter of the Revised Uniform Limited Liability Company Act (“ULLCA (2006)”) which has been enacted in ten states and currently is pending in the legislatures of four others.
In 1994, Professor Kleinberger and co-author Carter G. Bishop published their treatise, Limited Liability Companies: Tax and Business Law (Warren, Gorham & Lamont) which has become one of the bibles of LLC law. Among the many developing areas of the law of LLCs addressed in the treatise is the application of “veil piercing” principles, originally developed as part of the common law of business corporations, to enable creditors of LLCs, under certain circumstances involving abuse of the LLC form, to satisfy LLC obligations with the personal assets of the LLC owners.
According to Professor Kleinberger, a number of LLC statutes have eliminated disregarding “corporate” formalities as a ground for piercing the LLC veil, and some courts applying the law of other jurisdictions have discarded or at least discounted formalities. In an excerpt, printed below, from the forthcoming supplement to the Bishop & Kleinberger LLC treatise, Professor Kleinberger writes about the types of formalities that still matter even in jurisdictions that by statute or case law have done away with governance formalities as a piercing factor.
Formalities that Matter [new section to Chapter 6] copyright 2015 Carter G. Bishop and Daniel S. Kleinberger
In a February, 2015 post to LNET-LLC,1 a leading creditor-debtor litigator wrote:
So, yes, [under statutes that eliminate governance formalities] the [limited liability] company is not required to comply with corporate formalities, but that doesn’t mean that the company’s books can be in such a state of intentional or negligent disarray that legal ownership of its assets and basic financial operations cannot be clearly established. I think that some planners are mistaking “non-compliance with corporate formalities is not a grounds for veil piercing” with “there is no need for an LLC to keep basic records like any other similar business would”, and that is quite wrong.2
The authors of this treatise agree entirely with the posting, and the case law takes the same view. For example, in a decision piercing the veil of a Connecticut limited liability company, the Connecticut Court of Appeals focused in part on “evidence that Westview [Carlton Grp., LLC] lacked an agent for service, filed no annual reports with the secretary of the state and . . . failed to file tax returns for any of the years involved.”3
Thus, failure to follow formalities vis-à-vis the outside world (especially the government) remains a substantial ground for piercing the veil. Indeed, Minnesota’s version of ULLCA (2006) addresses this distinction explicitly: “The failure of a limited liability company to observe formalities relating exclusively to the management of its internal affairs is not a ground for imposing liability on the members, managers, or governors for the debts, obligations, or other liabilities of the company.”4
A Texas case illustrates how failure to document financial activity can evidence a disregard of economic separateness (which is a crucial piercing factor):
Funds and inventory of these companies were intermingled without documentation, as evidenced by Anthony Moschella’s frequent financial transfers among the various entities. Funds from Triple M Supply were being used to pay the debt of JTMM. Triple M Operating was paying the debts of Triple M Supply. After a checking account for Triple M Supply was opened, large sums of money were transferred out of Triple M Supply’s bank account to several related businesses including K–Cor Supply and JTMM. Additionally, over $500,000 of inventory was switched “on the books” from JTMM Supply to Triple M Supply without any further documentation between the two companies.5
More generally, a Massachusetts decision provides a textbook example of which formalities matter and how not to observe them. Kosanovich v. 80 Worcester St. Associates, LLC affirmed the trial court’s ruling piercing the veil of a limited liability company (WSA) so as to hold liable the limited liability company’s manager and sole member:
It is undisputed that Feuerman had sole ownership and pervasive control of WSA. However, pervasive control, standing alone, is insufficient to pierce the corporate veil. Here, in addition to pervasive control, the judge had sufficient evidence to conclude that corporate records did not exist or were not properly kept. Feureman testified that any documents he had were turned over to his attorney. However, the only evidence submitted by his counsel was the article [sic] of incorporation [sic]. He admitted that he ran his business “out of my house and out of my car.” He further stated he “ran the books, the bookkeeping, filed the returns and handled whatever paper work and legal work needed to get handled.” When asked about the records specifically however his responses were: “My ex-partner had papers that he disappeared. So he might have had stuff. They could have been moved.” When asked about tax records and whether he sought any records from his accountant Feureman responded: “I don’t remember. I don’t remember what happened with them and if I asked them for any paper work they might have had or tax returns that are filed.” When asked if he kept any records, such as checkbooks, dealing with payments to any subcontractors Feureman stated: “Not to my knowledge. When asked if his “ex-partner” was a member of WSA, or whether he had a formal partnership with him, Feureman stated, “[N]o, it was a bit informal.” When asked whether the ex-partner received a W–2 or a 1099 for tax purposes Feureman stated he would have received something from the accountant but was “not sure what” he would have received.6
1. LNET-LLC is the preeminent internet discussion group concerning limited liability companies and partnerships. https://groups.yahoo.com/neo/groups/lnet-llc/info (last visited February 24, 2015).
2. Posted by Jay Adkisson, RISER ADKISSON LLP, Tue 2/24/2015 3:33 PM (RE: [lnet] Re: Schlossberg v Bell Builders Remodeling [MD Ct Appeals 2/20/15] – advisory opinion to Bankruptcy Court on standards for Veil [Piercing]).
3. Connecticut Light & Power Co. v. Westview Carlton Grp., LLC, 950 A2d 522, 527 Conn. App. 2008) (statutory citations omitted). See also Last Time Beverage Corp. v. F & V Distribution Co., LLC, 98 A.D.3d 947, 951, 951 N.Y.S.2d 77, 81 (2012) (stating that “the companies failed to observe certain formalities such as keeping certain records“) (emphasis added); Hesni v. Williams & Boshea, L.L.C., No. CIV.A. 01-3745, 2002 WL 373273, at *4 (E.D. La. Mar. 7, 2002) (piercing the veil of a limited liability company and finding that the plaintiff “present[ed] evidence of both commingling of funds and a failure to follow statutory formalities for incorporation [sic]”); Contrast Breen v. Judge, 124 Conn. App. 147, 154, 4 A.3d 326, 332 (2010) (affirming the trial court’s decision to pierce the veil of a limited liability company and noting that the limited liability company “followed certain corporate formalities, such as maintaining separate books, filing company tax returns and, subsequently, filing the appropriate dissolution documents with the secretary of the state.”).
4. Minn. Stat. § 322C.0304, subd. 2 (2014) (emphasis added). The emphasized language is non-uniform and was drafted to respond to the state attorney general’s concerns.
5. McCarthy v. Wani Venture, A.S., 251 S.W.3d 573, 591 (Tex. App. 2007). However, other records existed, however, and they showed that the various transfers had left one of the companies undercapitalized. “Triple M Supply was then loaded with debt and subsequent creditors, including Norgips, were not paid back. McCarthy, however, was paid. This was the case even though significant deposits were made to Triple M Supply from customer payments from the sale of Norgips’s wallboard. As a result of these acts, Triple M Supply was left undercapitalized and without sufficient funding to pay its debts.” Id.
6. Kosanovich v. 80 Worcester St. Associates, LLC, 2014 Mass. App. Div. 93 (Dist. Ct. 2014) (citation omitted).