Nason Yeager Shareholder, Domenick Lioce, a contributor to
the drafting of the recent amendments to the Florida LLC Act, recently wrote an article which will be published in the Florida Bar Tax Section Bulletin about piercing the corporate veil of single member limited liability companies. See below:
THE LATEST IN THE SAGA OF THE PIERCED VEIL OF A SINGLE-MEMBER LIMITED LIABILITY COMPANY (SMLLC):
THE GREENHUNTER CASE
Piercing the veil of an entity is a case which a court decides to lookthrough the fiction of a company (corporation or LLC) to hold the owner liable for the company’s debts. While the Revised Uniform Limited Liability Company Act provides in Section 304(b):
“The failure of a limited liability company to observe any particular formalities relating to the exercise of its powers or management of its activities is not ground for imposing liability on the members or managers for the debts, obligations or other liabilities of the company.”
The new Florida Limited Liability Company Act, under Section 608.701, law provides:
“In any case in which a party seeks to hold the members of a limited
liability company personally responsible for the liabilities or alleged
improper actions of the limited liability company, the court shall apply the case law which interprets the conditions and circumstances under which the corporate veil of a corporation may be pierced under the law of this state.” Two rules, the “instrumentality rule” and “identity rule” have been developed to determine when a court can pierce the corporate veil.
- The instrumentality rule requires proof of three elements: (i) complete dominion and control of both the entity’s policy and business practices; (ii) use of such control to commit fraud or wrong, breach of a legal duty, or a dishonest or unjust
act (such as using such control to avoid personal liability previously assumed by an individual); and (iii) the aforesaid control and breach of duty proximately caused the injustice or loss.
- The identity rule is generally employed in a situation where two corporations are, in reality, controlled as one entity because of common owners, officers, directors or shareholders, and because of a lack of observance or corporate formalities between the two entities.
The seminal “corporate veil piercing” case in Florida is Dania Jai-Alai Palace, Inc. v. Sykes, 450 So. 2d 1114 (Fla. 1984), which holds that corporations are legal entities distinct from shareholders and the corporate veil will not be pierced either at law or in equity unless the plaintiff proves the corporation was organized or used to mislead creditors or to work fraud upon them.
The following factors are generally used to conclude the veil piercing:
- Inadequate capital
- Diversion of assets from the company to its owners or other party, detrimental to its owners
- Failure to maintain arm’s-length relationships among related parties
- Commingling of funds
- Non-payment of dividends (most appropriate in reverse piercing cases)
- Non-functioning management
- Failure to observe “corporate” formalities
- Insolvency of one debtor
- To sanction a fraud or promote injustice
Last year, the Wyoming Supreme Court, in Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc. (2014 WY 144), eased the requirements of a court to pierce the veil of an SMLLC subsidiary. In this case, the court found that the SMLLC had no capital, no cash, bank accounts had been intermingled with its sole member, that the SMLLC was insolvent, had no employees and was run by its sole member’s employees and that the SMLLC had been
“misused” by employing tax breaks without bearing any responsibility for the company’s obligations. It is important to note that no actual fraud or other wrongdoing was found by the
court. However, the court found that:
“The facts were such that an adherence to the fiction of its separate
existence would, under the particular circumstances, lead to injustice, fundamental unfairness or inequity.”
This is a step further than the old rule of actual fraud or injustice. It only requires that the circumstances could “lend to injustice, fundamental unfairness or inequity.”
And while it is not an easy task to pierce the veil in Florida, care must be taken in advising clients about how to operate their SMLLC. I find most clients taking a cavalier approach in entity maintenance, which could end up causing a lot of problems for them in court.
They should be aware of each of the factors that can make them a target for piercing.
Domenick R. Lioce attended undergraduate, graduate and legal education at Florida State University (B.S., 1973; M.A., 1978; J.D., 1979). Mr. Lioce has been a Certified Public Accountant in Florida since 1976. Florida Bar Association: Member of the Tax Section, Past-Chairman of the Tax Section Board of Directors; American Association of Attorney-CPA’s: Past President of the National Board of Directors and Member of the Executive Committee, Member of the Board of Directors of the Florida Chapter; Member of the Board of Directors of the Florida Lawyers Mutual Insurance Company; Director and Past President of Palm Beach Tax Institute; Author and Speaker on numerous tax topics, including ESOPs and Captive Insurance Companies. Mr. Lioce is rated AV (the highest rating possible) by the Martindale-Hubbell Law Directory, with a Peer Review Rating of 5.0 out of 5.0.