Piercing the Veil of a Limited Liability Company

Ways to prevent from LLC getting pierced.

Piercing the Veil of a Limited Liability Company


Maintaining Formalities

The main advantage offered by limited liability companies (LLC) is that they can operate with fewer formalities than a corporation, thereby enjoying greater flexibility in management and business dealings. Furthermore, the members of the LLC are shielded from personal liability for the debts and obligations of other members and the business itself.

However, in order to enjoy this limited liability protection, the members are required to establish, operate, and maintain the LLC as a separate entity. Although LLCs are not required to maintain as many corporate formalities as corporations, courts can still “pierce the corporate veil” and hold the members of the LLC liable for debts, obligations and even torts of the LLC.

The standards for piercing the veil for both corporations and LLCs are unclear and vary among jurisdictions. For example, some states’ LLC statutes specify the application of corporate veil piercing case law to LLCs (California, Colorado, Minnesota, North Dakota, Wisconsin) and other state statutes specify that liability will be as set forth in the operating agreement (New York); some courts (New York and Maine) have articulated specific criteria to pierce the veil, and other courts (Delaware) have not.

While there are no clear-cut rules, it is worth noting that courts are becoming reluctant to recognize the LLC as a separate entity that offers limited liability protection to its members when the members themselves do not operate the LLC as a separate entity.

Therefore, to ensure this does not happen:

• The LLC should maintain books and business records which evidence, among other things, the observance of certain corporate formalities, including a record of regular meetings and any actions taken by written consent;

• Any payment made to or by the LLC must be property documented and made in accordance with the operating agreement;

• The LLC should have its own bank account, separate from its members;

• There cannot be any commingling of the LLC’s funds and assets with the personal funds and assets of its members; and

• The LLC must be adequately capitalized.

Once the purpose of the limited liability company is determined, the operating agreement should set forth the general business of the limited liability company to define the "ordinary" business. In a member-managed limited liability company, the members of a limited liability company are liable for the acts of other members in the ordinary course of limited liability company business. In a manager-managed limited liability company, the managers of a limited liability company are liable for the acts of other managers, but not the members, in the ordinary course of limited liability company business. Defining the business of the limited liability company in the operating agreement will help to limit liability of the managers in the case of a manager-managed limited liability company, or the members in the case of a member-managed limited liability company, for the acts of other managers or members, respectively, by limiting what constitutes the ordinary business of the limited liability company.

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