In most cases, we use LLCs for business structures. You can elect the tax treatment for an LLC. That’s another conversation, but the LLC gives you the flexibility you need.
The LLC, though, is held as the best structure because it will both protect your personal assets from a judgement that may occur related to the business or property within the LLC and it will protect your business or property from a judgement that may occur related to your personal situation.
The story doesn’t end there, though. It’s not enough to just set up an LLC and everything is safe forever more. In fact, we’re seeing a growing number of cases trying to break through the LLC protection. This is called “piercing the corporate veil.”
How Attorneys Are Piercing the Corporate Veil for LLCs
One of the popular methods used to pierce the corporate veil is to prove the “alter ego.” Once the alter ego is proven, the creditor can enforce the judgement against the company’s individual owners and avoid the default rule respecting the separateness of an entity and its owners.
Let’s look at some current rulings.
In Orozco v WPV San Jose, LLC, the LLC signed the lease (the owner signed, as a manager/member of the LLC) but the owner signed the personal guaranty. In this case, the LLC was separate from the guaranty. So that means, the notification is enough to prove that the owner doesn’t have risk unless he or she has a personal guaranty.
When a creditor pierces the corporate veil, all the personal assets of the owner are at risk. We are now seeing more and more “reverse veil piercing”. In this case, the judgement is against the owner and when the corporate veil is pierced, the LLC (or corporate) assets are at risk. Some jurisdictions don’t allow this, but more and more are. The best way to avoid this issue is to keep your corporate veil in place.
Make Sure Your LLC is Properly Capitalized
In the Triyar Hospitality Management, LLC v WSI – HWP, LLC, the court addressed how “money shuffling” can lead to alter ego liability.
WSI had a judgement against Triyar but was unable to collect any of the money. WSI then filed to add the owners, who were brothers, to the judgement. If they were successful the brothers’ assets would be used to pay the judgement.
As part of the trial, one of the brothers stated “It’s not as formal as…having to abide by some operating document. …We borrow from these family entities quite often and repay.” In other words, they move money between other entities and from their personal funds to Triyar as needed. There are no formal agreements. The entities all had the same address and shared common employees. The brothers had also personally funded the litigation with WSI.
This is where the problems were. There was no legal documentation and even more so, alter ego liability can be imposed if the legal entity is so undercapitalized that it is likely to not have enough funds to meet debts
That was the main problem with Triyar. They weren’t a legitimate entity. They needed funds from the brothers and other entities in order to pay their bills.
The court concluded: “The (brothers) …. represented that they would be personally liable for Triyar’s debts... Now that the bill has come due, they should not be able to avoid that responsibility.”
We’ve always needed to have entities sufficiently capitalized in order to prove they are legitimately. However, owner laziness or just not wanting to put a bunch of money into a business account often means that the owners make last minute loans, as needed.
Failure to adequately capitalize your business leads to a huge risk that your business will be considered an alter ego. And that means it’s wide open for a judgement. And as we’re seeing more and more, it means both risk to your personal assets from a business judgement and also a risk of your business assets from a personal judgement
The Moral of the Story
Property follows corporate formalities. And that includes not just setting up the LLC correctly, but also running it correctly.
That’s just one of the topics that we discuss as part of the Wednesday Coaching sessions. Join today!