As I touched on in previous posts, in North Carolina, the factors to consider in determining whether to pierce the corporate veil include: (1) inadequate capitalization; (2) non-compliance with corporate formalities; (3) complete domination and control of the corporation so that it has no independent identity; and (4) excessive fragmentation of a single enterprise into separate corporations. See Ridgway, 329 S.E.2d at 330-31 (citing generally, Robinson, North Carolina Corporation Law ยงยง 2-12, 9-7 to -10 (3d ed. 1983)).
Yesterday in Part 2 of this series, I looked at the second factor - non-compliance with formalities. Today I will look at the first factor above, inadequate capitalization.
One common misconception surrounding this factor is the timing of its applicability. Litigants frequently assume that when a bill is unpaid, that this fact, standing alone, establishes inadequate capitalization, regardless of how old the business entity may be.
But in fact, inadequate capitalization only applies to the initial capitalization of the corporation; a new corporation must have sufficient capital with which to pay for operating costs that it can reasonably expect to incur. Over time, however, creditors have the opportunity to examine the creditworthiness of the corporation, and in extending credit, have the option of requiring a guarantor. For these reasons, courts are not especially prone to give great weight to this factor in most contract cases, particularly when those contracts were formed well after the corporation has been in business for some length of time.
Moreover, by itself, this factor is extremely unlikely to support a veil-piercing claim. An additional showing of an intent to use the corporate entity to defraud creditors would almost certainly be required.
In the LLC context, it is quite tempting to seek to apply the same rationale. Although there do not appear to be any published North Carolina cases specifically addressing this issue under the LLC Act, there is no reason why the policy of protecting creditors from fraud would be any less important - or treated differently - in situations involving LLC creditors.
For attorneys defending LLCs in contract, fraud and/or Chapter 75 cases in North Carolina, it is important to be aware that plaintiffs will attempt to allege these factors in order to reach the assets of the individual members of the LLC, and that courts could well be persuaded to overlook the LLC's protection in cases where undercapitalization is alleged. This is why a motion to dismiss should be filed, and the court made aware that there is no precedent for applying these factors to pierce an LLC. Even if the motion is unsuccessful, the rationale behind it can be re-employed when your opponent is seeking to draft a jury instruction at trial. The judge might not have granted your motion, but may be unwilling to instruct a jury on a doctrine whose applicabilty to an LLC has not been clearly established.
Absent specific facts alleging fraud by a member, a motion to dismiss as to the LLC members should be filed, along with a motion for sanctions under Rule 11.
In the next installment in this series, I will go into further detail about Rule 11 and how it applies to contract, fraud and Chapter 75 suits involving individual LLC members.
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