Wilmington North Carolina Business Law and Litigation Attorney Blog

Piercing the "Corporate" Veil of LLCs in North Carolina - Part 4

In the previous post, I promised a discussion of motions for sanctions pursuant to Rule 11 of the North Carolina Rules of Civil Procedure, in cases where LLC members are named as individual defendants in contract, fraud and Chapter 75 cases.

In North Carolina, the rule is straightforward:  an individual LLC member cannot be sued, except "by reason of his own acts or conduct."  See N.C.G.S. s 57C-3-30(a).  This section does not, however, establish an alter ego or veil piercing creteria.  It is intended to allow plaintiffs to recover for torts committed by LLC members, not, as some might have it, to establish member liability in actions against the LLC.

Clarifying this purpose, subsection (b) provides:  "A member of a limited liability company is not a proper party to proceedings by or against a limited liability company, except where the object of the proceeding is to enforce a member's right against or liability to the limited liability company."

This subsection should clarify any doubt a litigant might have about what subsection (a) allows. 

In Page v. Roscoe LLC, 128 N.C. App. 678, 497 S.E.2d 422 (1998) the plaintiff learned this lesson the hard way.  Plaintiffs sought to enjoin the defendant LLC from constructing a gas storage facility they deemed a nuisance.  LLC member Dale Bone was also named as a defendant.  No actions by Bone were alleged that were not also alleged to have been undertaken by the LLC.   Accordingly, the court held that naming Bone was a violation of Rule 11, on the theory that the complaint, in naming him, was not well grounded in law.

In so holding, the Court of Appeals agreed with the trial court, that "no acts by Bone, individually, were properly alleged. Therefore, under the above statute [N.C.G.S. s57C-3-30(b)], it was improper to name an individual member of a limited liability company as a party defendant without any evidence to support it.  As such, the naming of Bone as an individual defendant was not well-grounded in law and therefore a violation of Rule 11." 

The decision provides little guidance to a plaintiff hoping to pierce the corporate veil of an LLC.  There is no explanation about what would need to be alleged to state a complaint If anything, it provides broad grounds to support Rule 11 motions whenever an individual LLC member is named in the same complaint as the LLC.

Piercing the LLC Veil in North Carolina - Part 3

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 §§ 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.

Piercing the LLC Veil in North Carolina - Part II

The North Carolina Limited Liability Company Act protects LLC members from liability for the actions of the LLC.  N.C.Gen.Stat. § 57C-3-30(a) provides:

A person who is a member or manager, or both, of a limited liability company is not liable for the obligations of a limited liability company solely by reason of being a member or manager or both, and does not become so by participating, in whatever capacity, in the management or control of the business.

However, it is still possible for a member to incur liability, as noted in the final sentence of subsection (a):  A member or manager may, however, become personally liable by reason of his own acts or conduct.

The act does not, however, go on to define what sort of "acts or conduct" would cause a member or manager to become personally liable.  Litigants have sought to apply the traditional veil-piercing factors for corporations as a guide to piercing the liability protections of the LLC; and in some cases, have sought to use them as precedent.

Of course, such an approach misses the obvious:  an LLC is not a corporation.  They are different types of business entity altogether.  Just because the courts can look past a corporation's liability protection under certain circumstances, it does not automatically follow that those exact same circumstances should cause an LLC member to lose liability protection.

For one, the traditional "adherence to formalities" factor is not nearly the issue for LLCs that it is for corporations.  This makes sense, as the legislature, in enacting the LLC act, sought to offer entrepreneurs and business owners a simpler, more manageable type of entity that, unlike a general partnership, could still afford liability protection.  If "failure to adhere to formalities" were to be adopted in any type of veil-piercing test by the courts, doing so might well run afoul of the legislative intent behind the Act.  Surely this factor would be hard to implement as any kind of general factor in an LLC veil-piercing analysis.  While some LLCs could have significant formalities built into their operating agreements, it is not clear how any such provisions could be invoked by an outside party suing the LLC. 

In the next part of this article, I will review some of the other traditional corporate veil-piercing factors, and examine their applicability to LLCs.

Piercing the LLC Veil in North Carolina - Part 1

In North Carolina, litigants frequently seek to "pierce the veil" of limited liability companies, in order to reach the assets of individual members.  In Part 1 of this series, I outline the traditional approach to veil piercing in the corporate context, and how North Carolina construes the doctrine.

Historically the corporate veil can be pierced, and liability imposed on shareholders, when courts find sufficient evidence of a combination of the following factors:  (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. Glenn v. Wagner, 313 N.C. 450, 455, 329 S.E.2d 326, 330-31 (1985) (citing generally, Robinson, North Carolina Corporation Law §§ 2-12, 9-7 to -10 (3d ed. 1983)). 

In addition, North Carolina courts will "pierce the corporate veil" where an "individual exercises actual control over a corporation, operating it as a mere instrumentality[.]"  Becker v. Graber Builders, Inc., 149 N.C. App. 787, 790, 561 S.E.2d 905, 908 (2002) (citation omitted).  The North Carolina Supreme Court set forth the "instrumentality rule" as follows:
        "[When a] corporation is so operated that it is a mere instrumentality or alter ego of the sole or dominant shareholder and a shield for his activities in violation of the declared public policy or statute of the State, the corporate entity will be disregarded and the corporation and the shareholder treated as one and the same person, it being immaterial whether the sole or dominant shareholder is an individual or another corporation.  Henderson v. Finance Co., 273 N.C. 253, 260, 160 S.E.2d 39, 44 (1968).  Liability may be imposed on an individual controlling a corporation as an "instrumentality" when the individual had:
        (1)     Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and
        (2)     Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest and unjust act in contravention of plaintiff's legal rights; and
        (3)     The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of.
Glenn, 313 N.C. at 455, 329 S.E.2d at 330.

NEXT:  The North Carolina LLC Act, and its provisions relating to individual liability of LLC members.

Tips For Businesses: Getting the Most From Your Attorney

New York City business attorney Dan Abrams has published an article in the New York Enterprise Report called Getting the Most From Your Attorney.  I have linked to it here because it contains lots of helpful suggestions for business owners about how -- and when -- to make the best use of an attorney.  In the third item on Dan's list is one I always emphasize:

Use lawyers to prevent problems, not just fix them. Many small businesses do not have attorneys until they think they need them. You need to make sure you are proactive in identifying legal issues before they become problems, and problems before they become lawsuits.

I would personally prefer to have my days be filled with short, simple, inexpensive legal work that solves problems and ends them, instead of having them filled with long, complicated, intractable and expensive problems.  The latter might ultimately be slightly more lucrative for the attorney, but my view is that both myself and my clients are best served when the problems are handled while they are still small, manageable, easy to handle, and cost little to solve. 

North Carolina Law Holding CFOs Accountable for Unpaid Taxes Goes Into Effect

The North Carolina legislature's recent passage of a bill holding Chief Financial Officers personally responsible for delinquencies or errors in corporate taxes, has become law.  Senate Bill 242 amends G.S.§ 105-253 to include CFOs within the definition of "responsible officer" of a corporation (or member of an LLC) whose duties include deducting, accounting for, or paying withholding, sales and use, or motor fuel excise taxes.   The law went into effect as of January 1, 2008. 

World's Oldest Business Goes Out of Business

Japanese temple-building company Kongo Gumi has gone under, after 1,428 years in business.  The company was done in by two unrelated factors: (1) heavy borrowing in the 1980s to invest in real estate left the company with debt it could no longer service when the Japanese real estate market slowed down, and (2) a sharp decline in temple contributions since 1998. 

Kongo Gumi was a family-run business -- but unlike many such companies, it did not rigidly require that the company pass to the eldest son of the next generation.  Indeed, in several instances, women were installed as the top executive, as were sons-in-law, and in some instances, younger brothers, when it was shown that they were more fit to lead the company than their older brothers.

Moreover, the company's singular focus -- building Buddhist temples, and little else -- is credited for much of its success.  That the company delved heavily in real estate in the past few decades is cited as evidence that the company had lost sight of the prevailing philosophy and singular focus that had enabled it to thrive for a remarkable fourteen centuries.