Is Your Limited Liability Company Legally Protected?

 Many companies choose to conduct business through a separate legal entity, such as sole proprietorship, partnership, limited partnership, a corporation or, most recently where available, the Limited Liability Company (LLC). An LLC provides the freedom to structure management and financial interests and affords similar limitation on liability that had previously been available only to a corporation. An LLC is often the choice of homebuilders since they can form a "single purpose" entity, which applies to a particular project. This makes accounting, tax and other issues easy to track on a per-project basis (consultation with an accountant or other tax advisor is highly recommended).

One of the main reasons for forming an LLC is to protect the personal assets of the members against debt and liability of the LLC. This protection is often referred to as the "corporate veil." As long as the corporate veil is not pierced, the members' liability is limited to the amount of the investment or, in some circumstances, LLC disbursements.

It is important to remember that the act of simply forming an LLC is not the end of the process but, rather, the beginning. The LLC must be maintained and operated properly to ensure the individual asset protection offered by the corporate veil.

Claimants are increasingly filing suit against LLCs alleging an "Alter Ego" theory, which allows claimants to pursue the personal assets of shareholders if it is determined that the LLC was formed solely for the purpose of escaping liability. Depending on the facts of a case, the Court may determine that the LLC was a "sham," and merely an alter ego of individual members, so corporate protections may be eliminated. Courts will pierce the “corporate veil” to reach an equitable result when mandated by the facts.

Depending upon the state in which the LLC was formed, there will be specific case law that provides guidelines, which, if followed, reduce the risk of a creditor or claimant piercing the corporate veil to gain access to personal shareholders' assets. The following list, though not exhaustive, is representative of the minimum actions that should be taken by an LLC in order to reduce the chance of an alter ego ruling:

• Adequately capitalize the LLC.
• Maintain adequate general liability insurance.
• Validly issue stock.
• Maintain records of payment for stock.
• Maintain proper corporate protocol and governance by means of noticing and conducting, at a minimum, annual member meetings, along with maintenance of minutes.
• Manage the company through the appropriate members and maintain corporate status with your state’s Secretary of State.
• Do not commingle corporate and personal assets.
• Individual shareholders must not treat corporate assets as their own.
• When there are multiple entities involved, avoid having identical shareholders, directors, and officers; avoid using the same business location and employees for different corporations.
• Do not attempt to conceal or misrepresent identity of true owners.
• Do not personally guarantee any corporate obligation or debt.

These guidelines are well recognized and will reduce the risk of a claimant successfully piercing the corporate veil. However, there is another great risk to the corporate veil, particularly for homebuilders. In order to limit exposure, many builders consider winding down an LLC after the completion of a project. In addition to potentially violating a number of the guidelines listed above, there is a danger in winding down without proper long-term protections in place.

Even in the absence of fraud or deception, Courts may disregard a corporate entity if it is used to circumvent a statute or contractual obligation. Most states have a lengthy statute of repose for residential construction defect claims. Most states also have statutory “right- to-repair” or similar laws allowing the Builder the opportunity to repair problems prior to litigation, and many Builders also have contractual warranty obligations to buyers. A Builder who uses the LLC form and routinely closes its entities upon completion of projects, but fails to leave in place some method for handling warranty/defect issues, could be accused of circumventing a statutory and/or contractual obligation. A court might conclude that leaving the corporate veil in place would be inequitable to homeowners.

Pursuant to operative state guidelines, an LLC can be dissolved prior to the lapse of the applicable statute of repose. However, the LLC should ensure proper maintenance and operation of the entity to avoid the possibility that the veil may be pierced. For homebuilders, ensuring a long-term method of addressing homeowner defect complaints for the applicable statute of repose provides an additional safeguard against a claimant's attempt to eliminate corporate liability protection. Prudent LLC managers should take reasonable steps to implement a protocol to address statutory and/or contractual obligations that remain after the LLC dissolves.

By Roger Scouton, Esq.
Scouton & Scouton, LLP

2008 Copyright Scouton & Scouton, LLP