In this posting I will very generally explain how to properly use an LLC entity to keep potential litigation from piercing your corporate veil to collect assets that you personally own or that are owned by other LLC’s that you control. Initially, I will remind you that while the LLC formation should ultimately shield your personal assets or assets of your other entities; it does not prohibit someone from attempting to sue you individually or sue other entities. Keep in mind that if the veil is pierced in one LLC to where a creditor can attach their judgment against you personally, they can then go after all your assets –which includes the other LLC’s you hold in your name personally.
To explain, let us presume that one of your LLC’s is sued and the suing party wins. Once they receive a judgment on an LLC they are now a creditor of that LLC. The creditor will then execute that judgment on assets of the LLC by attaching them and liquidating
them through judicial sale or levying accounts that the LLC holds. After they have consumed all assets of the LLC, most creditors will look for a way to go after personal assets of the LLC holder. In order to do this, the creditor will have to bring an action in court
to “pierce the corporate veil.” Piercing of the corporate veil is not favored by Ohio law and according to Ohio Courts can only occur in certain situations. A judge will look to past case law and apply certain tests to determine if piercing the LLC veil is appropriate on a case by case basis.
Considerations by a Court When Considering Piercing a Corporate Veil:
1.) How is the suit framed – as a suit in tort or in contract? You cannot control how someone chooses to frame their suit, but if it is for a breach of contract, they will not be able to pierce the corporate veil, as their contract will be with the LLC. A tort is a cause of action that alleges a wrongful act or an infringement of a right leading to the actor having legal liability (but outside of any contract).
Torts include but are not limited to: Fraud, misrepresentation, defamation, interference with business relations, and infliction of emotional distress.
2.) Did you observe the corporate formalities? This factor has to do with how a business is run. The key point is did you keep your LLC in good standing with the Secretary of State (“SOS”). This requires you to keep your filing with the SOS current by filing updates on the correct Statutory Agent and their address, as well as paying the required renewal fees as the SOS dictates.
Otherwise this factor may apply if there is an Operating Agreement for the LLC and the owner did not observe the Operating
Agreement rules and procedures in conducting the business of the LLC.
3.) Was the LLC undercapitalized or without any assets? This factor directs the Court to determine if the capital invested in
the LLC is reasonable in relation to the liabilities of the LLC. There is no formula that courts use, just an inquiry into whether the LLC was purely set up as a “shell” that would leave potentially damaged parties with no ability to recover should the LLC cause harm. This is commonly resolved by having the LLC have some type of liability insurance in an amount that approximates the
potential for harm. An example might be an apartment complex that carries at least $250,000 liability policy with whatever other policies are being carried for loss of property.
4.) Did the owner of the LLC commit an act of fraud? This is fact intensive for the trier of fact (judge or jury) and
requires that fraud was committed by at least the LLC and possibly by some personal act of the owner. If the Court determines that the LLC committed an act of fraud, that may not in of itself allow the corporate shield be pierced. Fraud is a legal term with multiple definitions depending on the law it is being applied to, but generally it means to knowingly obtain, by deception, some benefit for oneself or another, or to knowingly cause, by deception, some detriment to another (ORC 2913.01).
5.) Did the owner of the LLC commingle personal funds with the LLC’s funds? The point here is to keep a separate existence between the LLC and the owner. Moving money from a personal account to a business one and back again without adequate business reasons or documentation is a common problem with LLC’s. Other than the fund that an owner uses to start an LLC, the only other funds from the owner to the LLC should be as loans (with proper promissory notes, etc.) or to purchase goods or services of the LLC. The only funds coming from the LLC to the owner should be as salary, reimbursement (use this rarely), or disbursements of profits (a dividend or distribution). Just writing a check to yourself from the LLC without documenting what it is for can give an appearance of co-mingling. Individuals commonly screw this up by having their LLC pay their personal credit card minimums or personal bills directly out of their business account.
I hope that you have found this helpful. Keep in mind that the above is just a cursory review of what you should consider in
protecting your LLC’s as a shield of your personal assets. It is not a complete list, but covers the most common ways that creditors have successfully pierced corporate veils to get at individuals personal assets. Ohio Law on this can change at any moment. This makes it imperative to have an attorney review your LLC or LLC’s you have created and the procedures you use in operating them.
In particular they should review your Articles of Incorporation and your LLC Operating Agreement to determine if they accurately fit your business and provide all the protections available by law.