The Corporate (or LLC) Veil: “sufficient corporate formalities were followed”

An interesting article at Lexology, regarding the fact that, as the title says, “Creditors Find Piercing the Corporate Veil is Not So Easy.” The piece tells the story of three different cases involving disgruntled plaintiffs suing either a corporation (2 cases) or an LLC (1 case), under the so-called “piercing the veil” theory. That theory basically says that if someone is basically hiding behind the facade of a corporate business form (or an LLC) when, in fact, the business is really no more than an individual, with one foot inside the corporation and one foot out.

As the opening paragraph explains:

[V]eil piercing is an equitable remedy only rarely allowed by courts and is limited to situations in which the corporation’s principals (or parent company) (i) so dominated the corporation that they can be said to be the “alter-ego” of the corporation; and (ii) misused the corporate entity to perpetrate a fraud or crime or otherwise work an injustice. A number of factors have been found relevant to a veil piercing analysis, including whether the corporation is undercapitalized, whether the corporation failed to observe corporate formalities or failed to maintain corporate records; whether the debtor corporation was insolvent; whether the corporation’s funds were siphoned off by the dominant shareholder; and whether the corporation served merely as a façade for the operations of the dominant shareholder or shareholders. (Emphasis supplied)

Though veil piercing sounds good and reasonable in theory, the veil is more teflon than chiffon. Take the LLC case for example:

The court [in Ossa v. Kalyana Mitra LLC, a New Jersey case noted that “sufficient corporate formalities were followed.” Apparently, the record showed that at least some regular corporate practices had not been observed but the court did not find them troubling, given the “documentation of minutes of meetings, notes, and agendas, and tax and bank records indicating that company funds were not siphoned for personal use.” The documents, in fact, showed that Miller was using the money to repay her husband’s company, which was one of Kalyana Mitra’s creditors. (Emphasis supplied)

Sufficient is apparently sufficient, but my advice continues to be, make the letter (and spirit) of the corporate form your mantra; otherwise, that protective veil may disappear just when you need it most.

 

To C or LLC? That’s Today’s Question

I just read an interesting post over at The Startup Law Blog, a post written six years ago. The writer lists “12 Reasons For A Startup Not To Be An LLC.” The key word in that post is “startup,” and key thing to understand is the author’s audience, largely captured in the following paragraph from the post:

For tech or growth companies planning to follow the traditional path of regular and ongoing equity grants to employees, multiple rounds of financing, and reinvestment of as much capital into the business as possible, with the goal of an ultimate sale to a big, maybe public, company in exchange for cash and/or stock, LLCs are typically not the way to go.

If that paragraph describes you, then maybe the C corporation should be the entity of choice for you.

As for the C corp, the author makes another important point. We’ve all heard that one reason–if not the major reason–to avoid the C corp is the possibility of double taxation. Well, maybe:

The bogeyman that you will hear about most frequently is the “double tax” bogeyman. You will be told—don’t form a C Corporation because you will be subject to a double tax.

What is meant by this is that if the C Corporation makes money, it will pay tax on that money. And if it pays dividends to its shareholders, they will pay tax on the dividends. This is true. And so if you anticipate your business being a cash cow, and immediately generating so much money that you will earn more than you can reasonably pay out in salary to the owner executives, then maybe an LLC is a good choice for you. But for most growth businesses, whose goal is to raise capital, reinvest capital, grow fast, grant equity incentives, and ultimately be acquired or go public, a C Corporation is the way to go.  For these businesses, the double tax bogeyman rarely appears, and most exits are structured as one layer of tax stock sales. (Emphasis supplied)

In the end, the real lesson, make that two lessons, from the blog post is that one size doesn’t fit all and that there are lots of questions to answer on the road to choosing an entity for your new business venture.

Will you know the answers? Better yet, do you know the questions?

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