The Michigan Limited Liability Company Act (“LLC Act”) extends absolute immunity to members of a limited liability company (“LLC”) from the liabilities of the entity “unless otherwise provided by law.” The LLC Act arguably does not permit a court to extend the doctrine of “piercing the corporate veil” to LLCs. However, many courts have extended the doctrine to LLCs and found members or managers personally liable for the debts of the LLC when fairness or justice requires. While there is no absolute test for when courts will impose personal liability on members of an LLC, courts may “pierce the LLC veil” when there is no real separation between the LLC and its members, the member’s actions were dishonest, involved self-dealing or were fraudulent and the LLC’s creditors suffered an unjust loss. Members of LLCs can take proactive measures to minimize the possibility that a court will “pierce the LLC veil” and find them personally liable for the LLC’s obligations. Some of these steps include:
- Adequate Capitalization. The LLC members must commit adequate capital to the LLC to ensure that the LLC can meet its ongoing obligations to creditors and pay for the LLC’s basic operating needs including insurance, rent, debt obligations, payroll and purchase of inventory. If the LLC makes commitments knowing that the LLC does not have money to pay the obligations, a court may view this as grounds to “pierce the LLC veil”.
- Follow Company Formalities. The LLC should have an operating agreement. Absent an operating agreement, the LLC Act will control how the LLC is governed. The LLC members should then strictly comply with the operating agreement, including provisions on member meetings, voting and approval of manager decisions. The LLC should keep minutes of meetings, voting and company decisions. Failure to follow company formalities as documented in the operating agreement or the LLC Act, is a factor courts consider in deciding to “pierce the LLC veil.”
- Don’t Commingle Business and Personal Assets. The LLC should set up bank accounts, in the name of the LLC, separate from its members. The personal funds of the members and the LLC funds should not be commingled. Distributions to members and managers should be documented, whether in the operating agreement or employment agreement, as appropriate, and should be authorized as required by the operating agreement. The LLC should establish appropriate controls on disbursements, such as expense and reimbursement policies.
- Sign Contracts on behalf of the LLC. A member signing a contract on behalf of the LLC should sign in his or her capacity as member or manager. The member should only sign on behalf of an LLC in existence, and not on behalf of an LLC that is yet to be formed or that has liquidated. In addition, the member must make sure the LLC has approved the transaction in accordance with the operating agreement. While a member would not typically be personally liable for contractual obligations of an existing and operating LLC (absent a guarantee), if the member does not sign in an official capacity on behalf of an operating LLC, a court may look at agency principles to support “piercing the LLC veil” to hold an unauthorized agent liable for documents allegedly signed on behalf of a the LLC.
- Avoid Self-Dealing. The law gives judges great discretion to fashion remedies when the judge believes fraud or other wrongdoing has occurred. A court is more likely to pierce the LLC veil to promote fairness and justice. To that end, courts may view self-dealing of any kind such as improper distributions and reckless borrowing as factors supporting piercing the LLC veil. In addition, making misrepresentations to third parties about the LLC’s financial condition in order to obtain financing or other accommodations may support grounds to pierce the LLC veil. Accordingly, LLC members and managers should be cautious in their actions, avoiding any course of conduct that could be perceived as dishonest or self-dealing, and subject any potentially questionable transactions to the appropriate LLC member and manager approvals.
In conclusion, members and managers of LLCs should not assume that by setting up an LLC structure, they are protected from individual liability. In order to protect the limited liability, members and managers must structure and operate the LLC so that it is truly separate from the individuals owning and running the LLC. This “separateness” should also be documented. Finally, members and managers should avoid any perception of dishonesty, fraud or self-dealing with respect to the LLC’s operations. The above steps are just a few of the actions that members and managers should take to avoid a court potentially “piercing the LLC veil”. While there is no guarantee of protection from a veil-piercing action, by understanding and taking proactive steps to avoid such an action, members and managers can help ensure that if a veil-piercing action is brought, they are well-positioned to succeed in defending such an action.