The Innovator’s Counsel
Q. Are small to mid-sized business owners’ personal assets protected when they operate as an LLC?
A. An LLC does not completely guarantee that a business owner’s personal assets are protected from creditors. Piercing the Corporate Veil is one instance where a business owner may be at risk.
When Is the Doctrine of Piercing the Corporate Veil Applied?
Under generally accepted legal principals, a corporation is a separate legal entity from its shareholder(s), and individual shareholders are not liable for corporate debts, including judgments and liability against the corporation. Evans v. Multicon Const. Corp., 30 Mass. App. Ct. 728, 732 (1991). However, Massachusetts courts have carved out certain circumstances in which the Court may disregard the corporate form and hold shareholders of a corporation individually liable for the debts, judgments and obligations of a corporate entity. Id. This result is accomplished through application the legal doctrine of piercing the corporate veil.
Traditional rules of Massachusetts common law permitted utilization of the doctrine of piercing the corporate veil in two distinct circumstances. Id. The first occurred when the evidence of the case shows that there is active and pervasive control of related business entities by the same controlling person and there is a fraudulent or injurious consequence by reason of the relationship among those business entities. Id. The second situation occurred when there is a confused intermingling of two or more entities engaged in a common enterprise with substantial disregards of the separate nature of the entities, or serious ambiguities about the manner and capacity for which the various corporations and their respective representatives are acting. Id. at 732-733, quoting My Bread Baking Co. v. Cumberland Farms, Inc., 353 Mass. 614, 620 (1968) (hereinafter “My Bread Baking”.
The 12 Factor Test for Piercing the Corporate Veil
After My Bread Baking, the courts at both Federal and state levels established a common outline of analysis in the form of a set of 12 factors that should be considered in determining whether piercing of the corporate veil is appropriate in any given case. Indeed, in Pepsi-Cola Metropolitan Bottling Co. v. Checkers, Inc., 754 F.2d 10 (1st Cir. 1985), the Federal Appeals court for the First Circuit stated that when considering whether the corporate form should be disregarded, the court should consider:
- common ownership of the related entities;
- pervasive control;
- confused intermingling of business activity assets, or management;
- thin capitalization;
- nonobservance of corporate formalities;
- absence of corporate records;
- no payment of dividends;
- insolvency at the time of the litigated transaction;
- siphoning away of corporate assets by the dominant shareholder(s);
- nonfunctioning of officers and directors;
- use of the corporation for transactions of the dominant shareholders; and,
- use of the corporation in promoting fraud. Id. at 14-16.
This 12 factor consideration was specifically adopted by the Commonwealth in Evans v. Multicon Constr. Corp., 30 Mass. App. Ct. 728, 733 (1991). It is not necessary for all 12 factors to be satisfied in order to justify piercing of the corporate veil; however, piercing of the corporate veil is more likely to be granted where more factors are satisfied than not. Evans, 30 Mass. App. Ct. at 736 (“the exercise is, of course, not one in counting. One examines the twelve factors to form an opinion whether the over-all structure and operation misleads.”)
Ultimately, in applying the 12 factor test of Pepsi-Cola Metropolitan Bottling Co./Evans to the facts of any given case, while it is not strictly an “exercise in counting,” the Court does heavily consider how many of the 12 factors can be established in making a determination as to whether it is appropriate to pierce a particular corporate veil. This being the case, each of the 12 factors should be individually considered and thoroughly vetted on a case-by-case basis, as often, the decision as to whether to pierce a particular corporate veil is incredibly fact specific.
Understanding Your Business Exposure and Minimizing Your Personal Risk
To this end, for a small to mid-sized business owner who has literally put everything into his or her business (and, as a result, is often the sole person in charge of the business, its operations and its success), consulting with an attorney experienced in business litigation and overall business exposure risk-management before a creditor seeks to pierce your business’s corporate veil is the best way to minimize your individual exposure both now and down the road as your business continues to grow and thrive. In my practice, I have advised many innovators and business owners (for businesses of all sizes) that believe they are protected through the corporate form alone. These innovators and business owners come to me exclaiming disbelief that the formation of an LLC – that is, a limited liability corporation – does not offer the bullet proof shield against liability of their personal assets from the creditors of litigation. Unfortunately, where a corporation, LLC or any other business form is not in compliance with the 12 factor test outlined in Pepsi-Cola Metropolitan Bottling Co./Evans, these same innovators and business owners may find their personal pockets open to the satisfaction of judgments rendered against the corporate form in Court.
- Often referenced as the pinnacle Massachusetts case for the proposition that corporations are generally to be regarded as separate from each other and from their respective stockholders, but only “where there is no occasion to look beyond the corporate form for the purpose of defeating fraud or wrong, or for the remedying of injuries.” Id.