The Innovator’s Counsel: LLC Basics – “Limited Liability,” What is it Good For?

Jeremy Weltman Uncategorized

It should come as no surprise that just because your business is registered as an LLC, you are not completely shielded from potential liability. Indeed, LLC stands for limited liability companies, reflecting the notion that perhaps some liability exposure remains. Section 22 of the Massachusetts LLC Statute, codified at  Mass. Gen. Laws c. 156C,  (“MA LLC Statute”) provides as follows:

Except as otherwise provided by this chapter, the debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities of the limited liability company; and no member or manager of a limited liability company shall be personally liable, directly or indirectly, including, without limitation, by way of indemnification, contribution, assessment or otherwise, for any such debt, obligation or liability of the limited liability company solely by reason of being a member or acting as a manager of the limited liability company.

So what does “except as otherwise provided by this chapter” mean? Under section 28, a member may be liable to the LLC for unpaid contributions and to creditors who relied on such contributions. Under section 35, members may also be liable to return distributions violating the operating agreement and to contribute to the return of such distributions by another member. Other exceptions are for fraudulent or criminal conduct or where a separate statute provides a basis for individual liability for certain entity actions in which the member actively participated or for which he/she was held personally responsible.

Even looking past the exceptions outlined above, if one were to read carefully between the lines, what section 22 really protects are members and managers against liabilities of the LLC only, not against their own liabilities – this is a distinction not many fully appreciate. By way of example, a member of a professional services LLC may be found personally liable for his/her own torts or malpractice. Under principles of agency law, a member acting on behalf of the LLC imputes liability to the LLC for his/her actions. However, section 22 does not provide that individual member a magic shield against liability for his/her own liabilities that do not arise out of his/her work as a member of the LLC. The real upshot here is that if there is an LLC comprised of a single owner with a nominal second member, in practice, the owner could be exposed to personal liability as a principal if he failed to transact business specifically through the LLC and, by extension, failed to maintain all corporate formalities to avoid opening the LLC up to an attack aimed at piercing the corporate veil.

All in all, the protection afforded LLC members in Massachusetts is superior to that afforded limited partners in limited partnerships, who can become personally liable for partnership obligations if they participate in management, or that afforded shareholders of corporations who must return distributions made when the corporation is insolvent, regardless of whether they knew about the insolvency (Mass. Gen. Laws c. 156B, § 45). Also, corporate directors are personally liable for distributions made during insolvency or distributions that violate the articles of organization (Mass. Gen. Laws c. 156B, § 61) and may also be liable for sales of stock for improper consideration (Mass. Gen. Laws c. 156B, § 60) and unpaid loans to insiders (Mass. Gen. Laws c. 156B, § 62). By way of comparison, managers of LLCs, for example, are liable only for distributions that violate the LLC’s Operating Agreement.

It is uncertain to what extent Massachusetts case law permitting creditors to “pierce the corporate veil” and reach individual shareholders of corporations will also be applied to LLCs. One might argue that because LLCs are a different form of organization formed under a separate statute, and section 22 of the MA LLC Statute is arguably more comprehensive than most corporate statutes, such corporate veil piercing case law carries little precedential value when it comes to LLCs. Indeed, other states have applied veil-piercing corporations law to LLCs without restriction. See, e.g., Ditty v. CheckRite, Ltd., Inc., 973 F. Supp. 1320 (D. Utah 1997) (court suggested veil-piercing theories could apply to LLCs); Tom Thumb Food Mkts., Inc. v. TLH Props., LLC, 1999 WL 31168 (Minn. App., Jan. 26, 1999) (state veil-piercing law applies to LLCs). Here in Massachusetts, when most recently faced with the question of an LLC’s individual member’s liability, the Massachusetts Appellate Division of the Boston Municipal Court upheld a trial court’s determination to pierce the corporate veil of an LLC that was established solely to sell a renovated condominium unit. In so doing, the court found the LLC’s sole owner personally liable because the owner had pervasive control of the LLC and failed to maintain proper corporate records and observe proper corporate formalities that arguably could have insulated him from personal liability. See  Kosanovich v. 80 Worcester St. Assocs., LLC, 2014 Mass. App. Div. 93 (2014).

Whether the Appellate Division’s Kosanovich decision foretells what other courts in our Commonwealth will do with questions centered on piercing the corporate veil of LLCs in Massachusetts remains an open question. Certainly arguments could be made distinguishing the extreme example of failure to maintain corporate formalities considered in Kosanovich. Regardless, the uncertainty outlined herein reflects the value in ensuring your LLC maintains accurate and proper corporate books and records so as to shield itself from a veil piercing attack down the road.