Illinois Court of Appeals Permits Veil Piercing of Delaware LLC
The Illinois Court of Appeals, First District, found for the first time that the doctrine of piercing the corporate veil applies to Delaware limited liability companies. The holding has sparked discussion regarding the import of the case, the practical effect it will have on LLCs going forward, and how best to proceed in light of the ruling.
The Westmeyer Decision
In Westmeyer v. Flynn, 382 Ill.App.3d 952, 889 N.E.2d 671 (Ill. App. Ct. 1st Dist. 2008), Dorie Westmeyer, the former chief marketing officer of iMatchNetwork, LLC (“iMatch”), a Delaware LLC, won a wage claim by a default judgment against her former employer. In filing a verified complaint against members and managers of iMatch, she sought to pierce the corporate veil in order to collect the amount due under the default judgment. A principle of business organization law by which a court may circumvent the limited liability status of a corporation to impose personal liability on its shareholders, officers and directors, courts have long employed veil piercing against corporations, but no Illinois court had previously held it applicable against Delaware LLCs.
Westmeyer asserted the propriety of veil piercing in her case because (1) iMatch was undercapitalized, (2) the managers failed to observe business formalities, (3) iMatch was simply an alter ego of its members, and (4) the members operated iMatch in such a way as to perpetrate a fraud on its creditors. In the second count of her complaint, the plaintiff charged that the defendants transferred iMatch’s assets to themselves individually, in violation of the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et seq. In doing so, Westmeyer alleged that the defendants caused the LLC to become insolvent and prevented her recovery under the wage claim.
After the trial court dismissed Westmeyer’s complaint on procedural grounds, she appealed her case to the Illinois Court of Appeals. Relying on Puleo v. Topel, 368 Ill.App.3d 63, 856 N.E.2d 1152 (2006), the defendants asserted that the doctrine of piercing the corporate veil was irrelevant, as iMatch was a limited liability company. Basing her argument on persuasive authority of unreported decisions, decisions in cases of other states, and decisions not directly dealing with the veil piercing doctrine, the plaintiff convinced the Court of Appeals that sufficient authority exists to pierce the corporate veil of a Delaware LLC.
In so finding, the court noted that Puleo did not even address the matter of veil piercing, but that the key issue in that case was whether, under the Illinois Limited Liability Company Act, 805 ILCS 180/1-1 et seq. (the “Act”), a member or manager of an LLC could be held personally liable for the debts of the LLC when it was involuntarily dissolved. Further, the court in Westmeyer focused on section 10-10(c) of the Act, stating in part that “[t]he failure of a limited liability company to observe the usual company formalities…is not a ground for imposing personal liability on the members or managers for liabilities of the company.” What is not excluded by the Act are the other justifications for veil piercing, including, as the plaintiff alleged in the first count of her complaint, undercapitalization, alter ego, and fraud. In reversing and remanding the case, the court held that the veil of an LLC may be pierced when appropriate under Delaware law.
Evolution of the Limited Liability Company
A brief history of LLCs and the efforts to standardize the forms of LLC legislation is useful in understanding the practical import of the court’s holding and determining how best to proceed in view of the court’s pronouncement. Unlike the well-established structure of a corporation, the limited liability company is a relatively novel form of business organization in this country. Indeed, the first limited liability company act in the U.S., permitting a business organization to be taxed as a partnership but have the limited liability of a corporation, was passed in Wyoming in 1977. Keatinge, Robert R., et al., The Limited Liability Company: A Study of the Emerging Entity, 47 Bus. Law. 378, 383 (Feb. 1992) (citing Act of March 4, 1977, ch. 155, 1977 Wyo.Sess.Laws 512). Most of the past thirty years has been devoted to states drafting and implementing their individual LLC acts.
Realizing the significance of the emerging business form, the members of the National Conference of Commissioners on Uniform State Laws (“NCCUSL”) released the first Uniform Limited Liability Company Act in 1996 and the Revised Uniform Limited Liability Company Act (“RULLCA”) in 2006. In the revised version, the NCCUSL not only tried to “identify the best elements of the myriad ‘first generation’ LLC statutes and to infuse those elements into a new, ‘second generation’ uniform act,” but also commented on all sections and gave examples to clarify their intent. Revised Uniform Limited Liability Company Act, Prefatory Note (2006), available at http://www.law.upenn.edu/bll/archives/ulc/ullca/2006act_final.pdf. Section 304(b) of the RULLCA explains that an LLC’s members are not to be exposed to liability merely for the failure to observe corporate formalities. In the comments to the subsection, the commissioners note that “[t]he doctrine of ‘piercing the corporate veil’ is well-established, and courts regularly…apply [it]…to limited liability companies.” Id. at Comment to §304(b). Indeed, in explaining their application of the veil piercing doctrine to iMatch, the court in Westmeyer explained that, just as the members gain the benefit of the limitation of liability of corporations as it applies to LLCs, they are similarly liable for piercing of the corporate veil, when appropriate. Further, the comment addresses the fact that a failure to observe corporate formalities is the only ground listed for which you cannot impose liability on a member: “[t]his subsection does not preclude consideration of…disregard by an entity’s owners of the entity’s economic separateness from the owners.” Id. Although the doctrine has not been previously applied by Illinois courts to Delaware LLCs, it appears then that the holding in Westmeyer is part of a trend rather than an outlier.
Best Practices for Members and Managers
In light of the objective of the NCCUSL, the relative youth of the LLC as a form of business organization, and the willingness of some states and courts to pierce the LLC veil, we are likely witnessing mere growing pains of LLCs rather than a systematic legal attack on the limitation of liability. The court in Westmeyer carefully noted that its holding does not signal the end of a limitation of liability for LLC members and managers in all instances, but rather that members and managers must take precautions to preserve the limitation of liability.
Considering that veil piercing has long been applied to corporations, the members and managers of an LLC should follow the example of conscientious corporate directors and officers as to how they protect themselves from the liabilities of their businesses. Members and managers should ensure that the company is well capitalized. In day to day transactions, they must make certain that they are not treating the LLC as their alter ego, and that they are honest and forthcoming toward those with whom they do business so as to not be accused of perpetrating fraud on the creditors of the LLC. Finally, although failure to observe corporate formalities is clearly not grounds for imposing liability as discussed above, the safest option is for the members and managers to be fully observant of business formalities of the LLC. The power to safeguard the limitation of liability is in the hands of members and managers.
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