What Non-Asset Protection Planning Lawyers Don’t Know about Limited Liability Companies

Today, with the proliferation of books, articles and seminars focused on asset protection planning, there is scarcely a lawyer about who does not know that limited liability companies have some built in asset protection planning features. Even to the uninitiated, there is a vague understanding of creditors not being able to seize a member’s interest and some awareness of the charging order remedy.

What non-asset protection lawyers often fail to realize and worse yet, fail to advise their clients, is that it is essential that the LLC not transact any business with its members and absolutely not pay any bills or expenses of its members. Too often we encounter situations where significant assets reside in an LLC that would have been unreachable by the members’ creditors. However, as a result of poor management of the LLC and foolish decisions by the members, the creditors are able to access the LLC’s assets for purposes of paying the LLC’s indebtedness to them. Based on how the LLC has been operated, the creditors will contend that the LLC is the alter ego or nominee of the members or that the circumstances compel that the veil of the LLC be pierced. Finding in favor of the creditors could result in the personal assets of the members becoming exposed for claims against the LLC.

The recent Maryland case of Serio v. Baystate Properties, LLC effectively tees up the latter issue. Baystate entered into an agreement with Vincent Serio, as managing member of Serio Investments, LLC, to build several houses for him. The houses were built and later sold by Serio Investments but it failed to satisfy its obligations to Baystate. Baystate knew it could not collect from the LLC as it was bankrupt so it sued Vincent Serio, the single member of Serio Investments, in his individual capacity. The only way Baystate could recover from Vincent would be if it could pierce the corporate veil and make Vincent liable for the debts of the LLC. Failing that, if Baystate could prove that the LLC was Vincent’s alter ego, Vincent would likewise be held liable for the LLC’s debts.

Cases such as this are very fact specific. In reversing the lower court’s decision, the Maryland appellate court held that the corporate veil will not be pierced to redress the breach of a contractual obligation in the absence of fraud (note that courts frequently look to corporate law precedent with regard to veil piercing since the subject has a long history and they find little difficulty applying the same concepts to LLC’s). Despite several facts that the plaintiff pointed out to support its claim that the veil of Serio Investments should be pierced, the court showed a great reluctance to do so. In fact, the court very narrowly construed the “paramount equity” rule which the lower court had applied. The lower court stated that there was no fraud present to justify a piercing but there were sufficient facts to establish a paramount equity and that there would be an inequitable result involving fundamental fairness if the corporate veil was not pierced. The appellate court disagreed and held that shareholders generally are not held individually liable for debts or obligations of a corporation except where it is necessary to prevent fraud or enforce a paramount equity. But it went on to state that “the standard has been so narrowly construed that this court has not found an equitable interest more important than the state’s interest in limited shareholder liability.” In other words, limited liability trumped paramount equity.

As to the alter ego theory, the Court stated that “it is only with great caution and only in exceptional circumstances could a corporate entity be disregarded. There would have to be a finding that (i) there was complete domination so that the corporate entity as to this transaction had no separate mind, will or existence of its own, (ii) that such control was used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or dishonest and unjust act in contravention of the plaintiff’s legal rights and that (iii) such control and breach of duty proximately caused injury or unjust loss.”

All in all a very powerful debtor-oriented case and one that should be cited by asset protection planning lawyers when similar situations arise.

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