Can You Be Held Personally Liable for Your LLC’s Debts?
Entrepreneurs who create a limited liability company (LLC) are protected from putting their personal assets at risk for business debts. Right? After all, that’s the main purpose of the LLC. “Limited liability” is even in the name.
Well, not always. There are situations in which a member of an LLC is not protected and can be held personally responsible for business debts.
Today we’re going to look at a 2019 case from the South Carolina Court of Appeals, Johnson v Little (read it here), that touches on a number of issues that are important for business owners to know, including limited liability and breach of contract.
Johnson v Little: The Facts of the Case
Robin Johnson of CQI Pharmacy Services, LLC and Robert Little of CQI Oncology/Infusion Services, LLC, had a rather unusual situation. Both were the sole owners of their companies and at the same time were employees at the other’s company, with the power to write checks from the other’s business.
In spring 2013, Johnson paid invoices in the amount of $25,568.59 to settle vendor accounts for Little’s company, CQI Oncology. At some point, Little removed Johnson as an authorized signatory for his business and the checks Johnson had signed and sent to the vendors ended up not going through.
Shortly thereafter, the two entered into a contract for Johnson to purchase assets of Little’s company for the price of $30,000. The contract stated that “the Property is free and clear of any liens or encumbrances” but due to the bounced checks, that turned out not to be the case. Johnson discovered that the invoices were still outstanding and that as the new owner, she owed the outstanding amount to the vendors.
Johnson sued Little for breach of contract, among other things. The matter was tried by a master, who found in favor of Johnson. An appeal followed.
The Three Elements of Breach of Contract
The master found that the following three elements of breach of contract were satisfied in this situation:
- There was a valid contract. Neither party disputed this.
- There was a breach of the contract. The contract contained language stating the Property was free and clear of “encumbrances” when that was not true. The outstanding invoices were a clear encumbrance. Little tried to argue this point unsuccessfully.
- There were damages resulting from the breach. Johnson had to pay the vendors’ invoices herself, costing her over $25,000.
All three criteria must be satisfied in order to find a breach of contract occurred, as they were in this case.
The standard remedy for a breach of contract is for the breaching party to reimburse the nonbreaching party so that it’s as if the breach had never happened. The Court of Appeals reaffirmed this standard in this case, by rejecting the master’s decision to award Johnson an additional $30,000 above the amount of the invoices. This would have put her in a better position than she would have been had the breach never occurred, which violates the general rule for breach of contract remedy.
A Lesson on the Limits of Limited Liability
Now we come to the part about personal liability for company debts. In the appeal, Little argued that the master erred in finding him personally liable in addition to his company. The contract he entered into with Johnson was done so and signed by Little as the sole member and manager of the LLC, and as an individual.
This is so important, it bears repeating: Little entered into the contract and signed it as a representative of his LLC and on his own behalf.
The Court of Appeals states that because Little “was a party to the contract as an individual and his actions caused the contract to be breached, the master did not err in holding him individually liable.”
A simple lesson here is to always sign anything relating to your business as the LLC’s owner. When signing a contract or endorsing a check, include the full name of the LLC and sign as “John Q. Smith, Manager.” Sign a company check (which already has the LLC’s name on it) with your name and role.
Other Limits of Limited Liability
If Little had signed only as a member/owner and not as himself, could he still have been found personally liable? Possibly. In its decision, the Court of Appeals cites a 2012 South Carolina Supreme Court case, Dutch Fork Dev. Grp. II, LLC v. SEL Props: “as a matter of law, a manager of a limited liability company can wrongfully interfere with his company’s contracts and be held individually liable for his acts.” In the case at hand, the Court did determine that Little’s actions constituted “wrongful interference” with the company contracts, whether he signed the contract as an individual or not.
Another way a business owner may be held personally liable is if they commit a tort, or wrongful act, such as fraud. Liability can also be suspended due to piercing the corporate veil. Learn more about this important concept on our blog, here.
Get Help with Contracts Strategic Business Advice
This is just a brief overview of the ways in which an LLC owner may be held personally liable for business debts, and the true lesson is that business law is often not as straightforward as it appears. For that reason, it’s smart to have an experienced business attorney in your corner who can provide you with strategic business advice like Gem McDowell.
Gem is a problem solver and a business attorney with over 25 years of experience who can advise you whether you’re looking to buy a company, start a new company, or grown an existing company. Call Gem and his associates at their Mt. Pleasant office at 843-284-1021 to schedule a free consultation today and get the help you need.
Why You Need to Keep Separate Businesses Separate
In the business world, it’s not uncommon for people to own stakes in multiple enterprises and take on various roles in different companies. This doesn’t often cause problems, but it can. When the lines between companies, roles, and interests are blurred, it can lead to a determination of amalgamation, which can be used to pierce the corporate veil and end an individual’s liability protection.
Amalgamation as a Way to Pierce the Corporate Veil (PCV)
The “corporate veil” is a metaphorical term for the liability protection covering owners and managers of certain business entities like corporations and limited liability companies. Piercing the corporate veil, then, refers to when the court removes that liability protection, making managers and owners liable for the company’s debts and more. (Learn more about piercing the corporate veil here on this blog.)
One way South Carolina courts can PCV is through demonstrating amalgamation. A 1986 South Carolina Court of Appeals case, Kincaid v. Land Dev. Corp., first addressed the “amalgamation of interests” theory, but it was only last year, 2018, that the South Carolina Supreme Court recognized amalgamation as a way to PCV, in the case Pertuis v. Front Roe Restaurants, Inc. (Read more about Pertuis here on this blog.)
Amalgamation is also called the “single business enterprise theory” because it has to do with multiple businesses acting as one. Essentially, when multiple businesses operate as if a single business, they may be treated by the court as a single business, rather than distinct businesses.
What Amalgamation Is and What It Requires
In Pertuis, the South Carolina Supreme Court stated “where multiple corporations have unified their business operations and resources to achieve a common business purpose and where adherence to the fiction of separate corporate identities would defeat justice, courts have refused to recognize the corporations’ separateness […]”
So there are two parts to determining amalgamation:
- Multiple corporations must have unified their operations and resources to achieve a common purpose, and
- Justice would be defeated if the corporations continued to be treated as if separate
To this second point, the Supreme Court said that intertwined operations aren’t enough to show amalgamation, requiring “further evidence of bad faith, abuse, wrongdoing, or injustice resulting from the blurring of the entities’ legal distinctions.”
The Supreme Court, importantly, also stated “we acknowledge that corporations are often formed for the purpose of shielding shareholders from individual liability; there is nothing remotely nefarious in doing that.”
Case in Point
A recent Court of Appeals case also looked at this issue of amalgamation, in Stoneledge at Lake Keowee v. IMK Development. (You can find the full PDF of the Court’s opinion here.)
Briefly, the HOA of a development in Oconee County sued Marick, Integrys Keowee, IMK, and other parties over defects causing leaks in the development’s townhomes. Marick, a construction company, and Richard Thoennes, one of its principals, appealed.
Among many other issues, Marick and Thoennes appealed the trial court’s finding that Marick, Integrys Keowee, and IMK were amalgamated, arguing they were distinct and separate entities.
The Court of Appeals affirmed the trial court’s decision. Here is just some of the testimony the Court cites as evidence of amalgamation between the three:
- They were “corporately affiliated” under the umbrella of IMK
- They passed corporate funds directly between one another
- They allowed individual members to operate as dual agents without distinction as to which business they represented at any given time
- IMK was created to hold title to Stoneledge project, Marick was to do construction, and Integrys Keowee was to provide the investment, and then split the profits
- Thoennes knew about the defects that (in the Court’s words) “plagued the project,” but was still involved with IMK and Marick’s marketing and sales, demonstrating “their operations were clearly in pursuit of a common business purpose, albeit to the detriment of the HOA members.”
The Court found “evidence of a unified operation” between the parties “as well as evidence of self-dealing,” satisfying both parts required to show amalgamation.
How You Can Avoid PCV Through Amalgamation
Refer to the post on this blog about PCV for what you can do to help maintain the liability protection your company offers you.
If you have other questions about liability protection, amalgamation, PCV, or business law, contact the Gem McDowell Law Group in Mt. Pleasant, SC. Gem and his associatess can help you navigate business law, which can be complex. Call today to schedule an initial consultation at 843-284-1021.
Are You Protected? What You May Not Know About “Piercing the Corporate Veil.”
One of the first things to do when going into business is to select the appropriate business structure for your venture and set it up correctly. A primary advantage of doing so is gaining the protection of the entity so that your personal finances are safe from being used to settle company debts or pay the company’s bills. Having the right business structure also allows for the business to be considered a separate entity, with its own income and debts separate from other businesses that you may also own.
But don’t assume that just because you’ve set up a legal structure that you and your business are fully protected; that protection is only valid if you follow all the rules. In other words, you are not guaranteed liability protection just because you have created a limited liability company or a corporation. (Note that sole proprietorships and partnerships do not offer the same liability protection and so are excluded from this discussion.)
Today we’ll look at the concept of “piercing the corporate veil” (PCV), which is when a court suspends the liability protection your business entity gives you, what it means, and how you can avoid it.
What Can Happen When You Fail to Keep Business and Personal Accounts Separate
One of most important ways to maintain your personal liability protection is to be scrupulous about keeping business and personal finances separate. Maintain separate checking and savings accounts and use different credit cards for your business and for yourself. The key idea is not to “commingle” your personal finances with your company’s finances. You pay your own bills from your personal account and you make sure to pay the company’s bills from the company’s account.
Let’s say you aren’t meticulous about keeping finances separate. Then your business hits a rough patch and is unable to pay a debt it owes. Since your finances aren’t separate, it may look like you and your business are essentially the same, and you personally may be on the hook. Your assets – including investments, cash, your car, and your house – could be taken to satisfy your company’s debt. That’s why it’s crucial to keep separate accounts.
What Can Happen When You Fail to Keep Individual Businesses Separate
PCV isn’t just an issue of separate business from personal accounts. It’s also a matter of keeping businesses distinct from each other.
Imagine a scenario like this. Alpha Corp. and Bravo Corp. are run by the same management group. About 60% of the shareholders are the same between the two, as well. Alpha Corp. runs into trouble and needs to pay a creditor immediately, but has no money. No problem, because Bravo Corp. has plenty of money. Bravo Corp. writes a check directly to pay Alpha Corp.’s debt.
The companies have now commingled funds. When this happens, they may be considered “alter egos” of one another under the alter ego doctrine, a.k.a. the instrumentality rule. Here are two examples of what can happen next:
- Three shareholders of Bravo Corp. who are not also shareholders of Alpha Corp. are, understandably, not happy that Bravo’s funds are being used to pay off Alpha’s debts. They bring a type of lawsuit called a derivative action against the management group arguing that there’s one giant pool of money, and the companies are in fact not separate.
- Another creditor sues Alpha Corp. for not paying its debt. During discovery, it’s determined that Alpha and Bravo have commingled funds. Now Bravo Corp. can be compelled to pay Alpha Corp.’s debts, as the two are alter egos.
It’s not just about money, either. Even seemingly simple things as sharing the same mailing address, office space, and letterhead may lead to trouble, as the “blurred identity theory” addresses situations where individual businesses don’t have individual identities. The two companies may be confused with each other as their identities are “blurred” into one another.
Proving PCV in Court
The concept of piercing the corporate veil (also known as “lifting the corporate veil”) was put to the test in the 1976 case that originated in South Carolina, DeWitt Truck Brokers v. W. Ray Flemming Fruit Co. The U.S. Court of Appeals for the Fourth Circuit upheld the District Court’s decision to pierce the corporate veil and impose individual liability on the owner. Flemming was found personally liable for debts owed by his company after it was discovered the business did not follow basic corporate protocols and that he, as the dominant shareholder, had drawn a salary, leaving the company undercapitalized and in debt.
In its decision, the court reiterated that while it recognizes a corporation is a separate entity that’s distinct from its owners and officers, it can “decline” to recognize that autonomy when doing so would “produce injustices or inequitable consequences.” Still, it will do so “reluctantly” and “cautiously.”
Bases for PCV noted in the DeWitt decision include:
- Fraud
- Inadequacy of capital
- Complete domination of the corporate entity
- Instrumentality theory (discussed above)
- Failure to observe corporate formalities
- Non-payment of dividends
- Insolvency of the debtor corporation at the time
- Siphoning of funds by the dominant shareholder
- Non-functioning of the other officers and directors
- Absence of corporate records
- Existence of the corporation as a façade for the operations of the dominant stockholder(s)
Ultimately, the court may pierce the corporate veil when “a number” of the above factors exist in order to right an injustice or unfairness.
How to Avoid PCV
You can make it less likely for a plaintiff/complainant to win (and less likely to sue in the first place) over this issue if you follow proper procedures.
- Keep finances separate between individual and company or company and company
- Move funds between entities through loans or other above-the-board methods
- Keep distinct business identities through separate addresses, trademarks, letterheads, etc. for each company
- *Hold regular shareholder meetings
- *Keep minutes
- *Pay dividends if applicable
*Applicable to corporations, not LLCs.
It’s not difficult to follow protocols to avoid PCV, it just takes discipline. When people get lazy and let basic things slip, that’s when problems arise.
Speak with a corporate attorney about your business
This is a very general overview of some elements of PCV; the topic is extensive and can become very complex. Maintaining the liability protection your business entity gives you is one of the most important things you can do. Make sure you’ve got your bases covered by speaking with a corporate attorney like Gem McDowell.
Gem handles a wide range of corporate law issues and advises on business matters. Contact Gem at their Mount Pleasant office today by calling (843) 284-1021 or filling out this contact form online. They are ready to help you with your business.
