Delaware Chancery Reiterates High Burden To Justify Veil Piercing

corporate ceilThe Court of Chancery recently issued an opinion reiterating that “piercing the veil” of a Delaware LLC – meaning the court disregards an LLC and imposes liability on the underlying owner(s) – is an extraordinary equitable remedy. The court has the unusual power to design a remedy to address situations in which “the owner is utilizing the [LLC] form to perpetuate fraud or an injustice.” But the court is extremely reticent to apply veil piercing, as it consistently states in such cases, as “Delaware public policy does not lightly disregard [LLC’s] separate legal existence[.]”

Equitable remedies are used where no legal remedy is available but fundamental fairness demands that the court intervene. The court examines five factors in determining whether corporate veil piercing is appropriate: (1) whether the company was adequately capitalized for the undertaking; (2) whether the LLC was solvent; (3) whether LLC formalities were observed; (4) whether the dominant member(s) siphoned company funds; and (5) whether, in general, the company simply functioned as a façade for the dominant member(s). No one factor is determinative or sufficient, “but . . . some combination of them [is] required, and . . . an overall element of injustice or unfairness must always be present.”

The most common action seeking veil piercing relies on the “alter ego theory.” Under that principle, the LLC is nothing more than an alter ego for its owner(s), which encompasses elements of each of the factors. Under such a claim, “to pierce the corporate veil based on an agency or alter ego theory, the corporation must be a sham and exist for no other purpose than as a vehicle for fraud.”

In the case at hand, the plaintiff alleged that the veil piercing would be appropriate because the defendant is “the sole owner of [the LLC] and that he observed few if any corporate formalities.” Corporate formalities are key indicium of whether an LLC is a sham, but are not sufficient in themselves. The court concluded, however, that such an allegation “could be said of most single-member LLCs, particularly given the few statutorily mandated formalities imposed on those entities.” Thus, the court will give reasonable flexibility if formalities are the primary issue, but a failure to respect formalities coupled with a greater need for equity, given a harm demanding redress as a matter of fairness, formalities become critical. Formalities include things such as a separate bank account, minutes of meetings, Correspondence on company letterhead, contracts in the LLC name, etc.

The party seeking veil piercing also asserted that the sole member siphoned funds from the LLC, pointing to the fact that the LLC has “never maintained any reserves or operating capital” or maintained significant assets. Nothing in the filings, however, contained any allegation that the sole owner took funds out of the company for the purpose of concealing them or otherwise keeping them from redressing legitimate claims against the LLC.

The court concluded that the facts presented did not constitute “the exceptionally rare stuff of veil-piercing.” While this case reiterates the high standard required to sustain veil piercing, it also a reminder that personal liability can attach in cases where justice demands. For any other questions about LLC veil piercing and corporate liability, contact our office today.

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