Biz Brief: Recent Case Affirms the Importance of Corporate Formalities for LLCs
An Ohio appellate court recently held in Denny v. Breawick, L.L.C., 2019-Ohio-2066, that the doctrine of piercing the corporate veil applied, and found the sole member of two limited liability companies was personally liable for a judgment. This case, although not binding in our Circuit, is a reminder of the importance for maintaining corporate formalities.
In Ohio, the test to determine whether one may pierce the corporate veil has three basic elements: “(1) control over the corporation . . . was so complete that the corporation has no separate mind, will, or existence of its own, [“alter ego”], (2) control over the corporation . . . was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and (3) injury or unjust loss resulted to the plaintiff from such control and wrong.” Belvedere Condominium Unit Owners’ Assn. v. R.E. Roark Cos. Inc., 67 Ohio St.3d 274, 275, 617 N.E.2d 1075 (1993). California’s test is similar.
In the Denny case, the court found that the contractor failed to maintain any corporate formalities. For example, the LLCs paid the contractor’s personal expenses, the contractor did not even have his own bank accounts, and the LLC failed to maintain any corporate records. The court also found that the contractor engaged in illegal acts by failing to provide the home construction services for which he was hired in a workmanlike manner and by charging the homeowner for excessive costs without approval. Finally, the court found that the homeowner incurred significant expenses as a result of the contractor’s actions. The court held that all three prongs had been satisfied, which justified piercing the corporate veil.
In California, to pierce the corporate veil one must show: (1) there is such a unity of interest and ownership that the individuality, or separateness, of the person and entity has ceased and (2) adherence to the fiction of separate existence would sanction a fraud or promote injustice. Adobe Sys. v. My Choice Software, LLC 2014 U.S. Dist. Lexis 161059, at *10-12 (N.D. Cal, San Jose Div, 2014). California courts will consider several factors but one of those is whether the entity maintained corporate records. Associated Vendors, Inc. v. Oakland Meat Co., 210 Cal. App. 2d 828 (1962).
While LLC’s are not required to have annual meetings like corporations, other corporate formalities still apply. The “ease” of maintaining an LLC contributes to its appeal (there is no annual meeting requirement and statements of information are due every other year). On the other hand, these “relaxed” requirements should not be misinterpreted as a free pass to disregard formalities. This includes the importance to document actions that are outside of the ordinary course of business through appropriate minutes. As members of an LLC, it is essential to respect the separateness of the entity and maintain good records. Failing to honor these formalities could result in serious consequences and the Denny case is great reminder.