{"id":6790,"date":"2014-03-18T08:10:55","date_gmt":"2014-03-18T15:10:55","guid":{"rendered":"http:\/\/www.keytlaw.com\/azllclaw\/?p=6790"},"modified":"2019-06-15T07:39:23","modified_gmt":"2019-06-15T14:39:23","slug":"piercing-the-veil","status":"publish","type":"post","link":"https:\/\/www.keytlaw.com\/azllclaw\/2014\/03\/piercing-the-veil\/","title":{"rendered":"What is Piercing the Veil of an LLC & Why is Do You Need to Understand It?"},"content":{"rendered":"

Question<\/strong>:\u00a0 I have heard the term “piercing the veil” of a corporation or a limited liability company.\u00a0 What does the term mean and why do owners of LLCs need to understand it?<\/p>\n

Answer<\/strong>:\u00a0 “Piercing the veil” means that a court disregards the shield or veil created by state law that says the owners of a corporation or an LLC are not liable for the debts of the entity.<\/p>\n

Example 1<\/strong>: Homer Simpson’s LLC called World Wide Widgets, LLC, borrowed $25,000 from Ned Flanders.\u00a0 The LLC signed the promissory note, but Homer didn’t.\u00a0 The LLC does not pay.\u00a0 World Wide Widgets, LLC, doesn’t have any assets so Ned knows if he gets a judgment against the LLC he can’t collect it.\u00a0 Ned never gets his money.<\/p>\n

Example 2<\/strong>:\u00a0 Same facts as Example 1, but in operating the LLC Homer did not follow Arizona LLC law and did not follow proper procedures.\u00a0 Ned sues the LLC and Homer and asks the court to pierce the veil and hold Homer liable for the LLC’s debt.\u00a0 The court finds there are grounds to pierce the company veil and holds Homer personally liable for the LLC’s $25,000 debt.\u00a0 This is the bad result for the LLC member and frustrates the reason people form an LLC, i.e., to protect themselves from liability for the debts of the LLC.<\/p>\n

Jay Adkisson, a nationally known asset protection lawyer, said the following in response to a recent court ruling in a case called Shermane Hector v. Mo\u2013Dad Environmental Serv., LLC<\/a>:<\/p>\n

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The veil-piercing\/alter ego challenges to LLCs are going to be interesting because they start out with the intended lack of formality of corporations, and then their owners often get loosey-goosey about how the company is operated, how it is capitalized (and continues to be capitalized), etc.\u00a0 IMHO, the real challenge for planners is not so much in the meticulous drafting of LLC management agreements and the like, but in the education of owners as to how the entity needs to be run after all the ink dries<\/strong>.<\/p>\n<\/blockquote>\n

How true.\u00a0 The vast majority of people think that if they file the Arizona Corporation Commission’s fill in the blanks form Articles of Organization they are home free and their life savings are protected from the LLC’s debts.\u00a0 Ignorance may be bliss, but ignorance of the legal concept called “piercing the company veil” can cost LLC members big bucks.<\/p>\n

Most people who form an LLC don’t know that they must comply with Arizona’s LLC law or risk a court piercing the veil and holding them liable for the LLCs debts.\u00a0 For example, Arizona LLC law requires that every Arizona LLC maintain certain records.\u00a0 If you own an Arizona LLC don’t you think it would be a good idea to comply not only with that statute, but other Arizona LLC laws too?<\/p>\n

The\u00a0Shermane Hector v. Mo\u2013Dad Environmental Serv., LLC court said this about veil piercing:<\/p>\n

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Some of the relevant factors considered in determining whether to apply the alter ego doctrine include: commingling of corporate and shareholder funds; failing to follow statutory formalities for incorporating and transacting corporate affairs; undercapitalization; failing to maintain separate bank accounts and bookkeeping records; and failing to hold regular shareholder and director meetings”<\/p>\n<\/blockquote>\n

In forming 10,000+ Arizona LLCs I learned a long time ago that I must educate my LLC clients about Arizona LLC law.\u00a0 I accomplish this two ways:<\/p>\n