Academic journal article Fordham Journal of Corporate & Financial Law

DELAWARE LLCs AND VEIL PIERCING: LIMITED LIABILITY HAS ITS LIMITATIONS[dagger]

Academic journal article Fordham Journal of Corporate & Financial Law

DELAWARE LLCs AND VEIL PIERCING: LIMITED LIABILITY HAS ITS LIMITATIONS[dagger]

Article excerpt

I. INTRODUCTION

This article discusses the application of veil piercing to limited liability companies ("LLCs") organized under the Delaware Limited Liability Company Act1 (the "Act"). The doctrine of veil piercing permits courts, under some circumstances, to disregard an entity's form and the protections from personal liability otherwise accorded to equity holders.2 The Act itself does not address veil piercing and the courts of Delaware have not ruled definitively on the issue. Nevertheless, there is ample reason to conclude that some form of veil piercing is applicable to Delaware LLCs.

The doctrine of veil piercing has been the subject of numerous judicial decisions and scholarly commentary in other contexts, albeit not entirely eliminating ambiguity even in those contexts.3 The doctrine most often arises in connection with plaintiffs' attempts to hold corporate shareholders liable for the debts of the corporation.4 In order to make some observations regarding the applicability of veil piercing to LLCs, and particularly Delaware LLCs, one must consider the limited liability provisions of the Act as well as relevant judicial decisions and scholarly commentary.5

II. LIMITED LIABILITY COMPANIES-GENERAL

LLCs represent a hybrid between corporations and partnerships.6 They are specifically authorized by, and formed under, the Act.7 Depending on the provisions of the entity's limited liability company agreement, also known as an "operating agreement," management rights may be vested in either managers or members, and may be centralized or decentralized.8 Most LLCs are closely held and member-managed.9 Limited liability for members and managers, pass-through income taxation, flexibility in defining rights incident to membership interests, as well as broad latitude in allocating profits and losses are among the more prominent characteristics of LLCs.10

The LLC form of business organization is relatively new in the United States.11 As a result of changes in federal tax regulations that ensure partnership tax treatment in most cases, as well as a number of other advantages over corporations, LLCs have become increasingly popular in recent years.12 Delaware is often considered the jurisdiction of choice for forming LLCs due to its well-developed body of business law and business-oriented courts and legislature.13 The law regarding many LLC issues, including veil piercing, however, still is in the process of development and evolution.

In any discussion of LLCs it must be emphasized that although the Act contains a number of important provisions, the Act leaves many of the details regarding particular LLCs and the relationships among the parties to the parties themselves.14 The Act itself emphasizes the principle of freedom of contract and the enforceability of operating agreements.15 In reality, LLCs therefore are largely creatures of contract.16

III. LIMITED LIABILITY UNDER THE ACT

While the Act provides great flexibility for members and managers to define their relationship to the LLC and to each other, it also contains several provisions that address their liability, or lack thereof, to third parties. The following sections describe the Act's core limited liability provisions.

A. Members and Managers

Limited liability is a critical component of the Act. Particularly, section 18-303 of the Act states that except as otherwise provided by the Act, the "debts, obligations and liabilities of a limited liability company, whether arising in contract, tort or otherwise, shall be solely the debts, obligations and liabilities" of the LLC.17 Section 18-303 of the Act further provides that no member or manager shall be "obligated personally for any such debt, obligation or liability . . . solely by reason of being a member or acting as a manager" of the LLC.18

Thus, according to the Act, an LLC is responsible for its own debts and obligations, and members and managers should have no liability for their activities relating to the LLC. …

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