LLCs – Mind your ABCs
A recent case out of Bucks County, Pennsylvania is a reminder that under the right circumstances a court can disregard the corporate form, even an LLC, and find individuals personally liable for the corporation’s debts. Power Line Packaging, Inc. v. Hermes Calgon/THG Acquisition, LLC, et al., 2010-02341(Bucks County Court of Common Pleas, J. Gilman, decided 9/30/2015).
In this case, the defendants induced the plaintiff to manufacture defendants’ product line and then never paid the plaintiff. Normally, only the limited liability company would be liable for the debt, but the judge found two of the individual defendants personally liable under the doctrine of “piercing the corporate veil.” The doctrine applies if a court finds that the entity: (1) is grossly undercapitalized; (2) fails to adhere to corporate formalities; (3) has substantial intermingling of corporate and personal affairs; and (4) is used to perpetrate a fraud. Power Line Packaging, Inc. v. Hermes Calgon/THG Acquisition, LLC, et al., 2010-02341, (Bucks Co. Court of Common Pleas, J. Gilman, decided 9/30/2015).
The court found that all four factors were present in this case. Even though the defendants requested that the plaintiff purchase the component parts for the defendants product line, the defendants stated that the the LLC was never capitalized because there were no capitalization needs of the company. To make matters worse, the principals of the LLC were made distributions to themselves so that the LLC became insolvent and could not pay the plaintiff. In addition, the operating agreement of the LLC was not followed, The court found that Several of the named directors did not participate in the management of the LLC. There were no director meetings and no minutes from any company meeting. Although one of the individual defendants was not a member, a director or unit holder of the LLC, he was the principal person in charge of the LLC and had financial control over the company. Two principals did not make any capital contributions to the LLC, but received significant distributions to the detriment of the plaintiff.
A principal of an LLC should keep the following rules in mind in operating the LLC:
1. You must remain separate and distinct from the company. You cannot use corporate funds for your own personal benefit, particularly at a time of financial distress for the company.
2. Although a limited liability company in Pennsylvania does not have the same formalities as a regular corporation, if there is an operating agreement, follow it!
3. You cannot make misrepresentations to induce another to take action, and then try to use the LLC to shield yourself from personal liability. In this case, the principals made misrepresentations to the Plaintiff about alleged commitments to sell the defendants’ product line, which induced the Plaintiff to begin manufacturing the defendants’ product line. This type of behavior will get you in hot water.
We Are Family – Not
In Schwartz v. Philadelphia Zoning Board of Adjustment, 1334 C.D. 2014 (Pa. Cmwlth. Ct., filed September 24, 2015), the Commonwealth Court had the opportunity to wrestle with the definition of “family.” The petitioners owned single-family houses and rented them out to Drexel University students. The Philadelphia Zoning Code defined “family” as a “group of persons living as a single household unit using housekeeping facilities in common, but not to include more than three persons unrelated by blood, marriage or adoption.” The petitioners were cited for violating the Zoning Code, and litigation ensued. The petitioners argued that: (1) the definition of “family” should be subject to “strict scrutiny” under the Constitution; (2) the definition of “family” is unconstitutional; and, (3) the trial court erred when it found that the evidence did not demonstrate that the use of the property by more than three unrelated persons was functionally equivalent to a single-family use of the property.
The Commonwealth Court first reviewed the case law concerning the level of scrutiny to be applied by the courts, and concluded that the definition of family that restricts the number of unrelated persons who may cohabitate in a single-family residence is not subject to strict scrutiny under the Pennsylvania Constitution. Instead, the zoning ordinance should be reviewed under the lesser standard of the rational basis test.
Second, the Commonwealth Court held that using relationships such as blood, marriage and adoption to limit the use of a single-family residence is not on its face unconstitutional. But, a court also needs to analyze the ordinance provision in the context of the record to make sure that the ordinance provision is not unconstitutional when applied to the specific use at issue.
Based on the record in this case, the Commonwealth Court found that the petitioners did not demonstrate that the definition of “family” was unconstitutional as applied to their use of the property. On the one hand, the evidence showed that the students living in the house cooked, dined and did chores together. On the other hand, the evidence also showed that during the lease term, two roommates moved out, and two new roommates moved in. While the Commonwealth Court found that the evidence supported a determination that the individual residents have formed a single-household unit, the definition of “family” caps the number of unrelated persons that can function as a single unit. The petitioners still have to prove by substantial evidence that their use of the property is equivalent to the use of the property by a group of persons that are related by blood, marriage or adoption. The Commonwealth Court found that the petitioners did not meet that burden.