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.