Operating LLCs

Lack of Business Records Leads Massachusetts to Pierce LLC’s Veil

In Kosanovich v. 80 Worcester Street Associates, LLC, the Massachusetts Appellate Division ruled that a single-member LLC’s veil should be pierced because of poor record keeping.  This case is particularly interesting because it seems inconsistent with previous rules and cases.

Here, the plaintiff bought a condominium from the single-member LLC.  In the agreement between the parties, the LLC was to repair any defects of the condominium within one year of the purchase date.  The LLC then failed to repair some of the defects, and the plaintiff sued for breach of contract and breach of an implied warranty.  The judge not only sided with the plaintiff, but also pierced the veil, holding the member of the LLC personally liable.  On appeal, the court started with the veil-piercing rule which states that the veil should only be pierced to defeat fraud or injustice.  Then, the court listed 12 factors that determine if piercing the LLC’s veil was justified.  These factors include:

  • (1) common ownership,
  • (2) pervasive control,
  • (3) confused intermingling of business assets,
  • (4) thin capitalization,
  • (5) nonobservance of corporate formalities,
  • (6) absence of corporate or LLC records,
  • (7) no payment of dividends or distributions,
  • (8) insolvency at the time of the litigated transaction,
  • (9) siphoning away of corporation’s funds by dominant shareholder or member,
  • (10) nonfunctioning of managers, or officers and directors,
  • (11) use of the corporation or LLC for transactions of the dominant shareholders or members, and
  • (12) use of the corporation or LLC in promoting fraud.

The court noted that when analyzing these factors, the veil-piercing was justified.  In particular, the court looked to the pervasive control and poor record keeping to support the trial court’s decision.  The court suggested that the poor record keeping applied to the other factors, since the LLC member could not provide documents convincing the court otherwise.

This decision seems odd because this case was not regarding fraud or injustice (the reason the court stated that veil-piercing should exist).  Also, the burden of proof in this case seemed to have shifted to the LLC member by suggesting that it was this duty to keep good records to show that the 12 factors weighed in his favor.  Still, one of the ways to prevent a veil piercing is to formally treat the LLC as a business.  This means keeping good books and records, and following the formalities of ordinary businesses.

By |2016-12-13T21:20:16-07:00February 25th, 2014|Categories: Operating LLCs|0 Comments

Can a California LLC Have Officers Such as a President?

Question: Can an California limited liability company have a President, Vice President, Chief Executive Officer or personnel with other titles?

Answer: Yes. California Revised Uniform Limited Liability Company Act Section 17704-07(v) provides that California LLCs can have officers such as a President, Vice President, Secretary, Treasurer, CEO or CFO if officers are authorized in the LLC’s Operating Agreement.  If there is no Operating Agreement or the Operating Agreement is silent as to officers and the LLC is manager managed, the managers can appoint officers.

California Revised Uniform Limited Liability Company Act Section 17704-07(w) states that a contract signed by a California LLC’s President, Vice President, Secretary, Treasurer, chair person of the Board or Chief Financial Officer is not invalid unless the act is prohibited in the LLC’s Articles of Organization or the other party to the contract knows the LLC’s officer does not have the authority to sign the contract.

If your LLC will have people serve as President or CEO the LLC’s Operating Agreement should contain provisions that create the positions, give names to the positions and describe the duties associated with the position.  FYI:  Our custom Operating Agreement gives you the option to add one or more positions such as President and have appropriate language inserted into the Operating Agreement.

Caution:  If you or your company will enter into a contract with a California LLC you should always ask the LLC to give you a copy of resolutions signed by all the members of the LLC (or the minimum number of members necessary to approve the contract) that authorizes the LLC to enter into the contract.  The resolutions should always specify the name and title of the person who will sign the contract for the LLC.  If the members of World Wide Widgets, LLC, give a copy of such a resolution to you then you will know that Homer Simpson, as President of the LLC, as the power to sign the contract on behalf of the LLC.

See “President of Corporation Personally Liable for Signing Contract.”

By |2016-12-13T21:20:16-07:00February 9th, 2014|Categories: FAQs, LLCs & Corporations, Operating LLCs|0 Comments

Amended Indemnification Provision does not Eliminate Previous Obligation

An LLC’s Operating Agreement can modify basic functions of LLC members or managers.  This includes indemnification clauses which may require the LLC to indemnify members or managers against lawsuits.  In Branin v. Stein Roe Inv. Counsel, a disagreement arose when the LLC amended the indemnification provision.  Unlike the old provision, the new indemnification rules prevented an employee from being indemnified in certain circumstances.  That employee, Francis Branin, filed suit arguing that his original indemnification rights should not be replaced by the new amendment.  The Delaware Court of Chancery agreed.

In this case, Branin was being sued by his former employer for soliciting former clients.  After 10 years of litigation, the charges were eventually dismissed.  In this interim period, the LLC which Branin worked for changed their indemnification clause in the operating agreement.  This second version of the indemnification clause was much more stringent, and would not cover Branin’s $3million legal fees.  The question then became the following: Does the second version of the indemnification preclude the indemnification allowed under the original clause?

The court decided that the first agreement included an enforceable indemnification clause.  Also, after looking to previous cases involving indemnification clauses, the Delaware Court of Chancery ruled that the right to be indemnified vests when the initial lawsuit was filed.  Due to Branin’s right being vested under the first version of the indemnification provision, the second version had no effect.  This shows that LLCs cannot rid their responsibility to indemnify once the provision has been triggered.  Therefore, LLCs should design these types of clauses carefully and not blindly accept a boilerplate indemnification clause which may expose the LLC to more liability than desired.


By |2016-12-13T21:20:16-07:00January 25th, 2014|Categories: Operating LLCs|0 Comments

Pre-2014 California LLCs & RULLCA

Question:  I formed my California limited liability before January 1, 2014, the date on which the new California Revised Uniform Limited Liability Company Act (“RULLCA”) became effective.  Does my LLC have to file any document with the California Secretary of State as a result of the new law?

Answer:  No.  California LLCs created before January 1, 2014, do not have to file an amended Articles of Organization or any other document as a result of the new California RULLCA.

By |2015-04-30T19:17:34-07:00January 1st, 2014|Categories: CA Law, FAQs, Operating LLCs|0 Comments

President of Corporation Personally Liable for Signing Contract

Improperly Worded Company Contracts can Cause Signer to be Liable

One of the primary reasons people form limited liability companies and corporations is to protect the owners from the debts and liabilities of the company. The general rule of California law is that the members of a California LLC and the shareholders of a California corporation are not liable for the company’s debts. One of the biggest exceptions to this rule arises when an owner signs a contract and becomes personally obligated to pay the company’s debt.

The Personal Guaranty

The most common type of contract that obligates an owner of a company to pay the company’s debts is called a “guaranty” or “personal guaranty.” A guaranty is a contract by which the signer/guarantor promises to pay or satisfy the debt of another person (the company). Guaranties are frequently required by landlords and lenders who know that if the company doesn’t pay, the debt will never be paid.

Contracts that Create Personal Liability

Owners and employees of a company can create contractual personal liability for themselves if they sign a contract on behalf of the company, but the wording of the contract does not make it clear that the signer is signing on behalf of a company.

If the signer of an LLC or corporate contract wants to avoid becoming personally liable for the debts of the company created in the contract, the language in the contract must clearly state that the party is the LLC or corporation and indicate the capacity of the signer.

Iowa limited liability company and corporate attorney Marc Ward reports on a recent Iowa case that where the court found that the person who signed a two page contract on behalf of a corporation was personally liable to pay the corporation’s debt under the contract.

The Iowa Court of Appeals opinion in Builders Kitchen and Supply Co. v. Moyer, N0. 0-655/09-0194 (September 2, 2009) is a deceptively simple case. On the one hand it represents the folly of not having even run of the mill contracts reviewed by lawyers before they are signed. And on the other hand, it is a warning to lawyers that things aren’t as simple as they appear.

Unfortunately for Moyer the contract contained a clause that said “I hereby personally guarantee to pay on demand any and all sums due that my/our company shall fail to pay.”

Mr. Moyer did not sign the signature block for the personal guaranty, but the court found he was liable anyway.

Proper Way to Sign Contracts

Right Way to Designate the Company in a Contract:

World Wide Widgets, LLC, a California limited liability company.

Note the LLC after the name and the written out “limited liability company.” Make sure both the abbreviation and the full designation are used. Typically the proper designation of the company should be in the first paragraph and in the actual signature block where the signer signs. If it is not, the signer should hand write the missing information above where he or she signs and/or on the first paragraph where the company is named.

Right Way to Designate the Capacity of a Signer in a Contract:

Homer Simpson, President (for a California corporation), or Homer Simpson, Manager (for a manager-managed California LLC), or Homer Simpson, member (for a member-managed California LLC).

Wrong Way to Designate the Company in a Contract:

World Wide Widgets

Wrong Way to Designate the Capacity of a Signer in a Contract:

Homer Simpson.

Beware of Personal Guaranty Language in the Contract

If a contract contains any language that would cause the signer to be a guarantor and impose personal liability on the signer, the signer who wants to avoid personal liability must take a pen and cross-out or strike-out all of the guaranty language. If you are signing a contract, you must read it and strike-out any language you don’t want and write on the document any additional language you want. You can modify with hand-written changes all pre-printed contracts before signing.

By |2017-10-05T10:36:19-07:00January 1st, 2014|Categories: Asset Protection, LLCs & Corporations, Operating LLCs|0 Comments

Can My California LLC Do Business in Another State?

Question:  If I form a California limited liability company, can it do business in a state other than California?

 Answer:  Yes.  An LLC formed in any of the fifty states may engage in business in any of the other state if the LLC registers to do business in the other state.  Registering to do business in a state means filing a form and paying an initial registration fee and annual fees each year. If the state where the LLC registers to do business has a state income tax then if the LLC earns income from within the state the LLC must file a state income tax return and pay state income tax to the registration state.

By |2015-02-26T20:17:54-07:00October 2nd, 2009|Categories: FAQs, Operating LLCs|0 Comments
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