The Alter Ego Doctrine and Limited Liability Companies
Business Formation Concerns: The Problem of the Applicability to Limited Liability Companies of the “Alter Ego” and “Piercing the Corporate Veil” Doctrines
One of the more popular business entity forms in Nevada is the limited liability company (otherwise known as the “LLC”). Governed by N.R.S. Chapter 86, limited liability companies combine many of the appealing features of a partnership (a single level of taxation) with those of a corporation (protection for its members from personal liability for the companies’ debts and liabilities). However, following a ruling of the Federal Bankruptcy Court in the matter of In Re Giampietro, 817 B.R. 814 (D.Nev.2004), there is cause for concern about exactly how much protection from personal liability the LLC form provides its members.
The doctrines of “alter ego” and “piercing the corporate veil” are long-standing corporate doctrines used to determine circumstances where a corporate fiction should be disregarded to hold the officers, directors, or shareholders personally liable for the debts and liabilities of the corporation. In Giampietro, the Court was asked to predict whether a Nevada court applying Nevada law would determine that these doctrines were applicable to an LLC in the same manner as they are to a corporation. The Giampietro court determined that it would do so:
“The question is whether Nevada law would recognize “alter ego” claims with respect to limited liability companies… If presented with the issue, this court believes it highly likely that Nevada courts would recognize the extension of the alter ego doctrine to members of limited liability companies.”
Giampietro at 845-846. While this is not binding authority on the Nevada court, but rather a mere prediction of how a Nevada court would rule, it is enough to send shivers down the spine of the member of any LLC. N.R.S. 78.747 prescribes a three-part test for when application of these doctrines is appropriate:
(1) the corporation must be influenced and governed by the person asserted to be the alter ego;
(2) there must be such unity of interest and ownership that one is inseparable from the other; and
(3) the facts must be such that adherence to the corporate fiction of a separate entity would, under the circumstances, sanction fraud or promote injustice.
Application of the first of these two factors to an LLC is extremely problematic, unlike a corporation. These two factors are designed to test the level of separation between ownership and management, with the more separation between them, the less likely the doctrine should be applied. The problem lies therein: while it is a requirement in a corporation that ownership and management be separate, the same requirement does not apply to LLC’s. LLC’s are not designed with the intent that ownership and management necessarily be separate. As such, the potential lies for an LLC to fail the first two factors of the test automatically and by virtue of their nature as closely-held entities, making it far more likely a member could be found to be personally liable for the liabilities of an LLC.
By: Leland Eugene Backus