Like Cloth Masks, Corporate Protections Are Not Absolute

July 9, 2020 | Evan H. Krinick | Corporate

We live in a different world than a few months ago. The existence of a pandemic in our community has impacted every aspect of our day-to-day life and has brought an unprecedented amount of uncertainty and anxiety as to the shape and tenor of our future experiences.

So, in order to enjoy some degree of normalcy, I am not going to write about the pandemic, Covid-19, masks, social distancing or PPP loans – all of the things that have dominated business owners’ conversations and thinking for the last 100-plus days. I am not going to discuss the 6 feet rule and try to explain why 6 feet is safe but 5 feet is not, and why we just don’t go to 8 feet and call it a day.

Conducting your business as a limited liability company (LLC) is a tried-and-true means to avoid personal liability for corporate actions. An LLC is said to provide the corporate-style limited liability protection with partnership-style flexibility. And while the truism is generally accurate, there are circumstances where using an LLC provides as much protection from an airborne virus as a cloth mask worn on your chin and not covering your mouth or nose. Sadly, that was the first metaphor that jumped into my brain, probably influenced by the people I saw last night outside a tavern, whose interpretation of social distancing also left a lot to be desired.

If you are a managing member of an LLC, you will not be protected from individual liability if you breach your fiduciary duty even if the operating agreement seeks to give you unlimited discretion. And a member of an LLC may be held liable for the actions of the LLC if the member utilizes the LLC as a sham to commit a fraud. These are just two situations where a corporate form affords no protection. Recent cases illustrate these situations.

In many LLCs, the operating agreement will give the managing member the “sole and absolute discretion” over investment and other business opportunities. When other members of the LLC complain about the conduct of the managing member in regard to investment opportunities, and insist that he has violated his fiduciary duty to the other members, the managing member’s reliance on the “sole and absolute discretion” clause is not enough to provide immunity. As a 2020 appellate decision recently decided, the exercise of discretion in bad faith and to self-deal is sufficient to establish a breach of fiduciary duty, despite the existence of the discretion clause.

The protections afforded to an individual member of an LLC can also be lost when there are enough facts to justify “piercing the corporate veil,” which is legalese for saying that the LLC existed on paper only and did not adhere to any of the required corporate formalities to separate itself from its individual members. Among the factors that courts will evaluate is the amount of capitalization, the commingling of corporate and individual assets and the use of corporate funds for personal use. Mostly, the court will look to whether the LLC was dominated by an individual who used the corporate form to commit a fraud or a wrongful injury.

Another recent 2020 appellate decision upheld a bench trial decision by Justice Elizabeth Emerson in Suffolk County, which had applied this doctrine to impose personal liability.

All in all, if you want to benefit from the protections of an LLC, make sure that you adhere to its procedural requirements and act in the best interests of the LLC and all of its members. And, if you want to be protected from airborne viruses, wear a mask that covers your nose and mouth, stay socially distant and avoid large groups of people in crowded environments.

This article appeared in the July 8, 2020, issue of Long Island Business News. ©2020 Long Island Business News.

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