Piercing The LLC Veil—Is Tax Classification A Relevant Characteristic?

While the equitable remedy of veil piercing "seems to happen freakishly, like lightning, it is rare, severe and unprincipled"1; it seems that courts are finding that its limitations and principles as developed in the context of the corporation are applicable in the context of LLCs. For example, in Kubican v. The Tavern, LLC, the West Virginia Supreme Court wrote: "Accordingly, we hold that W. Va. Code §31B-3-303 permits the equitable remedy of piercing the veil to be asserted against a West Virginia Limited Liability Company."2 This also appears to be the case in Delaware.3 As observed in Bowen v. 707 On Main, "The principle of piercing the corporate veil ... also is applicable to limited liability companies and their members."4 Still, courts are struggling with certain aspects of the application of piercing doctrine to LLCs, especially the question of "compliance with [corporate] formalities."5 Another feature that is making an appearance in favor of piercing is the consideration of the tax status of the LLC.

As is discussed below, tax treatment has no place in the piercing analysis, and tax classification should not be a factor in whether or not to set aside the rule of limited liability.

GreenHunter Energy

In GreenHunter Energy, the Wyoming Supreme Court affirmed the piercing of a single-member LLC, therein permitting issues of tax classification and treatment be utilized as part of a decision to pierce. This reliance upon tax characteristics is a troubling concept.6

GreenHunter Energy, Inc. was the sole member of GreenHunter Wind Energy, LLC (the "LLC"). The LLC contracted with Western Ecosystems Technology, Inc. ("Western") for certain consulting services. Western was never paid for those services. After receiving a judgment in its favor against the LLC exceeding $43,000 and finding the LLC without assets to satisfy the judgment, an action was brought against the corporate member seeking to pierce the veil of the LLC.

Initially, it is worthy of note that the opinion describes piercing as the "extraordinary equitable remedy," providing further support to the notion that piercing is not of itself a cause of action.7 Further, the Court noted that this determination, as are all determinations on piercing, must be made "under the specific circumstances of [the] case."8

The single-member LLC had, for itself, no employees. Rather, employees of the member corporation performed services on behalf of the LLC. The most damning factor in support of piercing was the under-capitalization of the LLC. Essentially, it had no dedicated capital. Rather, from time to time, the parent corporation would contribute certain amounts to the LLC with the direction that certain invoices be satisfied. Needless to say, no contribution was ever made for the purpose of satisfying the plaintiff's invoices. This control of what invoices would and would not be satisfied also indicated the parent's inappropriate domination of the LLC's activities.

To this point, the opinion appears to be well within the accepted grounds and factors for piercing the veil. That said, there are troubling aspects of this opinion in that the trial court appeared to focus on issues of tax classification of the LLC, an analysis that was permitted by the Wyoming Supreme Court. This single-member LLC had a federal default tax classification as a "disregarded entity," and no election was filed to treat the LLC as an association taxable as a corporation.9 It was noted that the LLC's tax return was consolidated with that of its corporate parent; consequent thereto, the parent was able to deduct $884,092 in expenses and claim an additional loss of $61,047.10 From these facts the Court concluded:

Appellant has enjoyed significant tax breaks attributable to the LLC's losses, without bearing any responsibility for the LLC's debt and obligations that contributed to such losses. Such a disparity of the risk and rewards resulting from this manipulation would lead to injustice.11

When the...