Limited Liability has its Limits – Piercing the Corporate Veil

Limited Liability has its Limits – Piercing the Corporate Veil
Why your LLC or Inc. isn’t as bulletproof as you may think.

Introduction
When starting a new business, it’s common for the business owner(s) to establish some sort of business entity in an effort to protect their personal assets against the debts or obligations incurred by the business. Two common types of business entities include the Limited Liability Company (LLC) and Corporation (Inc.).

The legal protections offered by these entities are plenty, with the law considering the entity as a separate and distinct “juridical person.” Just like one person isn’t typically liable for the debts of another person, the individual equity owners of a LLC or Inc. aren’t typically liable for the debts and obligations of their business.

However, while “limited liability” is one of the principal characteristics of business entities, the limited liability is not necessarily absolute.

When Limited Liability is Limited – Piercing the Corporate Veil
The doctrine of “veil piercing,” permits courts under certain circumstances to disregard an entity’s form and the protections from personal liability otherwise accorded to the members, shareholders or other equity holders. The doctrine most often arises in connection with a person’s attempt to hold corporate shareholders or LLC members liable for the debts of the organization.

Louisiana courts will pierce the corporate veil and hold its equity owners personally liable for a debt or obligation when the business organization is found to be simply the “alter ego” of the shareholder or when shareholders disregard the requisite corporate formalities to the extent that the corporation ceases to be distinguishable from its shareholders.

In the landmark 1991 case, Riggins v. Dixie Shoring Company, Inc., the Louisiana Supreme Court noted that in determining whether to pierce the corporate veil, the following factors are among those to be considered:

  1. Whether there is commingling of funds between the company and the equity owners (Members, Shareholders, etc.);
  2. Whether the organization follows statutory formalities for incorporating and transacting corporate affairs;
  3. Whether the organization is under-capitalized (did your company have enough start-up capitol? is your company properly capitalized?);
  4. Whether the company provides separate bank accounts and bookkeeping records for the organization;
  5. Whether the company holds regular shareholder and director meetings.

590 So.2d 1164.

The consideration of these factors, and others, will guide the court in determining whether your organization is truly a separate legal entity or simply the “alter ego” of your personal business affairs and transactions, thus holding you (i.e. Members/Shareholders) directly liable for the business’ debts and obligations.

On the positive note, in general, Louisiana courts are reluctant to pierce the corporate veil. The court stated in Riggins that “limited liability….should be disregarded only in exceptional circumstances.” Id. Further, when considering the above factors, whether the legal entity has failed in respect to any one factor is not always determinative. Instead the courts will consider the “totality of the circumstances” to make a decision.

Nevertheless, it is extremely important for business-persons operating their businesses through a Corporation, Limited Liability Company, or other business organization to rather intimately understand the veil piercing doctrine, and to run their businesses in conformity with it.

Protecting oneself from personal liability in the ordinary course of business is quite possible, but it oftentimes involves more than simply filing Articles with the Louisiana Secretary of State.

Big Business v. Small Business
Tips to Avoid the Doctrine of Veil Piercing

Let’s be honest – it’s a lot less likely for a court to pierce the corporate veil of a large and established business than to pierce the veil of a small or mid-size operation. Large companies will likely follow more formalities than small organizations (holding meetings, etc.), they will likely have lawyers on staff, and they will also likely have more than one, two, three or twenty shareholders and directors.

As a small business owner – or as a one-man operation – is there anything you can do to avoid being considered by law as simply the “alter ego” to your organization? After all, if it’s just you, how can the business not be your alter ego?

If a company only has one or a very few shareholder(s) or member(s), that factor will likely be considered by the Court in determining whether to pierce the veil of your organization. However, the law is fairly clear that this fact alone – that one individual owns all or a majority of the organization – does not support the drastic veil piercing event.

Therefore, here are some tips to help avoid the doctrine of veil piercing:

  1. Have a separate bank account for your business organization in that organization’s name. No exceptions.
  2. Do not “commingle” – or freely transfer – funds between your organization’s account and your personal account, or between different organizations. Talk to a lawyer or CPA about making proper distributions to Members, or perhaps loans from a Member to the organization.
  3. If you are a small operation and you have an Inc. or Corporation, consider changing to a Limited Liability Company. Inc.’s require that you hold mandatory meetings, have shareholders, directors and officers, and other tedious formalities. An LLC offers most of the liability protection of an Inc. and significantly less formalities.
  4. Make certain that you sign contracts and other legal documents as an agent for your organization, and do not simply sign your name without reference to your organization.
  5. Properly capitalize your organization.

Consult with an Attorney
There are slight and important differences between how the doctrine of “veil piercing” is applied to Corporations versus Limited Liability Companies in Louisiana. For the purposes of this short article, however, general principals of “veil piercing” were identified and explored. You should consult an attorney to learn more about these differences, the doctrine of veil piercing, and whether your organization is at-risk.

Related articles

Payment Provisions in Construction Contracts – Louisiana Law

Background on Payment Provisions & What is a “Pay When Paid” Clause

While it’s common practice in the construction industry to provide for partial payments from the contractor to subcontractor as work progresses, in Louisiana, unless the contract specifies otherwise, payment from the general contractor to the subcontractor is not actually due until the project is completed. See LA CC Art. 2550; See also Sacco v. Koepp, 169 La. 789, 793-94 (1930).

Therefore, if such progress payments are desired, it’s important to have a clause clearly providing for these payments in the contract.

A common contract provision in many contractor-subcontractor agreements provides that progress payments are not payable to a subcontractor until the owner pays the corresponding amount to the general contractor. These contract provisions typically come in two varieties, and are commonly referred to as “pay when paid” and “pay if paid” clauses.

“Pay when paid” and “Pay if paid” clauses are designed to shift the burden of owner non-payment from the contractor to its sub-contractors and suppliers. Accordingly, both provisions can be very onerous for the subcontractor – oftentimes preventing payments to a sub or supplier when the Owner is in an unrelated dispute with the general contractor, or merely becomes financially unable to make payments under the contract.

Enforceability of “Pay When Paid” Provisions

“Pay when Paid” provisions and other conditional payment provisions are not favored in courts, and therefore, it’s imperative to carefully draft and review any such provisions in the construction contract.

Hostility towards these types of provisions are fueled by subcontractors and their trade organizations.

Courts in some parts of the country have even gone so far as to call such provisions against public policy and unenforceable. See Capitol Steel Fabricators, Inc. v. Mega Construction Co., 58 Cal App 4th 1049 (2d Dist. 1997). Legislatures in a number of states have considered such provisions as impermissible waivers of the subcontractor’s constitutionally protected mechanics’ lien rights.

In Louisiana, properly drafted “Pay when Paid” provisions are enforceable, but the wording must be clear and unambiguous.

However, even with an enforceable conditional payment provision, Louisiana courts still require payment to the subcontractor within a “reasonable period of time,” thereby watering down the effect of the provision. See Southern States Masonry, Inc. v. J.A. Jones Contr. Co., 507 So.2d 198 (La. 1987). Through this Southern States decision, and similar decisions, the courts re-shift the risk of non-payment back upon the general contractor.

If the parties truly intend for the subcontractor to bear the risk of non-payment, or if payment from the owner is not reasonably certain, this intent should be clearly expressed in the construction contract. In these situations, the contract should have a “Pay if Paid” provision instead of a “Pay when Paid” provision. See C. Bel for Awnings, Inc. v. Blaine-Hays Constr. Co., 532 So.2d 830 (La. App. 4th Cir. 1988).

“Pay When Paid” versus “Pay If Paid”

Although only separated by one word, legally the two provisions are drastically different.

Pay when Paid

This common payment provision stipulates that a general contractor is legally obligated to pay a subcontractor only when it receives a corresponding payment from the owner. As discussed above, however, most courts view such a clause as a timing provision and not the basis for nonpayment.

Accordingly, if payment is never received from an owner, under a “Pay when Paid” payment provision, the general contractor must still make payment to a sub or supplier within a “reasonable time.”

Pay If Paid

“Pay if paid” clauses are more specific than their “pay when paid” counterparts. Unlike the “pay when paid” clause, oftentimes considered a timing provision, the “pay if paid” clause more clearly expresses the parties’ intention to shift the credit risk of owner nonpayment down through the contracting ranks.

Accordingly, payment to the subcontractor is more likely to be contingent on the general receiving payment from the owner under a contract with a “pay if paid” provision than a “pay when paid” provision.

Conclusion

Deciding when payments are due a subcontractor can sometimes lead to long and complicated legal disputes. As such, it’s very important for the parties to clearly express their intent when contracting.

The Wolfe Law Group is experienced in drafting and reviewing construction contracts to clearly reflect the intent of the parties. Contact us today to learn more about how the Wolfe Law Group can be your company’s new legal department.

Non-Compete Agreements in Louisiana

Read this Blog Post to learn:

  • Louisiana’s approach to Non-Compete Agreements
  • Hurdles facing Non-Compete Agreements
  • Keys to Drafting an Enforceable Non-Compete Agreement
  • The Perils of Small Mistakes in a Non-Compete Agreement
  • Whether a Non-Compete Agreement is Right for your Company

Generally, Non-Enforceable
It is difficult to overstate the degree of scrutiny judges all across the country provide to non-competition and non-solicitation agreements. Because these agreements are definitively anti-competitive and contrary to the public policy of encouraging free enterprise, they are very strictly analyzed and very often unenforceable.

Louisiana in particular approaches non-compete agreements with great caution.

The Louisiana State Legislature has made Louisiana’s position on these types of agreements Statute very clear by enacting Louisiana Revised Statute 23:921, and particularly in its drafting of the statute’s opening provision: “Every contract or agreement, or provision thereof, by which anyone is restrained from exercising a lawful profession, trade, or business or any kind, except as provided in this Section, shall be null and void.”

23:921’s very first line, in other words, sets the standard that all non-compete agreements are null and void unless they meet certain requirements. Louisiana courts have taken the cue from 23:921 and have also stressed that these agreements must climb uphill before achieving enforceability.

In Aon Risk Services of Louisiana, Inc. v. Ryan (2002), the Louisiana 4th Circuit Court of Appeals stated, “[s]tatutory exceptions to the public policy against anticompetition agreements are tightly drawn and should be narrowly construed in keeping with underlying policy of prohibiting restraint of free competition.”

Making It Work
Despite the clear legal skepticism against non-compete agreements, they are very popular all across the country, and its common to find a non-compete agreement in corporate , employment and independent contractor contracts.

As indicated by their presence throughout the country, non-compete agreements obviously have a value to organizations. A new company in a new market could suffer greatly if a new employee swoops in, takes a few weeks to learn the ropes and then sets up a competing business in the same area.

If your business could benefit from a non-compete or similar agreement, it’s imperative to understand the Louisiana requirements before putting pen to the paper. A non-compete agreement must be written correctly to carry any weight in a Louisiana court, and the margin for error is slight.

LA R.S. 23:921, after its general proclamation that non-compete agreements are in general null and void, allows such agreements in the following circumstances:

  • When a business is purchased, the seller may agree to refrain from engaging in a business similar to the business being sold within specified parishes, for a period not to exceed 2 years.
  • An employee may agree with his employer to refrain from engaging in a similar business to that of the employer within specified parishes for a period not to exceed 2 years from termination of employment.
  • An independent contractor, whose work is performed pursuant to a written contract, may agree to refrain from engaging in business similar to the business with whom the independent contractor has contracted, on same basis as if the independent contractor were an employee, for a period not to exceed 2 years from date of last work performed under the written contract.

The Louisiana 1st Circuit Court of Appeals summed up the requirements as simply as possible when in Cellular One, Inc. v. Boyd (1995), it stated: “[t]o be valid, noncompetition agreement may limit competition only in business similar to that employer, in specified geographic area, and for up to two years from termination of employment.”

However, this simple statement should not mislead one into thinking that a non-compete agreement technically meeting these three requirements will be valid. In fact, valid non-compete agreement must also (1) properly limit the type of business being restricted; (2) must identify and define a geographic area and ensure it is relevant and proper; (3) must properly and fairly restrict the non-competition time.

Additionally, there are other hidden considerations. For example, Louisiana courts have consistently held that a non-compete agreement will be unenforceable in absence of any specialized training or marketing tailored to the promotion of individual employees – the rationale being that there is no need to restrict competition if the employee or independent contractor doesn’t gain a competitive edge. Groome Enterprises, Inc. v. Network Paging Corporation (1993).

Conclusion

Non-Compete and similar agreements present legal hurdles, and are rarely enforceable by accident. No word or phrase in a non-competition agreement should be used without a thorough analysis of its import. Ordinarily, contracts are written with broad language to extent to hypothetical or broad circumstances, but in the case of non-compete agreements, the opposite is required.

It might be prudent to state the following: non-compete agreements are available to protect the employer’s (or business’) vital interest only. It’s important to not only express this in your non-competition agreement, but to also write in such a way as to exclude the possibility of other interpretations of the contract.

The Wolfe Law Offices is experienced in drafting non-competition and non-solicitation agreements, and would be happy to talk with your organization about its needs and whether such an agreement is right for business.

The Lien Maze for Louisiana General Contractors

Read This Post to Learn:

  1. Special Considerations for General Contractors when Filing Liens
  2. Importance of Filing Notice of Contract to Preserve Lien Rights
  3. Special Requirements to Lien Private Residences
  4. The Value of a Contractor’s Lien
  5. Penalties and Perils of Filing Liens Improperly

The Louisiana Private Works Act contains the legal requirements for general contractors to reserve and file “liens.”  If you’re a small general contractor doing work in Louisiana, its critical for you to familiarize yourself with the contents of this Act and the special requirements applicable to general contractors to file liens.

While a subcontractor can typically lien any job by filing the proper documents within 30 or 60 days after stopping work, a general contractor lacks this kind of luxury. In most circumstances, a general contractor must begin preserving its rights to file a lien before any work begins on the jobsite.

Contracts More Than $25,000.00

If a construction contract exceeds $25,000.00, the general contractor must file a “Notice of Contract” with the proper recording office before beginning any work. Failure to file this document forfeits the general contractor’s lien privileges. If the general contractor later files a lien on the project, the lien will be filed improperly and removable at the general contractor’s expense.

Construction on Residential Properties

If your general contracting company is doing work on a residential building, you may be required to comply with the Resident Truth in Construction Act to preserve your lien privileges.

The Residential Truth in Construction Act mandates that the general contractor have any homeowner sign a rather lengthy “Notice of Lien Rights” waiver before work begins on a residential project. Failure to get this document signed results in a forfeiture of a general contractor’s lien rights. For purposes of this Act, a “residence” is defined as a dwelling occupied by its owner.

General Lien Requirements

Additionally, all the typical lien requirements apply to generals, including: timelines, necessity of a legal property description, identification of the parties and their mailing addresses, statement of when payment of the price is to be made and descriptions in general terms of the work to be done.

Importance of These Precautions and Filing a Lien

Taking the necessary precautions to preserve your right to lien a project is important and imperative. Liens are a priceless tool for your company to promptly collect on its account receivables and protect you company’s ability to get paid for its work.

Failure to understand and to meet the conditions of the Private Works Act can be fatal to your lien privileges. An improperly filed lien – while perhaps on the books – is a legal liability for your organization. An interested party can easily remove an improperly filed lien and the removal of the lien will quite possibly be at your company’s expense.

What Louisiana Subs and Suppliers Should Know about Liens

While subcontractors and suppliers often feel that they are at the bottom of the construction world’s food chain, nearly every state protects them against non-payment with powerful lien laws. To utilize the force of these laws, however, its imperative to understand their scope and requirements.

In Louisiana, the Private Works Act allows a subcontractor or supplier to lien a project to ensure prompt payment from both general contractors and property owners. While the actual filing of a lien is important, it’s only the first step and it alone may not result in payment.

There is really no way to “enforce” a lien. A lien is simply a way for the contractor or subcontractor to protect its rights for payment. The step itself, however, is very important. Filing a lien formally notifies the property owner that the general contractor is not timely paying its laborers, and more importantly, that legal action can be commenced against them if a payment is not timely received.

Accordingly, if a subcontractor does not timely file a lien on a project, it cannot later seek payment from the owner of the property for the unpaid work. However, if a lien is timely filed, not only can the subcontractor bring suit against the general, but it may also sue the property owner directly. The lien, in other words, puts all parties on notice that there is unpaid work.

The significance of knowing and following lien laws is it will help your company to be more efficient in the collection of payment on projects. Lien laws are very technical and strict in Louisiana. The Private Works Act requires liens to be in writing, signed by the person asserting the claim, reasonable as to the amount owed with the amount itemized as best as possible. The lien must include a legal property description and description of work completed, and filed with the clerk of court or recorder of mortgages in the parish where the property is located.

While the Lien Laws are crafted to strongly favor subcontractors in a construction project, they do require careful attention to detail. It is very important to file the lien within the appropriate amount of time, which, depending on the project, is either thirty or sixty days, and to follow-up after filing.

When used correctly, liens are a powerful tool for subcontractors, and properly filed liens will ensure that those parties controlling the money do not abuse those who are working hardest on the projects.

Want to learn more about the mechanic lien requirements for contractors and suppliers in Louisiana?   Check out another blog that I write focused specifically on construction lien laws across the United States…including, of course, my home state of Louisiana.   The blog is the Construction Lien Blog, and you can read the Louisiana related posts by viewing the Blog’s Louisiana Tag.