As a general matter, Ohio law provides that owners of a limited liability entity, such as a corporation or limited liability company (LLC), are not personally liable for the debts or obligations of the entity unless they agree to be personally liable (e.g., signing a personal guaranty). See Revised Code (R.C.) 1705.48(B). This principle of liability protection is commonly referred to as the “corporate veil” because it protects the owners of a limited liability entity from personal liability. However, there are certain situations where Ohio courts are willing to “pierce the corporate veil” and impose personal liability on the owners of a limited liability entity for the debts or obligations of the entity. Owners and companies need to be aware of new developments in Ohio statutory law that may affect Ohio’s test for “piercing the corporate veil” for LLCs.
Since 1993, Ohio corporate law has dictated that “piercing the corporate veil” should be a rare exception, and not the rule. See Dole Food Co. v. Patrickson, 538 U.S. 468, 475, 123 S.Ct. 1655, 155 L.Ed.2d 643 (2003). In fact, the Ohio Supreme Court developed a stringent three-factor test that Ohio courts must use when deciding whether to “pierce the corporate veil”:
- control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own;
- control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity; and
- injury or unjust loss resulted to the plaintiff from such control and wrong. Belvedere Condominium Unit Owners' Assn. v. R.E. Roark Cos. Inc., 67 Ohio St.3d 274, 275, 617 N.E.2d 1075 (1993).
The appropriate application of these individual factors has been developed through subsequent jurisprudence. Because LLCs are thought of as a hybrid between a partnership and a corporation, Ohio courts have historically found that LLCs also must follow corporate formalities or risk having their “corporate veil” pierced. See Sutter v. Henkle, 3d Dist. Mercer No. 10-15-14, 2016-Ohio-1143, 2016 WL 1090466, ¶ 24.
Due to recent developments involving the first factor, this article focuses on this factor which is commonly referred to as the “alter-ego” doctrine. When applying the first factor of the Belvedere test to LLCs, Ohio courts seek to determine whether “piercing the corporate veil” is warranted because “it would be unjust to allow the [members] to hide behind the fiction of the corporate entity” when in reality, the LLC is merely an “alter-ego” of the members themselves. See Premier Therapy, LLC v. Childs, 7th Dist. No. 14 CO 0048, 2016-Ohio-7934, 75 N.E.3d 692. Ohio courts consider various factors to determine if an LLC is an alter-ego of the members or other affiliated companies, including whether:
- the LLC was inadequately capitalized;
- the LLC was insolvent at the time of the disputed act;
- the member held the member out as personally liable for certain company obligations;
- the member siphoned funds or assets of the entity for personal expenditures or use;
- the LLC was unable to pay debts due to high salaries of members or loans to members;
- there was a commingling of funds;
- there was a disregard of company roles;
- there was a disregard of company formalities;
- whether there was a lack of company records, especially regarding claimed loans to or from the entity to be pierced;
- the degree of domination by the person to be held liable - where a company is a mere facade for the operations of the dominant member; and
- in the case of related companies or affiliates, whether they shared common office space, personnel, and other assets.
However, in 2016, Ohio’s General Assembly amended R.C. 1705.48 and added a new subparagraph that specifically deals with “piercing the corporate veil” of an LLC. R.C. 1705.48(C) states:
"The failure of a limited liability company or any of its members, managers, or officers to observe any formalities relating to the exercise of the limited liability company's powers or the management of its activities is not a factor to consider in, or a ground for, imposing liability on the members, managers, or officers for the debts, obligations, or other liabilities of the company. R.C. 1705.48(c) (emphasis added)."
In short, this language prohibits the compliance, or lack thereof, with company formalities from being considered as a factor when determining whether to “pierce the corporate veil” of an LLC. Notably, this change to Ohio’s statutory law preempts at least part, if not all, of the first factor in Ohio’s “piercing the corporate veil” jurisprudence with respect to LLCs.
The importance of this change can be gleaned from the 2019 Ohio Court of Appeals case of Denny v. Breawick, LLC, 3rd Dist. Hancock No. 5-18-12, 2019-Ohio-2066. Although the opinion was issued in 2019, the original case was filed prior to the enactment of the amended R.C. 1705.48; therefore, the amended statute did not enter the court’s analysis. In Denny v. Breawick, LLC, the court upheld the trial court’s decision to pierce the corporate veil of two LLCs that had the same sole owner/member. One of the companies acted as general contractor in constructing a home for a customer, and the other company owned the area being developed. The court found that the contractor company breached its contract with the customer and violated the Home Construction Service Law.
The court in Denny v. Breawick, LLC imposed the liability of the contactor entity on the affiliated developer company and personally on the individual owner/member of the two entities. In its analysis, the Ohio Court of Appeals concluded that the first factor of the Belvedere test was satisfied because the member could not identify when or if company meetings took place, the member did not keep company records, the funds of the two LLC’s were comingled, and the member used the companies’ funds for personal expenses. Id. at ¶ 21. In sum, there was a failure to follow the requisite company formalities as required by the first factor of the Belvedere test.
Importantly, the court may have reached a different conclusion in Denny v. Breawick, LLC if the current version of R.C. 1705.48 was considered. Because R.C. 1705.48(C) effectively removes certain Premier Therapy considerations from the first factor of the Belvedere test, the court’s analysis would have changed. Moving forward, it is expected that Ohio courts will continue to use the Belvedere test when determining whether to “pierce the corporate veil” of an LLC and that the Premier Therapy considerations will continue to be the backbone of the first factor analysis. However, the failure to follow requisite company formalities should no longer be considered as a factor in favor of “piercing the corporate veil” if the new statutory section is properly raised as a defense. This change is a welcome change because it removes the pressure of LLCs having to follow the rigid guidelines of Ohio corporate law formalities.