How to Collect a Contract Debt from the Member(s) of an LLC

What if an LLC owes you or your business money but refuses to pay? If the LLC has assets or money, you can file a lawsuit to collect on your debt. But what if the LLC has no assets or money? What can you do?

The General Rule is that Members are Not Liable for an LLC’s Contract Debts

The bad news is that most states, including Texas, Louisiana, and Florida, protect members of LLCs from liability for the LLC’s debts. There are several reasons for this general rule. The most important reason is that states want to encourage entrepreneurs to start small businesses. States hope to encourage the growth of small businesses by shielding the owners of an LLC from liability for the LLC’s debts. The Limited Liability Company (LLC) combines the liability shield of a corporation with the “pass-through” tax benefits of a traditional partnership.

There are Exceptions to the General Rule.

The good news for you is that courts in Texas, Louisiana, and Florida have, in the past, recognized that the general rule can lead to unfair results. There are times when courts have said that the members of an LLC should be held liable for the contract debts of the LLC. Below is a discussion of factors courts have considered in the past when deciding if the “corporate veil” between the LLC and its owner(s) should be pierced.

There are no bright-line rules. Each case is fact intensive. Courts around the country have consistently held that the decision whether to pierce the corporate veil is dependent on the facts of each individual case. Factors considered by courts in the past have included:

Whether the members used the LLC to perpetrate a fraud on the creditor;
Whether the members paid personal expenses using the LLC’s funds and vice versa (“commingling”);
Whether the LLC was undercapitalized;
Whether separate bank accounts and bookkeeping records were kept;
Whether the members used the LLC to perpetrate a fraud on the creditor;
Whether the member “participated” in making misrepresentations as an individual as opposed to acting as an agent of the LLC, and,
Whether the members followed corporate formalities.

Of these factors, fraud is usually the strongest factor and the one courts most rely upon to pierce the veil between an LLC and its members.

Holding Members Liable for an LLC’s Debt in Texas

The Texas Limited Liability Company Act governs whether a member or manager of an LLC can be held liable for the LLC’s debts. The Texas Legislature took action to make it more difficult to pierce the corporate veil against LLCs and their members in 2011. Effective September 1, 2011, Section 101.002 of the Texas Business Organizations Code provides that a member may not be held liable for a contract obligation of an LLC unless the requirements of Section 21.223 are met. In other words, the same requirements for piercing the corporate veil between corporations and their shareholders should apply to LLCs and their members.

Professor Elizabeth Miller from Baylor University presented a paper entitled Essentials of Business Law to the State Bar of Texas. Her paper contains an excellent summary of recent cases in which Texas courts have either pierced the corporate veil of an LLC or refused to do so.

Holding Members Liable for an LLC’s Debt in Louisiana

The Louisiana Supreme Court listed some of the factors considered by Louisiana courts when deciding to pierce the corporate veil. Louisiana law recognizes exceptions to limited liability, and in certain circumstances permits “piercing the corporate veil” on an alter ego basis. Riggins v. Dixie Shoring Co., 590 So.2d 1164, 1168 (La.1991). This usually involves “situations where fraud or deceit has been practiced by the shareholder acting through the corporation.” Id. The Louisiana Supreme Court stated in Riggins that:

“Some of the factors courts consider when determining whether to apply the alter ego doctrine include, but are not limited to: 1) commingling of corporate and shareholder funds; 2) failure to follow statutory formalities for incorporating and transacting corporate affairs; 3) undercapitalization; 4) failure to provide separate bank accounts and bookkeeping records; and 5) failure to hold regular shareholder and director meetings.”

An important question about Louisiana law was raised in Hollowell et al. v. Orleans Regional Hospital LLC et al. There, the defendant alleged that a finding of fraud was needed before the veil could be pierced between a Louisiana LLC and its members. The federal Fifth Circuit Court of Appeals found that there is no such requirement under Louisiana law. In other words, even though fraud is an important factor, it is not essential under Louisiana law.

Holding Members Liable for an LLC’s Debt in Florida

Under Florida law, the corporate veil will be pierced only if a creditor proves both that the LLC is a “mere instrumentality” or alter ego of the member and that the member engaged in what the courts refer to as “improper conduct”. XL Vision, LLC. v. Holloway, 856 So. 2d 1063 (Fla. 5th DCA 2003).

In Hilton Oil Transp. v. Oil Transp. Co., S.A., 659 So. 2d 1141, 1151-52 (Fla. 3d DCA 1995) the court provides us with the following list of factors courts consider when determining whether a corporation or an LLC is a “mere instrumentality” or “alter ego”:

“There are at least fifteen factors that have been deemed to be relevant in a determination of whether a corporate entity should be disregarded: (1) the absence of the formalities and paraphernalia that are part and parcel of the corporate existence, i.e. issuance of stock, election of directors, keeping of corporate records and the like; (2) inadequate capitalization; (3) whether funds are put in and taken out of the corporation for personal rather than corporate purposes; (4) overlap in ownership, officers, directors, and personnel; (5) common office space, address and telephone numbers of corporate entities; (6) the amount of business discretion displayed by the allegedly dominated corporation; (7) whether the related corporations deal with the dominated corporation at arm’s length; (8) whether the corporations are treated as independent profit centers; (9) the payment or guarantee of debts of the dominated corporations by other corporations in the group; (10) whether the corporation in question has been properly used by others of the corporations as if it were their own; (11)financing of subsidiary by parent; (12) informal inter-corporate loan transactions; (13) parent and subsidiary’s filing of consolidated income tax returns; (14) whether subsidiary’s directors act independently in interest of subsidiary rather than in interest of parent; (15) existence of fraud, wrongdoing or injustice to third parties.”

Will a Law Firm Take My Business Litigation Case on a Contingent Fee Basis?

Many creditors can’t afford to hire a law firm to collect a contract debt on an hourly fee basis. Their only option is to find a firm that represents business litigation clients on a contingent fee basis. For a detailed description of how contingent fee contracts work, see our explanation and video at Contingency Fee Business Litigation Lawyers on this website.

Can We Be of Help to You?

The attorneys at LaGarde Law Firm have a long history of representing Fortune 500 companies, small business owners, and individuals in business lawsuits in Texas, Louisiana and Florida. Many of these cases have involved the question of whether a corporate veil should be pierced to hold the shareholders of a corporation or the members of an LLC liable for the entity’s contractual debts. With offices* in Naples, Florida and Houston, Texas, our firm stands ready to help. For a free consultation, call us today, at our Houston, TX office (713) 993-0660, our Naples, FL office (239) 500-6040, our toll free number 1-(866)-LAGARDE (1-866-524-2733), or send us your questions using our “Contact Us” page.

DISCLAIMER

This article is meant to provide general informational for educational purposes only. It is not offered as legal advice upon which anyone may rely. The law is different from state to state. The law changes. You should contact an attorney before taking any legal action. This firm does not represent you unless and until a Letter of Engagement is signed by you and this firm.

Copyright ©2021 by LaGarde Law Firm, P.C. All rights reserved worldwide. Richard LaGarde is licensed to practice law in Texas, Florida, and Louisiana. He is board-certified in both civil trial and personal injury trial law by the Texas Board of Legal Specialization.

*By appointment only.