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29 • 2022

Single Member LLCs Should Not Pose Any Greater Risk of Alter Ego Liability

One of the primary purposes of forming a limited liability company (LLC) or a corporation is to limit the liability of members or shareholders for the entity’s debts.[1] We have previously compared the liability protection offered by these two kinds of business entities, concluding that the differences, if any, are so small that they should not be a principal consideration in deciding which type of entity to form.[2] We have also looked at why it is good practice for corporations with a single shareholder to keep annual minutes to aid in avoiding alter ego liability, a doctrine that results in the shareholder being held liable for the corporation’s debts and thus defeating one of the primary purposes of incorporation.[3]  Yet another question related to these issues is whether a single-member LLC poses any greater risk of alter ego liability?

In some ways, a single-member LLC may actually pose a slightly lesser risk of alter ego liability, at least compared to a single-shareholder corporation. The reason is related to our insistence that corporations with just one shareholder should be especially careful to keep up with annual minutes, when such corporations might otherwise be tempted not to hold annual meetings or prepare annual consents just to elect the only shareholder as the sole director and officer of the corporation every year. Unlike corporations, an LLC can appoint one or more managers to manage the company from year to year and be done with it, without having to worry about electing directors and officers every year.[4]

In addition, some LLC statutes, like California’s, explicitly eliminate some considerations as “a factor tending to establish that a member or the members have alter ego or personal liability for any debt, obligation, or liability of the limited liability company.”[5] Those considerations are the “failure to hold meetings of members or managers or the failure to observe formalities pertaining to the calling or conduct of meetings,” so long as the LLC’s articles of organization or operating agreement “do not expressly require the holding of meetings of members or managers.”[6] In other words, the statute specifically provides that it is okay for the sole member of an LLC to worry less about some corporate formalities, without increasing the risk of alter ego liability, which is not true of a single-shareholder corporation.[7] Of course, the LLC’s member cannot simply ignore the other factors that go into deciding alter ego liability and expect not to be held personally liable for the company’s debts.[8]

A single-member LLC also should not pose a greater risk of alter ego liability compared to LLCs with more than one member. The LLC statutes specifically provide for the limited liability of LLC members, without regard to how many members the LLC has. For example, California’s LLC statute provides that, absent alter ego liability, the LLC’s debts, obligations, or other liabilities, whether arising in contract, tort, or otherwise, “are solely the debts, obligations, or other liabilities of the limited liability company to which the debts, obligations, or other liabilities relate,” and “do not become the debts, obligations, or other liabilities of a member … solely by reason of the member acting as a member.”[9] And the LLC statutes also expressly contemplate than a company may have only one member.[10] The statutory limited liability thus applies to single-member LLCs. Therefore, there is no persuasive reason to believe that single-member LLCs should pose any greater risk of alter ego liability than either a single-shareholder corporation or a limited liability company with more than one member.[11]

[1] See 1 Larry E. Ribstein & Robert R. Keatinge, Ribstein and Keatinge on Limited Liability Companies § 1:5 (2022) (“A principal motivation for the creation of LLCs was the desire to eliminate the owners’ vicarious liability for the obligations of the LLC.”); 1 Fletcher Cyclopedia of the Law of Corporations § 14 (2021) (“[A] corporation may properly be organized and conducted for the avowed purpose of maintaining it as a separate entity free from shareholder responsibility for the corporation’s debts.”).

[2] See eMinutes, “Does a Corporation or a LLC Provide Better Liability Protection?” (Jan. 21, 2016).

[3] See eMinutes, “Why Single Shareholder Corporations Need Annual Minutes” (Mar. 20, 2022).

[4] See, e.g., Cal Corp Code § 17704.07(c)(5) (“A manager may be chosen at any time by the consent of a majority of the members and remains a manager until a successor has been chosen, unless the manager at an earlier time resigns, is removed, or dies, or, in the case of a manager that is not an individual, terminates.”). Of course, an LLC may have officers, just like a corporation, but it is generally not required to, unlike a corporation. See eMinutes, “Corporate and LLC Terms” (June 14, 2022).

[5] Cal Corp Code § 17703.04(b).

[6] Id.

[7] Cf. Mix v. Tumanjan Dev. Corp., No. B157394, 2003 WL 21810813, 2003 Cal. App. Unpub. LEXIS 7592, at *6-7 (Cal. Ct. App. 2d Dist. Aug. 7, 2003) (in refusing to impose alter ego liability, court emphasized that sole shareholder, officer, and director of corporation scrupulously “complied with corporate formalities”).

[8] See, e.g., Conn. Light & Power Co. v. Westview Carlton Group, LLC, 950 A.2d 522, 527 (Conn. App. 2008) (affirming lower court’s piercing of veil of LLC that was undercapitalized, lacked an agent for service, filed no annual reports with the secretary of state, lacked any of the documentation required for a limited liability corporation, failed to maintain any business records for its property, failed to file tax returns for any of the years involved, and commingled funds with the sole member for his benefit). Notably, the court in that case specifically rejected “the defendants’ suggestion that this was simply a case of a single [member] being charged with a corporate debt solely because of his ownership status.” Id. To the contrary, the court found “ample evidence that [the LLC] had no separate existence, that [the sole member] treated it as such[,] and that [the sole member] used it to perpetrate an unjust act in contravention of the plaintiff’s legal rights.” Id.

[9] Cal Corp Code § 17703.04(a).

[10] See Cal Corp Code § 17704.01(a); see also 6 Del. C. § 18-101(8) (defining “limited liability company” as “a limited liability company formed under the laws of the State of Delaware and having 1 or more members”); N.Y. Ltd. Liab. Co. Law § 102(m) (defining a “limited liability company” as “an unincorporated organization of one or more persons having limited liability for the contractual obligations and other liabilities of the business”).

[11] One commentator has stated that “[a]lthough a single member is not necessarily evidence of the LLC being the alter ego of the single member, single member or closely held membership may raise a red flag in many situations, and many may think that single member LLCs are more subject to potential abuse.” Allen Sparkman, Will Your Veil Be Pierced? How Strong Is Your Entity’s Liability Shield? — Piercing the Veil, Alter Ego, Ego, and Other Bases for Holding an Owner Liable for Debts of an Entity, 12 Hastings Bus. L.J. 349, 375 (2016). The author then goes on to say, however, that “[i]f the single member completely disregards the separateness of the LLC, a court will treat the LLC as a sham or alter ego of the member.” Id. at 375 & n.140 (citing the Connecticut case discussed in note 8). But that is true of any LLC, whether it has one, or more than one, member. In addition, the idea that alter ego liability is more likely to be imposed just because the LLC has only one member was specifically rejected in that same Connecticut case, as well as in a Massachusetts case quoted in the article: “Single-shareholder corporations and limited liability companies are not de facto illegal or inherently a sham.” Id. at 375 (quoting Smith v. Shining Rock Golf Cmty., LLC, No. 2006-1510-B, 2007 WL 2110958, 2007 Mass. Super. LEXIS 222, at *7 (June 14, 2007)). In short, the considerations involved in imposing alter ego liability should be the same, without regard to how many members the LLC has.