The “LLC Veil”: Thinner than it Appears?

In two recent court cases, one in New York (applying Delaware law) and one in Colorado, the courts allowed the “veil” of an LLC to be pierced on the basis that the LLC was the “alter ego” of the owners.  Notably, there was no evidence or allegation of fraud or misconduct in either case.  This raises some interesting questions: would the result have been the same if the entities had been corporations rather than LLCs?  Does the absence of corporate formalities in the life of an LLC make it easier for judges to perceive a LLC as an “alter ego of its members, particularly when there are only one or two members, as in the two cases discussed below.

 Soroof Trading Development Co. Ltd. v. GE Fuel Cell Systems LLC, No. 10 Civ. 1391(LTS)(JCF), 2012 WL 209110 (S.D.N.Y. Jan. 24, 2012)

In this recent case, the Federal District Court in the Southern District of New York, applying Delaware law, granted summary judgment to the plaintiff, Soroof Trading Development Co. Ltd., allowing the plaintiff to pierce the veil of a Delaware limited liability company, GE Fuel Cell Systems LLC.  The court found the LLC to be the “alter ego” of its two members, GE Microgen, Inc. and Plug Power, Inc.  Surprisingly, however, the court gave very little attention to a requirement of Delaware law that a Delaware court would undoubtedly have analyzed rigorously and applied in a strict manner, i.e., an element of unfairness or injustice.

Briefly, the Soroof case involved an alleged breach of a contract that was entered into by Soroof and GE Fuel Systems in 2000.  The defendant LLC was unable to meet the contract requirements and was dissolved in 2006 through the filing of a certificate of cancellation in the Delaware Secretary of State’s Office.

Soroof sued the LLC and its two members, alleging breach of contract and several other claims.   Soroof made a motion for summary judgment on two grounds: to nullify the LLC’s certificate of cancellation, which was denied, and to pierce the LLC’s veil so that its two members could be held liable for the alleged breach of contract by the LLC.  This part of the motion was granted.

Regarding the motion to nullify the certificate of cancellation, Soroof alleged that the LLC had not been properly wound up because no provision had been made for unpaid claims, specifically, Soroof’s loses under the contract.  The court correctly pointed out that under the applicable Delaware statute a dissolved LLC is only required to pay or make provision for claims to the extent of its available assets. In the case, the LLC had no assets at the time of its dissolution.   Accordingly, the court dismissed this part of the motion for summary judgment.  (The court seems to have ignored the fact that if the dissolution of the LLC was valid, there was no remaining “Veil” to be pierced.)

The court then addressed Soroof’s claim that the LLC’s veil should be pierced, thereby allowing Soroof to pursue its claims against the LLC’s two members. The court quoted the following language from a Second Circuit Court of Appeals opinion (notably, the court did not cite any Delaware court decisions dealing with the corporate veil):

Delaware law permits a court to pierce the corporate veil where there is fraud or where [the corporation] is in fact a mere instrumentality or alter ego of its owner…. To prevail under the alter-ego theory of piercing the veil, a plaintiff need not prove that there was actual fraud but must show a mingling of the operations of the entity and its owner plus an overall element of injustice or unfairness.

(from NetJets Aviation, Inc. v. LHC Commc’ns LLC, 537 F.3d 168, 177 (2d Cir. 2008)).

The court then recited the following factors as support for a finding that the LLC was the “alter ego” of its two members:  (i) the LLC had no cash assets at the time of dissolution, (ii) the LLC had no employees but instead was staffed by employees of the members, (iii) the LLC did not lease its own office space but used the premises of its members and (iv) there was no sign on the premises used by the LLC to indicate it was there.

It is remarkable that a court could make an “alter ego” finding on these facts.  As anyone with experience in the business world knows, single-purpose entities are typically staffed with employees of a parent company or joint venture partners, not with their own employees.  Similarly, such entities commonly have no address of their own.  They simply exist “on paper” and use the office address of an operating company, usually a parent or other shareholder or member.  Moreover, many companies have no assets when they dissolve.  That’s why they dissolve.  And finally, in over 200 years of American jurisprudence, there does not appear to be a single precedent from any state to support the proposition that the absence of signage is a factor in piercing the corporate veil.  Signs are primarily for the retail public.  Single-purpose entities seldom have signs.

The factors usually mentioned by courts when they make a finding of an alter ego are those suggesting that the owner or owners of a legal entity consistently ignored the entity’s separate legal existence, factors such as co-mingling of funds, failure to maintain separate financial records, failure to pay the owner for services or resources provided by the owner (e.g., employee time and office space), failure to execute relevant contracts in a way that identifies the legal entity as the contracting party, and failure to maintain corporate formalities, which show that management of the legal entity was controlling its own affairs.   The Soroof court did recite any of these factors.

After finding that Soroof had alleged sufficient facts to establish that the defendant LLC was a mere instrumentality or alter ego of GE Microgen and Plug Power, the court then found that there was “an overall element of unfairness to Soroof”, although what exactly the element of unfairness was we are left to guess about since the court did not elaborate. Presumably, the judge felt that it would be unfair to effectively deny a remedy to the plaintiff by upholding the LLC veil.  Of course, that’s what the veil doctrine is all about.   If a legal entity has enough asses to cover a plaintiff’s claims, there is no need to pierce the veil to obtain a recovery.

It is very unlikely that a Delaware court would have reached the same result on the facts in the Soroof case.   Indeed, it is not surprising that the Soroof court did not cite any Delaware cases to support its decision.  Only a few Delaware cases have allowed piercing and those case all involved a finding of fraud, illegality, or other egregious conduct resulting in an injustice.

There is perhaps a lesson to be learned from the Soroof case.  That is, corporate formalities (meetings with notice and a written agenda, and minutes of the meetings to record decisions taken) can be a shield.  And while LLCs are not required to observe such formalities—indeed, the absence of formalities is considered by many commentators to be an advantage of a LLC over a corporation—such meetings and records can be used to support an argument that the LLC was not merely the alter ego of its member or members.

Martin v. Freeman, No. 11CA0145, 2012 WL 311660 (Colo. App. Feb. 2, 2012)

In this case, the Colorado Court of Appeals, applying Colorado law, affirmed the decision of the trial court to pierce the corporate veil of a single-member Delaware LLC.  Surprisingly, the appellate court allowed the LLC’s veil without a showing showing of fraud, wrongful intent, or bad faith, despite the words of the relevant Colorado statute,.

Dean Freeman was the single member of Tradewinds Group, LLC, a Delaware limited liability company. Tradewinds entered into a contract with Robert Martin for the construction of an airplane hangar.  In 2006 Tradewinds sued Martin for breach of contract.  One year later, while the litigation was pending, Tradewinds sold its only asset and made a distribution of the sale proceeds to Freeman.  Freeman thereafter paid the litigation expenses from his own funds.  The trial court found in favor of Tradewinds on the breach of contract claim, but Martin appealed and the judgment was reversed on appeal.  On remand, the trial court awarded $36,600 of costs to Martin costs. Tradewinds had no funds to pay the $36,600 so Martin brought an action against Freemen to pierce the LLC veil. The trial court allowed the LLC veil to be pierced and found Freeman personally liable for the costs.  On appeal the Court of Appeals affirmed.

The appellate court recited the requirements to pierce the veil under Colorado law: “the court must conclude (1) the corporate entity is an alter ego or mere instrumentality; (2) the corporate form was used to perpetrate a fraud or defeat a rightful claim; and (3) an equitable result would be achieved by disregarding the corporate form.”   On each of these three elements the Court’s opinion is less than illuminating.

On the element of Tradewinds acting as the “alter ego” of Freemen, the court listed several factors to support its conclusion, all of which can be reduced to three categories: the absence of corporate formalities, commingling of Freemen’s and the LLC’s funds and inadequate capitalization of the LLC.

As to the absence of formalities, this is characteristic of a LLC, and the Colorado Limited Liability Company Act expressly states, “. . . the failure of a limited liability company to observe the formalities or requirements relating to the management of its business and affairs is not in itself a ground for imposing personal liability on the members for liabilities of the limited liability company.”    §7-80-107

Regarding the commingling of funds and the inadequate capitalization of the LLC, these factors were hardly compelling under the facts of the case.  The LLC sold its only asset for $300,000 after filing the lawsuit against Martin and distributed these funds to Freeman.  Thereafter, Freeman paid the litigation costs.  While it is true that the LLC had no assets during the term of the lawsuit, it also had no liabilities and, notably, was the plaintiff in the suit and therefore not subject to liability from an adverse judgment (except as to costs).  The trial court had expressly found as a factual matter that Freeman had fully provided for all known or reasonably possible debts of the LLC at the time of the distribution of the proceeds from the sale of the LLC’s sole asset.  The appellate court dismissed this finding as irrelevant but offered no facts in opposition to the trial court’s finding of fact on this point.   

Most surprising of all is that the appellate court glossed over the requirement of Colorado law that the legal entity was used to “perpetrate a fraud or defeat a rightful claim” thereby leading to an “inequitable result”.   The trial court had stated in its findings that there was no fraud, wrongful intent or bad faith in Freeman’s actions.  Therefore, the Court of Appeals focused on the question of whether LLC form was used to “defeat a rightful claim.”  Looking at the sale of the LLC’s only asset and distribution of the proceeds two years before the trial was over, the Court of Appeals concluded that “defeating a potential creditor’s claim is sufficient to support the second prong…. Any party engaged in litigation is exposed to potential liability” and that “as a matter of first impression, that wrongful intent or bad faith need not be shown to pierce the LLC veil.”  One wonders how this could be a matter of “first impression”.  A dissenting judge on the court wrote an opinion that cited and quoted numerous Colorado cases requiring fraud, crime, an illegal act, or conduct intended to defeat the creditor’s claim, before piercing will be allowed.  And, as in the Soroof case, if not have having enough assets to cover potential liabilities (under the rubric, “under capitalized”) is a basis for piercing the corporate or LLC veil, then the doctrine has little meaning.

Some Thoughts

The Soroof and Martin cases appear to be further examples of a growing trend in which courts find the application of the corporate or LLC veil to be “unjust” because it has the effect of depriving the plaintiff (or counter-claiming defendant) of a remedy.  This is a classic example of turning a doctrine on its head because the “injustice” is then cited by the court as a factor in its conclusion that the veil can be pierced.

LLCs and especially single-member LLCs are more vulnerable than corporations to veil piercing because they typically do not observe “corporate formalities”, the absence of which traditionally has been a factor in veil piercing cases involving corporations.   To be sure, the state statutes authorizing the formation of LLCs do not require the formalities normally associated with a corporation but that is not necessarily persuasive in a piercing case.  The absence of formalities may not be a negative factor but neither can the LLC point to the observance of formalities as a positive factor to demonstrate the separate legal identity of the LLC.  Generally, the only evidence an LLC can produce to show its separate legal existence is the filing of the articles of formation, the filing of annual reports, signing of contracts in the name of the LLC, separate financial accounting, and the segregation of funds  (i.e., separate bank account, with all LLC revenue and payments going into an out of the account).  As recent cases suggest, the last of these factors offers little comfort if the court finds that the inability of a LLC to pay its debts or other claims is evidence of “under-capitalization”.

Is this recent tendency of some courts to pierce the LLC veil an indication of a fundamental shift in perspective?   Are judges influenced by the fact that it is so easy to create and maintain a LLC, i.e., is there a perception that owners of a business should not be able to avoid personal liability with such a simple edifice?  True, the very purpose of corporations (and now LLCs) is to insulate shareholders (and LLC members) from the debts and liabilities of a business enterprise, thereby facilitating investment, but is there a point at which the courts will view the separate business enterprise, especially the LLC and even more so the single-member LLC, as a vehicle that can be unfair to creditors and claimants while not actually resulting in the creation of businesses that would not otherwise have been created?   It’s possible that courts are applying a different policy for LLCs than they do for corporations.  In the case of corporations, if a court pierces the corporate veil of a small corporation, the rationale applied by the court can be used by future plaintiffs in other cases to pierce the veil of much larger corporations and this could have serious ramifications.  In contrast, piercing the veil of an LLC does not such broad implications.   This is all just speculation, of course, but trends—assuming we are seeing a trend—have underlying causes and those causes, while often obscure, may call into question our assumptions about how courts will behave when confronted with certain facts.   The strength of the “veil”, particularly in the case of a LLC, and more particularly in the case of a single-member LLC, may be one of those widely held assumptions that is now open to question.

Posted in Uncategorized | 1 Comment

Corp and LLC Name Requirements and Restrictions: State by State

The following link leads to a chart that shows the requirements for and restrictions on the names of corporations and LLCs under the laws of each State:

What’s in a name? That which we call a rose. . .



Posted in Uncategorized | Leave a comment

Sell Your Business in 2012 to Avoid Higher Tax on Capital Gains and the New Medicare Tax?

If you have been thinking about selling your business, you might want to consider a sale before the end of 2012.  Otherwise, the tax consequences could be noticeably worse.

Capital Gains

For shareholders who have held their shares for more than one year, the long-term capital gains rate will be 15% through the remainder of 2012 (assuming the taxpayer is in the 25% tax bracket or higher for total income).  This 15% rate is set to expire at the end of 2012 with the other “Bush tax cuts”, and long-term capital gains are generally expected to be subject to tax at a rate of at least 20% thereafter.

Medicare Tax

The Patient Protection and Affordable Care Act enacted in 2010 (Obamacare) includes a new Medicare tax that will apply commencing in 2013. This tax law change imposes an additional 3.8 percent tax on the lesser of a stockholder’s (i) net investment income or (ii) modified adjusted gross income (MAGI) in excess of $200,000 (for single filers) or $250,000 (married, filing jointly). MAGI includes, and “net investment income” (for purposes of this rule) probably includes, capital gains from the sale of a business. Thus, an owner of a business could potentially be subject you to an additional 3.8% tax on the sale of the business if the transaction occurs after year-end 2012.


Max has owned and operated a company for many years.  He owns 100% of the shares of the company and his tax basis in the shares is close to zero. If Max were to sell his shares and receive, say, $10 million in net proceeds, the tax difference between a sale in 2012 and a sale in 2013 could be close to $900K for Max.


 Of course, the Bush tax cuts may be extended, including the 15% long-term capital gains rate, and Obamacare may be struck down by the U.S. Supreme Court.  Then again, maybe neither of those things will happen.  We won’t know about the Bush tax cuts until long after the November elections, probably not until the eve of their expiration.  Unless there is a Republican sweep in November, a compromise on the tax cuts seems likely and the 15% capital gains rate looks vulnerable in such a compromise.  We should have a decision from the Supreme Court in June or July, but this does not help very much for planning purposes.  First, a Court decision in mid-Summer does not allow much time for a sale of a business before year-end.  And second, even if the Court declares invalid the part of the Obamacare legislation that requires individuals to obtain health care coverage (or pay a penalty) unless they are covered by an employer’s plan, it is quite possible, even likely, that the Court will not invalidate the remainder of the legislation.  Such a result could make Obamacare untenable from a cost perspective, but that is not the Court’s problem.  It would be a problem for the White House and Congress–a problem that would not be touched until after the November elections.  If parts of Obamacare survive the ensuing political battle, the Medicare tax is likely to be one of those parts.  The 3.8% tax has not been a particularly controversial issue in the heated debate over Obamacare, and the government certainly needs the revenue.

Information in this blog is for general educational purposes only and should not be construed as legal advice or a legal opinion on any specific facts or circumstances.


Posted in Uncategorized | Leave a comment

NLRB Poster Requirement: Another Interesting Development

In our post of August 30, 2011, we noted that the National Labor Relations Board (NLRB) had adopted a final rule requiring most employers to notify employees of their rights under the National Labor Relations Act (NLRA) by posting a notice in a conspicuous location in the workplace.   The poster requirement, designed to notify employees of their rights under the NLRA, such as the right to organize a union, had an original deadline of November 14, 2011.  This deadline for posting the notice was subsequently extended to April 30, 2012 because of litigation challenging the rule brought by various plaintiffs including the National Association of Manufacturers, the National Right to Work Legal Defense and Education Fund, Inc., the Coalition for a Democratic Workplace, and the National Federation of Independent Business.  (As noted in our August 30th post:  “This rule will undoubtedly be tested in the courts.”)

In a post of March 16, 2012, we advised that on March 2, 2012, the federal district court in Washington, D.C., upheld the statutory authority of the NLRB to require employers to display a poster informing employees of their rights under the NLRA.  Significantly, however, the court struck down two of the penalty provisions included in the NLRB’s final rule.  That ruling is now on appeal before the U.S. Court of Appeals, District of Columbia Circuit.

Now, in the latest development, the federal court in South Carolina found that the NLRB did not have the authority to issue the notice-posting rule and that it was, therefore, unlawful under the Administrative Procedure Act.  In this April 13, 2012 ruling, the court reasoned that the poster requirement was not “necessary to carry out” the NLRA because there is no provision in the NLRA itself that requires any type of notice posting.  The court also said that the NLRA contemplates that the NLRB will serve a reactive function, responding to charges or petitions filed by others, not a proactive function in requiring employers to take preventive actions.  Importantly, the court held that Congress did not intend to give the NLRB the power to require employers to post a notice of the rights afforded under the NLRA.

There now two different and opposing federal court decisions on the validity of the NLRB rule requiring employers to post the prescribed notice.  The April 30th effective date of the rule has not been extended by the NLRB.  The Circuit Court for the District of Columbia has been asked by the appellants to stay the effectiveness of the rule until the Circuit Court reaches its decision, but no ruling on the request for a stay has been issued. This creates a number of interesting questions.

Will the NLRB voluntarily extend the effective date of the rule beyond April 30, 2012?  If they do not, employers in the District of Columbia will be subject to the rule after April 30th while employers in South Carolina will not be.  Technically, employers in other states will still subject to the rule, but if the NLRB takes any future action against an employer based on the rule, the South Carolina decision, unless overturned on appeal, will offer the employer a basis for challenging the action.  Moreover, federal agencies abhor the idea of being able to apply their rules in some states but not others.

Will the NLRB appeal the South Carolina court’s decision?  Some commentators believe the NLRB will appeal but do not think so.  The appeal would be taken to the Fourth Circuit Court of Appeals in Richmond, Virginia, which, while not as ultraconservative as it once was, is not likely to side with the NLRB.  If the NLRB failed to get the South Carolina ruling overturned at the Fourth Circuit (likely), and assuming the Court of Appeals in Washington D.C. upholds the ruling of the federal court in D.C. (also likely), then there would be a “split in the Circuits”.  Such a split could be resolved only by a decision from the U.S. Supreme Court.  Even if the Supreme Court would hear such a case—always hard to predict—we do not think the Administration would want to run the risk of bringing national attention to a rule that small employers consider another example of burdensome and unnecessary federal regulation.  Of course, once the “split in the Circuits” occurs, the federal government is not the only party that can ask the Supreme Court to resolve the issue.  Such a request can be initiated by either party, and there is no reason to think that the National Association of Manufacturers, the National Right to Work Legal Defense and Education Fund, Inc., the Coalition for a Democratic Workplace, and the National Federation of Independent Business would be shy about seeking a decision from the Supreme Court.

Hence, the NLRB faces a dilemma.  If it appeals the South Carolina decision and loses, the poster rule will be dead for all practical purposes.  Applying the rule anywhere, even outside the Fourth Circuit, after an adverse ruling from the Fourth Circuit, would open the door to endless legal challenges.   The only option to save the rule would be to ask the Supreme Court to review the Fourth Circuit decision, but that would create political risks.

We will keep you posted (excuse the pun).

Posted in Uncategorized | Leave a comment

New Section 6050W of the Internal Revenue Code: How Might it Affect Your Business? 

New Section 6050W of the Internal Revenue Code, which was added by Section 3091(a) of the Housing Assistance Tax Act of 2008 (the “Act”), requires all credit card processors (such as LawPay, First Data and TSYS) and third-party payment aggregators (such as PayPal and Square) to file with the IRS and send to the participating merchant an information return on new Form 1099-K for each calendar year reporting all payment card transactions and third party network transactions with the participating merchant occurring in such calendar year.  This amount reported on Form 1099-K is the gross dollar amount of all credit card transactions during the calendar year without regard to any adjustments for credits, cash equivalents, discount amounts, fees, refunded amounts, or any other amounts.   Payments made in settlement of third party network transactions, however, are required to be reported only if the amount paid exceeds $20,000 and the aggregate number of transactions exceeds 200 with respect to any payee within a calendar year.

The purpose of the Form 1099-K is to give the IRS an idea of the gross amount of credit card payments that were processed for a merchant.   There is no clear indication at present that if the gross amount reported on Form 1099-K does not correspond with a merchant’s reported sales the IRS will require the taxpayer to provide a reconciliation. Note, however, that Line 1a of Form 1120 (U.S. Corporation Income Tax Return) asks for “Merchant card and third-party payments.”    The instructions to Form 1120 for tax year 2011 state that the amount on Line 1a is “0” for all taxpayers but presumably that will not be the case in future years.  Thus, it will be an easy matter for an IRS computer to match Line 1a against Form 1099-K and if the latter exceeds the former by a certain amount (allowing for credits and refunds, etc.), it could trigger an audit or at least a letter from the IRS asking for an explanation.

An issue of more near-term concern is that Section 6050W also requires card processors to verify and match the payee’s federal tax ID number and its legal name to IRS records.  The name and the EIN on Form 1099-K must exactly match what the IRS has on file. If it is not an exact match, then beginning in January 2013 the IRS will impose a 28% withholding penalty on all credit card transactions handled on behalf of the payee.  Presumably, this amount withheld can subsequently be recovered by the taxpayer if the legal name and EIN are corrected to correspond to IRS records, but the current regulations do not say how such a refund could be obtained, and, in any case, it is never a simple matter to put an egg back together after the IRS breaks it.

This issue of name and EIN matching is not as simple as it might sound.  Most Visa and MasterCard processors use merchant statements that are limited to only 25-35 characters. Consequently, many long-name merchants have either abbreviated their name or used an acronym for their merchant account. If these case, the merchant will need to ensure that its legal name on the Form 1099-K exactly matches the legal name on file with the IRS (in this regard, it is important to remember to notify the IRS by letter whenever a legal entity changes its name).

 Card processors that meet the threshold mentioned above should have already sent out 1099-Ks for tax year 2011 but the IRS considers this a “trial run” and will not impose the 28% penalty until next year. Therefore, the 1099-K for 2011 is a good opportunity to see what name and EIN the processor is using.   If a merchant does not receive a 1099-K for 2011 it should ask the processor for one simply to check this information.

The Corporation Secretary 


Posted in Uncategorized | Leave a comment

“Back Door” SEC registration – Some Filing Issues

“Back door” registration occurs when a private operating company acquires a SEC-registered public shell company and then the parties enter into a “reverse merger”, i.e., the acquiring company (the private operating company) merges into the acquired company (the SEC reporting shell company).   Note, however, that post-merger the private operating company is the acquirer for accounting purposes and the public shell becomes the acquiree for accounting purposes under SEC rules. These transactions are done as a quick and cost-effective way for a private operating company to become public.  That said, the SEC reporting requirements for these transactions are not obvious from a reading of the SEC regulations and errors in accounting treatment or registration procedures, which are quite common, can be difficult and burdensome to resolve.    Back-door registration is reported on a Form 8-K rather than a 1933 Act registration statement, such as an S-1, S-2 or S-3.  Thus, SEC staff review occurs after the 8-K has been filed, not by means of staff comments prior to the effectiveness of a pre-effective registration statement.   Correcting mistakes after an 8-K filing has been made can complex and time-consuming.

 Unless the same audit firm audited both the public shell and the private operating company, a reverse merger always results in change of accountants for purposes of Item 4.01 of Form 8-K.  If the due date or filing date of the Form 8-K, whichever is earlier, occurs after the end of the private operating company’s most recently completed annual or quarterly period, but before financial statements for that annual or quarterly period would be required to be presented in a Form 10, the financial statements of the private operating company required by Items 2.01(f) and 9.01 of Form 8-K may not include the private company’s most recently completed annual or quarterly period. The public shell company, however, remains subject to Exchange Act Rules 13a-1 and 13a-13, or 15d-1 and 15d- 13, requiring annual and quarterly reports, respectively. The public shell company must file its applicable annual and quarterly reports. Additionally, the public shell company must file an amended Form 8-K with the financial statements of the private operating company’s most recently completed annual or quarterly period prior to the date of the reverse recapitalization, as applicable, within 90 or 45 days, respectively, after the private operating company’s period end.

 While the historical financial reporting for pre-transaction periods may change to that of the private operating company once the transaction has occurred, the SEC registrant does not change in this type of transaction. The SEC registrant is still the public shell company (now with new assets and liabilities), and therefore it is not a newly public company for purposes of SOX 404.  However, the SEC staff has issued a Compliance and Disclosure Interpretation (“CDI”) to provide guidance to companies in this situation. It acknowledges that it might not always be possible to conduct an assessment of the private operating company or public shell’s internal control over financial reporting in the period between the consummation date of a reverse acquisition and the date of management’s assessment of internal control over financial reporting required by Item 308(a) of Regulation S-K.  The CDI also recognizes that in many of these transactions, such as those in which the legal acquirer is a non-operating public shell company, the internal controls of the shell company may no longer exist as of the assessment date or the assets, liabilities, and operations may be may be insignificant when compared to the consolidated entity. Therefore, the SEC staff does not object if the registrant excludes management’s assessment of Internal Controls over Financial Reporting (“ICFR”) in the Form 10-K covering the fiscal year in which the transaction was consummated. However, this CDI would not apply if the company had to file an amended Form 8- K under the Rule 13a-1 interpretation discussed above in the second paragraph.

 Example of SEC staff interpretation of Rule 13a-1:

  • Reverse merger occurs on February 1, 2012
  • Shell company (accounting acquiree) and non-public operating company (accounting acquirer) each have a fiscal year-end of December 31
  • Audited financial states of the private operating company for the year-end December 31, 2010 and the unaudited financial statements for the interim period ended September 30, 2011 and comparable prior periods would be filed on Form 8-K
  • The SEC registrant would file its annual report on Form 10-K for the year ended December 31, 2011 within 90 days of that date.
  • The SEC registrant would file an amended 8-K within 90 days of December 31, 2011 containing the same information for the private operating company required in a 10-K. 

In SEC Release No. 33-8587, the SEC said that investors in operating businesses newly merged with shell companies should receive the same level of information as provided for reporting companies that did not originate as shell companies. Therefore, such companies are required to include equivalent information as if they were registering under the Exchange Act.

Under current accounting literature, the acquisition of a private operating company by a non-operating public shell company is considered by the SEC Staff to be a capital transaction in substance rather than a business combination (it is outside the scope of FASB ASC Topic 805). That is, the transaction may be viewed as a reverse recapitalization — issuance of stock by the private operating company for the net monetary assets of the public shell company accompanied by a recapitalization. In order to reflect the change in capitalization, earnings per share should be recast for all historical periods to reflect the exchange ratio. The common stock account of the public shell continues post-merger, while the retained earnings of the shell company should be eliminated as the historical operations are deemed to be those of the private operating company.

Recapitalization example:

  • The reverse merger was consummated on April 10, 2011
  • At March 31, 2011, the public shell had 100,000 shares outstanding (par value $1.00 per share)
  • At March 31, 2011, the private operating company had 100,000 shares outstanding (par value $2.00 per share)
  • The public shell issues 400,000 shares for 100% of the private operating company
  • No other equity transactions occurred between April 10, 2011 and June 30, 2011
  • The post-merger Registrant has net income of $300,000 for the period from April 1, 2011 to June 30, 2011

Back-door SEC registration has been used by a number of Chinese companies that wanted to become publicly traded on an expedited basis.  Some of these transactions did not turn out well for investors.  It is fair to say that the SEC staff will carefully review the disclosure and accounting procedures in these filings.




Posted in Uncategorized | Leave a comment

LLC Annual Costs by State — Updated

Updated: March 15, 2012

The following discussion of the annual costs of forming an LLC in each state and the District of Columbia apply only to LLC’s that are classified as partnerships for tax purposes.  The discussion does not apply to LLCs that have elected to be treated as corporations for tax purposes.  It also does not apply to single-member LLC’s because there are special rules for such LLCs in several states.  The amounts below are subject to change, especially during times like these when states are looking for ways to increase revenues.

Important reminder:   A LLC must register as a “foreign” LLC in each jurisdiction in which it is “doing business” other than the jurisdiction in which it was formed.  (The question of what constitutes “doing business” in a state is very complex and will be the subject of a future post.)  Thus, finding the lowest cost jurisdiction in which to form an LLC may be counter-productive because in many cases the LLC will still be required to register as a foreign corporation in the state where the principal place of the business is located.  Thus, a LLC might find itself paying fees in two jurisdictions when it could have paid fees in only one.

LLC Annual Costs by State

The Corporation Secretary

Posted in Uncategorized | Leave a comment