NLRB Proposes Notice Requirement

On December 22, 2011, the National Labor Relations Board (NLRB) published a proposed rule in the Federal Register that, if adopted, would require employers, including many small businesses, to post a conspicuous notice in the place of employment informing employees of their rights under the National Labor Relations Act (NLRA).  The NLBR solicited public comments on the proposed rule.  The comment period expired February 22, 2011.

Under the NLRA, employees have the right to self-organization, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.

According the proposed rule, “The NLRA is almost unique among major Federal labor laws in not including an express statutory provision requiring employers routinely to post notices at their workplaces informing employees of their statutory rights. Such postings are required under the Fair Labor Standards Act,  Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Occupational Safety and Health Act, the Americans with Disabilities Act, the Family Medical Leave Act, the Uniformed Service Employment and Reemployment Rights Act, the Railway Labor Act, the Employee Polygraph Protection Act, the Migrant and Seasonal Agricultural Workers Protection Act,  and other Federal statutes.   Thus, the NLRA stands out as an exception to the widespread notice-posting practice that has long been common in the workplace, even though it is the basic Federal labor law protecting private-sector employees who act together to address terms and conditions of employment.”

The Labor Department currently requires Federal contractors to post the following notice to employees:

“Employee Rights Under The National Labor Relations Act’’

‘‘The NLRA guarantees the right of employees to organize and bargain collectively with their employers, and to engage in other protected concerted activity. Employees covered by the NLRA* are protected from certain types of employer and union misconduct. This Notice gives you general information about your rights, and about the obligations of employers and unions under the NLRA. Contact the National Labor Relations Board, the Federal agency that investigates and resolves complaints under the NLRA, using the contact information supplied below, if you have any questions about specific rights that may apply in your particular workplace.

‘‘Under the NLRA, you have the right to:

  • Organize a union to negotiate with your employer concerning your wages, hours, and other terms and conditions of employment.
  • Form, join or assist a union
  • Bargain collectively through representatives of employees’ own choosing for a contract with your employer setting your wages, benefits, hours, and other working conditions.
  • Discuss your terms and conditions of employment or union organizing with your co-workers or a union.
  • Take action with one or more co-workers to improve your working conditions by, among other means, raising work-related complaints directly with your employer or with a government agency, and seeking help from a union.
  • Strike and picket, depending on the purpose or means of the strike or the picketing.
  • Choose not to do any of these activities, including joining or remaining a member of a union.

‘‘Under the NLRA, it is illegal for your employer to:

  • Prohibit you from soliciting for a union during non-work time, such as before or after work or during break times; or from distributing union literature during non-work time, in non-work areas, such as parking lots or break rooms.
  • Question you about your union support or activities in a manner that discourages you from engaging in that activity.
  • Fire, demote, or transfer you, or reduce your hours or change your shift, or otherwise take adverse action against you, or threaten to take any of these actions, because you join or support a union, or because you engage in concerted activity for mutual aid and protection, or because you choose not to engage in any such activity.
  • Threaten to close your workplace if workers choose a union to represent them.
  • Promise or grant promotions, pay raises, or other benefits to discourage or encourage union support.
  • Prohibit you from wearing union hats, buttons, t-shirts, and pins in the workplace except under special circumstances.
  • Spy on or videotape peaceful union activities and gatherings or pretend to do so.

‘‘Under the NLRA, it is illegal for a union or for the union that represents you in bargaining with your employer to:

  • Threaten you that you will lose your job unless you support the union.
  • Refuse to process a grievance because you have criticized union officials or because you are not a member of the union.
  • Use or maintain discriminatory standards or procedures in making job referrals from a hiring hall.
  • Cause or attempt to cause an employer to discriminate against you because of your union-related activity.
  • Take other adverse action against you based on whether you have joined or support the union.

‘‘If you and your coworkers select a union to act as your collective bargaining representative, your employer and the union are required to bargain in good faith in a genuine effort to reach a written, binding agreement setting your terms and conditions of employment. The union is required to fairly represent you in bargaining and enforcing the agreement.

‘‘Illegal conduct will not be permitted. If you believe your rights or the rights of others have been violated, you should contact the NLRB promptly to protect your rights, generally within six months of the unlawful activity. You may inquire about possible violations without your employer or anyone else being informed of the inquiry. Charges may be filed by any person and need not be filed by the employee directly affected by the violation. The NLRB may order an employer to rehire a worker fired in violation of the law and to pay lost wages and benefits, and may order an employer or union to cease violating the law. Employees should seek assistance from the nearest regional NLRB office, which can be found on the Agency’s Web site: http://www.nlrb.gov. ‘‘Click on the NLRB’s page titled ‘‘About Us,’’ which contains a link, ‘‘Locating Our Offices.’’ You can also contact the NLRB by calling toll-free: 1–866–667–NLRB (6572) or (TTY) 1–866– 315–NLRB (6572) for hearing impaired.

‘‘* The National Labor Relations Act covers most private-sector employers. Excluded from coverage under the NLRA are public- sector employees, agricultural and domestic workers, independent contractors, workers employed by a parent or spouse, employees of air and rail carriers covered by the Railway Labor Act, and supervisors (although supervisors that have been discriminated against for refusing to violate the NLRA may be covered).

“This is an official Government Notice and must not be defaced by anyone.”

It is likely that the NLRB will require a similar notice for covered employers in the final rule.  In addition, the proposed rule states that employers that have significant numbers of employees who are not proficient in English will be required to post notices of employee rights in the language or languages spoken by significant numbers of those employees. The NLRB will make available posters containing the necessary translations.

In addition to requiring physical posting of paper notices, the proposed rule requires that notices be distributed electronically, such as by e-mail, posting on an intranet or an internet site, and/or other electronic means, if the employer customarily communicates with its employees by such means.  An employer that customarily posts notices to its employees on an intranet or internet site must display the required employee notice on such a site prominently—i.e., no less prominently than other notices to employees. The NLRB proposes to give employers two options to satisfy this requirement. An employer may either download the notice itself and post it in the manner described above, or post, in the same manner, a link to the NLRB’s website that contains the full text of the required employee notice. In the latter case, the link must contain prescribed introductory language from the poster.

The NLRB has proposed the following sanctions for failure or refusal to post the required employee notices: (1) Finding the failure to post the required notices to be an unfair labor practice; (2) tolling the statute of limitations for filing unfair labor practice charges against employers that fail to post the notices (Note: the statute of limitations for filing an unfair labor practice charge is six months); and (3) considering the knowing failure to post the notices as evidence of unlawful motive in unfair labor practice cases.  It will be unlawful for an employer to threaten or retaliate against an employee for filing charges or testifying in a NLRB proceeding involving an alleged violation of the notice-posting requirement.

The NLRB notice requirement will not apply to small businesses over which the NLRB does not have or has chosen not exercise jurisdiction.  The list of such businesses is fact-specific and depends on the type of business and the annual gross revenue (ranging from $100,000 to $1 million).  A complete discussion of the NLRB’s jurisdictional standards may be found in An Outline of Law and Procedure in Representation Cases, Chapter 1, found on the NLRB website, www.nlrb.gov.

One member of the NLRB, Brian E. Hayes, dissented from the decision to issue the proposed rule.  Mr. Hayes said in his dissent, “I believe the Board lacks the statutory authority to promulgate or enforce the type of rule which the petitions contemplated and which the proposed rule makes explicit.”

If the proposed rule is adopted, which seems likely, we may have to wait a long time for a court challenge but it will eventually occur.

http://www.thecorpsec.com

 

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Recent “Veil Piercing” Posts

piercingthecorporateveil

Several recent posts on “piercing the corporate veil” from JD Supra.

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Where to Incorporate?

Delaware, Nevada and Wyoming are considered by many to be the best states in which to form a new corporation because they are “business friendly” and have low fees and taxes.  Below is a comparison of these three jurisdictions.  But note:  While a corporation can be set up in any of the 50 states or D.C. even if there is no other connection with the place of incorporation, it is usually necessary to qualify as a foreign corporation in the state or states where the corporation is “doing business”.   For example, a Delaware corporation with its home office in, say, Minnesota, that conducts all its business in Minnesota will have to qualify as a foreign corporation in Minnesota.  This means payment of annual fees to two states and payment of state corporate income taxes in Minnesota.  In addition, incorporation is a state where the company has no physical presence usually requires the appointment of a registered agent in the state of incorporation, which typical costs around $150 per year.  In contrast, if one of the officers or directors lives in the state of incorporation, he or she can be designated as the registered agent and the cost of an independent registered agent will be avoided. In the example just given, the obvious question is whether anything is gained by incorporating in Delaware rather than Minnesota.

Delaware

More than 850,000 business entities have Delaware as a home state, including more than 50% of all U.S. publicly traded companies and 63% of the Fortune 500.   Delaware is in the forefront of new developments in corporate governance (e.g., email meeting notices), its filing procedures are efficient and not bureaucratic, its website is very easy to navigate (corp.delaware.gov), and it has procedures for almost immediate notice of a filing—for a fee, of course.

The advantages of Delaware incorporation are particularly important to big corporations.  If your corporation is trying to close a multi-million dollar merger with another corporation and you cannot make payment until you have official notice of the filing of the Certificate of Merger, it is possible to get that official notice from the Delaware Division of Corporations while everyone is waiting in a conference room to close.  In contrast, there are jurisdictions that will not provide official notice of a merger filing for a few days.  Similarly, a corporation that is sued by its shareholders, as sometimes happens with publicly held corporations, is probably better off defending itself in the Delaware Court of Chancery.  The state laws in Delaware relating to corporate governance, both statutory and case law, are well developed, having evolved over a period of 110 years, and the judges in the Court of Chancery are very knowledgeable.

The basic filing fee to incorporate in Delaware is $89, although it can vary depending on the amount of stock authorized.  The annual franchise tax for small corporations is $125.  Large corporations pay an annual fee based on a formula that considers both authorized capital stock and assets, and the annual fee can be quite large.   Delaware has a state corporate income tax but it does not apply to Delaware corporations that do not conduct business in the state.

Nevada

Nevada is often referred to as a friendly place to incorporate, especially for small businesses.  Some websites claim that courts in Nevada tend to favor the interests of management over competing interests.   Whether that is true or not, there are other factors to consider.

The annual filing fee in Nevada is $75, although it can higher, up to $11,100, depending on the authorized capital stock.  For the purpose of computing the filing fee, the value (capital) represented by the total number of shares authorized in the Articles of Incorporation is determined by computing the total authorized shares multiplied by their par value (or total authorized shares without par value multiplied by $1.00).  Filing fees are calculated on a minimum par value of one-tenth of a cent (.001), even if the stated par value is less.  Thus, with a little planning the maximum filing fee need not be an issue.  For example, a Nevada corporation could have 100,000,000 shares authorized, par value $0.001 per share, and the fee to incorporate would be only $175.

Nevada corporations and foreign corporations qualified in Nevada are required to file an “Annual List of Officers, Directors and Registered Agent and State Business License Application”.   The annual Business License Fee is $200 (home-based businesses are exempt) and the “Annual List” fee starts at $125, with a maximum of $11,100, calculated in the same way as the initial filing fee for domestic Nevada corporations.

Nevada does not have a state personal or corporate income tax and it does not share information about Nevada corporations with the IRS.  While this latter point may give the IRS less information to use as the basis for an audit, it is a situation that the IRS does not like.  That in itself may trigger IRS scrutiny.

Nevada now requires the Social Security number, date of birth, resident addresses, and telephone numbers of all shareholders, partners, officers, managers and members of all companies formed in the state.   The names of shareholders are not part of the public record.  The names of directors and officers can be concealed from public view by using nominees.  The use of what is commonly called “nominee service” has been practiced in the State of Nevada for around 75 years. Typically, this service, offered by most of the large, well-established resident agents in the state, provides the name and signature of a nominee on the annual list of officers filed with the Secretary of State, the only mandated public record of the corporation. A nominee officer or director, when properly used, has no authority to act in any manner for the corporation except that as a nominee signer. When the Articles of Incorporation and corporate bylaws are formed correctly the Corporation will appoint the nominee signer with specific, limited authority. The purpose of course is only to be the public face of the private Corporation.  While this procedure solves what might be considered an issue, it is an unnecessary complication.

According some commentators, Nevada offers the best corporate veil protection available.

Finally, the website for the Secretary of State of Nevada (www.nvsos.gov), where information about corporations is found, is not easy to navigate.

Wyoming

In Wyoming, unlike most states, it is not necessary to include “corporation”, “incorporated”, “company” or any abbreviation of one of them in the name of corporation.

The filing fee to form a corporation in Wyoming is $50.  The annual fee depends on the amount of assets of the corporation located in Wyoming.  If none, the annual fee is $50 plus $2 if the filing is made on line.   The names and addresses of officers of directors are disclosed on the annual report but business addresses can be used.

Like Nevada, Wyoming has no personal or corporate income tax (and the state has a budget surplus!).

Wyoming is one of only two states that provides for true continuance in its corporate laws.  Many states provide for domestication, but the two concepts are not the same. If a corporation chooses to domesticate in another state it can create a new corporate entity in that state and merger the existing corporation into the new corporation.   The new corporation, which survives the merger, acquires all the assets and liabilities of the disappearing corporation, but the date of corporate formation is the date of the formation of the new corporation.   However, in Wyoming, continuance is a process by which Wyoming creates the legal fiction that the corporation has always maintained its domicile in Wyoming.   That is, the corporation can retain its original incorporation date after becoming a Wyoming corporation. Anyone examining the Wyoming public record would find a corporation dating back to the original date of formation of the non-Wyoming corporation.

Wyoming does share information with the IRS but only information relating to companies with real assets inside the state.  If a corporation has no assets Wyoming, it is as protected in that regard as it would be if incorporated in Nevada.

Wyoming has well-established criteria concerning the piercing of the corporate veil. Where fraud is not present, a Wyoming corporation that does not co-mingle funds and maintains corporate formalities, including holding meetings of shareholders and directors, will not be pierced.   Some consider Wyoming to be inferior to Nevada in terms of corporate veil protection, while others claim the two states are comparable.

The Wyoming Secretary of State’s website (soswy.state.wy.us) is easier to use than Nevada’s but it is not as “user friendly” as Delaware’s.

The forgoing discussion applies only to corporations and not limited liability companies, limited partnerships or other legal entities.

The Corporation Secretary is a Wyoming corporation (www.thecorpsec.com).

 

 

 

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Small Business Jobs Act of 2010 — The Dark Side

On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010 (the “Act”).   While the White House claims that the Act will stimulate growth and hence jobs, and many business organizations have expressed public support for the Act, there is a dark side to it.

Rental Income Information Reporting

Under the Act, taxpayers who rent real estate must now report payments of $600 or more for rental property expenses, with three exceptions: (i) taxpayers who only temporarily rent their principal residences (including members of the military); (ii) taxpayers whose rental income is less than an IRS-determined amount; and (iii) taxpayers for whom the reporting requirement would create a hardship, as determined by the IRS.  This reporting required will be effective for purchases after December 31, 2010.

Penalties for Failure to Timely File Information Returns

The Act increases penalties for failure to timely file information returns with the IRS, which includes Forms 1099 and W-2.  This is particularly significant in the case of Form 1099.  Currently, a business is required to file a Form 1099 with the IRS to report purchases of goods and services above $600 made from unincorporated providers. As part of the healthcare reforms passed earlier this year, from 2012, this will be expanded to include purchases from all providers, including business entities, thus greatly increasing the paperwork burden for small businesses.  (An example sometimes given to show the effect of this requirement is that of an interstate trucking company filing a 1099 for every gas station at which its drivers purchase more than $600 of fuel.)  The penalties for the late filing of a 1099, per 1099 that is required to be issued, are as follows:

$30 penalty, if not more than 30 days late (previously $15);

$60 penalty, if more than 30 days late and before August 1 (previously $30);

$100 penalty for filing a 1099 on or after August 1 (previously $50);

$250 penalty for intentional failure to file (previously $100).

The maximum penalties that can be imposed per year have also increased.  The IRS employs a “tiered” system that specifies penalty amounts based on levels of violation (i.e., the delay in filing and whether it was corrected in a timely manner).  There are three tiers corresponding to the first three ‘per 1099’  penalties above.  The maximum penalty also depends up whether the taxpayer meets the definition of “small business”, i.e., gross receipts of not more than $5 million.

The first-tier maximum penalty increases from $75,000 to $250,000 (from $25,000 to $75,000 for small businesses).  The second-tier penalty increases from $150,000 to $500,000 (from $50,000 to $200,000 for small businesses).  The third-tier maximum penalty increases from $25,000 to $1.5 million (from $100,000 to $500,000 for small businesses).

New Source Rules on Guarantee Fees Affecting International Business Operations

Under the Act, guarantee fees paid to a non-U.S. entity will be treated like interest payments to a non-U.S. entity, i.e., guarantee fees paid by a US entity to a non-US entity will now be characterized as a US source payment subject to US withholding tax (30% of the gross amount) as if it were an interest payment, unless a W-9 or W-8 BEN is obtained and an exemption from withholding applies.  This provision of the Act relating to guarantee fees applies immediately after enactment of the Act on September 27, 2010.

 

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The ERISA Dragon May Tear Away Your Veil

Be very afraid.  Danger lurks yonder.  If your company has an ERISA plan—and most do—make sure your corporate veil is intact.

The Employee Retirement Income Security Act (ERISA) is a federal law that sets minimum standards for pension and health plans offered by employers, including private businesses, to their employees.  ERISA covers health plans, retirement plans and many equity and option plans, including “phantom stock” plans.  For example, in the case of a privately owned company, a stock ownership plan offered to a broad range of employees in which the employees are given the opportunity to purchase shares of the employer’s stock at, say, 90% of book value, with a commitment by the employer’s to repurchase the shares at book value at the time of termination of employment, would be an ERISA plan.

Consider this hypothetical situation:  NewCo has a stock purchase plan that is subject to ERISA.  NewCo unexpectedly loses a number of important contracts and is forced into bankruptcy by its creditors.  NewCo’s stock is now worthless.  Who might the employees sue for the losses in their stock purchase plan accounts?  Newco, for not disclosing the risks of investment?  Maybe, but NewCo is insolvent, and besides, the employees were given a well drafted disclosure document before each purchase of shares that clearly identified the risk that the company’s financial condition depended entirely on retaining certain major contracts.  The directors, for breaching their duty of care to the company?  Perhaps, but the directors, who have the benefit of the “business judgment rule”, will argue that the loss of the major contracts was unforeseeable and, moreover, they obtained legal advice when setting up the plan and making proper disclosure to employees.

Who, then, can the employees sue?  There must be someone.  ERISA plan fiduciaries? Under ERISA, the individuals responsible for overseeing an employee benefit plan (plan fiduciaries) must act in the best interests of the plan participants; act prudently; and avoid conflicts of interest when managing the plan’s assets. Breaches of fiduciary duty can result in a lawsuit being filed against plan fiduciaries.  ERISA fiduciary liability can attach in two circumstances:  The first is when the plan expressly designates a person as a fiduciary, generally as the plan administrator, plan trustee, or member of an administrative committee.  No one is so named in our hypothetical scenario.  The second basis for ERISA liability is when a manager performs a function that ERISA deems a fiduciary function. Such functions include (i) discretionary authority or control over the management of the plan or any authority or control over management or disposition of the plan assets, (ii) the rendering of investment advice for a fee or other compensation, and (iii) discretionary authority or control in the administration of the plan.  If a court determines that a person is a fiduciary and has breached his or her fiduciary duty, liability attaches and the fiduciary is personally liable to make good the losses to the plan.  The former employees might try to use this “deemed fiduciary” argument against the directors because the directors did adopt the plan and had authority to amend it, but the directors will argue that they did not exercise any discretion over the plan and did not make any investments with plan assets.  They merely established the plan and let the employees make their own decisions.

Who is left?  What about the company’s owners on a theory of piercing the corporate veil?   Surprisingly, that idea might have legs, as suggested by the recent Federal court decision (Delaware) in Delaware court decision in Blair v. Infineon Tech. A.G., Civ. No. 09-295 (SLR), 2010 WL 2608959 (D. Del. June 29, 2010).   In its decision, the court noted that the standard for piercing the corporate veil was reduced in ERISA cases. Where does that come from?  The court cites two cases in support of its statement: United Elec., Radio & Mach. Workers of Am., 960 F.2d at 1092 (“In an ERISA case, the applicable federal standard can sometimes be less rigorous than its state common law counterparts. The rationale … is grounded on congressional intent.  ERISA clearly favors the disregard of the corporate entity in cases where employees are denied their pension benefits.”); and Alman v. Danin, 801 F.2d 1,4 (1st Cir. 1986) (“Allowing [the parent] of a marginal [undercapitalized subsidiary] to invoke the corporate shield in circumstances where it is inequitable for them to do so and thereby avoid financial obligations to employee benefits plans, would seem to be precisely the type of conduct Congress wanted to prevent.”).

In the Blair case, the plaintiffs, who were former employees of two subsidiary companies named as defendants, claimed that their former employer failed to make payments due under the companies’ group severance plan following a period of layoffs.  They sought to pierce the corporate veil of the subsidiary companies in order to hold the parent company liable for the severance payments.  The plaintiffs claimed that the parent misdirected funds, exercise crippling control and purposefully siphon profits from one subsidiary to prop up another.  Relying on these and other allegations, the court found that plaintiffs successfully alleged that the corporate parent and subsidiary defendants were a “single entity” under the alter ego doctrine, and that if the parent did what was alleged, then plaintiffs successfully alleged a sufficient case to pierce the corporate veil. While the Blair case (like United Elec) involved piercing the veil of a subsidiary to reach a parent corporation, the court in Blair noted that “the same principles apply to corporation/shareholders and parent/subsidiaries.”

Back to our hypothetical:  Suppose that the shareholders of NewCo were also the directors and senior executives of the company.  Suppose further that the former employees allege that the shareholders pulled cash out of the company in the form of bonuses and dividends too often and in excessive amounts, thereby causing the company to face a fatal liquidity crisis when the major contracts were lost.  Would a court find that the public policy underlying ERISA was more important than the corporate veil?  The question is impossible to answer because the concept of a “federal veil-piercing standard” seems to be little more than a court’s notion of what is fair.  One thing is certain.  The owners will incur significant legal fees to defend themselves in court.

If the dragon heads your way, it is better to have a castle with strong walls than a large sword. http://www.thecorpsec.com

 

 

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Piercing the “LLC Veil”

The ‘limited liability company’, like the corporation, is a creature of state law.  The first states to adopt the LLC as a form of business organization did so less than 20 years ago.  Other states followed after the American Bar Association drafted a proposed uniform law for LLCs, and by the late 1990’s a majority of the states had laws allowing for the formation of LLCs.  This is a relatively short time ago yet the LLC has been become quite popular as a form of organization for start-ups and businesses with a small number of owners.   Many new businesses are now set up as LLCs rather than corporations. There are two reasons for this.  First, an LLC offers pass-through tax treatment without the added complexity of a Subchapter S election or the restrictions on Sub S share ownership.  (An LLC can elect to be treated as a corporation for tax purposes but in the absence of such an election, pass-through tax treatment applies.)

The second advantage of an LLC is the absence of corporate formalities.  An LLC can be managed by its members (owners) or by appointed managers.  There is no specific requirement in state LLC laws for the election of officers or the holding of periodic meetings of members or managers.  One might even say that state law leaves the matter of ‘corporate’ governance to the members.  To the extent the members adopt governance procedures, they are typically set out in an Operation Agreement for the LLC that establishes many of the rights and obligations of the members and, if applicable, the authority of the managers.

In effect, the LLC is like a general partnership.  However, unlike a general partnership, the LLC offers limited liability to the members, i.e., the members are not personally responsible for the debts or other liabilities of the LLC.  Their liability is limited to the amount of their investment, as is the case for shareholders of a corporation.

That’s the good news.  The bad news is that the absence of corporate formalities that make a LLC attractive also create a vulnerability.  With regard to corporations, failure to follow corporate formalities (meetings of directors and shareholders, minute books, etc.) can be one factor in a court’s decision to allow the corporate “veil” to be pierced, thereby allowing a creditor or plaintiff to reach the personal assets of the shareholders.  But the converse is true as well.  If the corporation has a record of observing corporate formalities, it becomes harder to pierce the corporate veil.  In the case of a LLC, if on-going organizational formalities are ignored, it deprives the members of one element of a defense when the plaintiff claims that the LLC had no separate identity from that of the members.

We are starting to see court cases that address the issue of piercing the “LLC veil” and this trend is likely to continue.

Connecticut.   Last month, in Breen v. Judge, 124 Conn. App 147, 2010, the Connecticut Court of Appeals affirmed the trial court’s decision not to pierce the LLC’s veil.  In 2007, Breen, a creditor of Patriot Truck Equipment, LLC sued Judge, the managing member of the LLC, seeking to hold him personally liable for the LLC’s debt. Connecticut law allows an LLC’s veil to be pierced if the plaintiff can show that (i) the defendant completely dominated the LLC’s finances, policies, and business practices, (ii) the defendant used that control to commit fraud, waste or a dishonest or unjust act, or to violate a legal duty, and (iii) the defendant’s conduct caused the injury or loss complained of.   The court in Breen listed ten factors relevant to whether an entity is dominated or controlled, and reviewed the relevant factors considered by the trial court. At all times Judge was no more than a 50% owner of the LLC.  The LLC was a properly formed company doing business in Connecticut. The LLC followed the various formalities, such as keeping separate books, filing company tax returns, and filing dissolution documents when it dissolved.  Based on those factors the court affirmed the trial court’s decision not to pierce the LLC’s veil.

New Jersey.   In another recent unreported case, Brown Hill Morgan v. Lehrer, the Appellate Division of the State of New Jersey considered the question of whether the doctrine of “piercing the corporate veil” applied to a limited liability company.  The Court said “we can perceive no reason in logic or policy why the principles should not be fully applicable in the context of a limited liability company.”  This case supports the proposition that when a party in litigation claims that the corporate (or LLC) veil should be pierced, thereby allowing access to the owners’ personal assets, the court will look at various factors, “including whether or not the company is grossly undercapitalized, the day to day involvement of the company’s directors, officers and personnel,” and whether personnel from affiliated companies fail to distinguish between different entities when conducting operations.  Traditionally, a court would also consider whether a corporation failed to observe corporate formalities, lacked corporate records, and merely acted a façade for the owners’ or a parent company’s operations.  In a case involving an LLC, the lack of corporate formalities and lack of corporate records would presumably not be negative factors, but that is not to say that having them would not be positive factors.   Moreover, “formalities” does not necessarily mean formalities required by state law.  If the Operating Agreement for the LLC says that there will be an annual meeting of members, then the annual meetings should be held and minutes should be maintained as a record of those meetings.

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Board Portals (from The Corporate Board)

Board Portals

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Personal Liability of Directors of U.K. Companies

It is interesting to compare the risk of personal liability for directors of U.K. companies against the risk for directors of U.S. companies.  In the U.S., personal liability can exist for directors when they cause financial harm to the corporation, act solely on their own behalf and to the detriment of the corporation, or commit a crime or wrongful act.  Causing financial harm to the corporation may result from (i) a breach of the duty of care to the corporation, (ii) a breach the duty of loyalty to the corporation, (iii) misappropriation of a corporate asset for personal use or use by another business, (iv) commingling personal and business assets, or (v) failure to disclose potential or actual conflicts of interest.  Generally, officers and directors can be indemnified by the corporation against loss under the laws of the state of incorporation.  For example, the Delaware Corporation Law permits indemnification “if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.”

In contrast, the risk of personal liability for directors of U.K. companies is much greater.

U.K. Companies Act 2006

Under the Companies Act 2006, the duties of directors in the U.K. were codified for the first time.  Directors can be held personally liable for breaches of duties (discussed below).  Moreover, the Companies Act restricts the indemnity that can be provided to the directors.   Companies can indemnify directors in respect of third party claims, but not in respect of any liabilities to the company (or an associated company); any fines or penalties arising from criminal or regulatory proceedings; or any liabilities incurred by the director in defending criminal proceedings in which he is convicted or in defending civil proceedings brought by the company or an associated company in which judgment is awarded in the company’s favor.

The main duties owed to the company under the Companies Act are the following:

  • Duty to exercise independent judgment
  • Duty to exercise reasonable care, skill and diligence
  • Duty to avoid conflicts of interest
  • Duty not to accept benefits from third parties
  • Duty to declare an interest in a proposed transaction or arrangement
  • Directors must promote the success of the company having regard for:
    • Long term consequence of any decision
    • Interest of employees
    • Need to foster new relationships with suppliers and customers
    • The impact on the community and environment
    • The desirability of the company to maintain a reputation for a high standard of business and conduct.
    • The need to act fairly towards shareholders.

Shareholders have recourse against directors if they suffer loss as a result of the directors’ actions or inaccuracies in the company’s financial statements. A director who is honest but “reckless” can still be liable if the financial statements are inaccurate or misleading.

There are other statutory obligations of directors in the Companies Act. These include administrative duties, such as a duty to keep statutory records up to date and file annual reports.  The liability for breach of these duties attaches to the company and all directors and officers. In the event of failures with regard to filings, directors can be convicted of an offense and fined.

U.K. Insolvency Act 1986

The Insolvency Act 1986 provides a number of grounds on which a liquidator of an insolvent company may pursue the directors personally to contribute towards payment of the company’s debts, and under which directors can also be subject to a 15 year ban.

Directors are guilty of “wrongful trading” if they allow the company to continue to conduct business and incur debts when there is no reasonable prospect of the company repaying the debt. There is no need to prove any element of intent for wrongful trading; the test is whether the director knew or ought to have known that there was no reasonable prospect of the company getting out of its financial difficulties.

U.K. Health and Safety at Work Act and employers’ liability

Directors can be personally liable and subject to criminal prosecution in the event that an offense is committed under the U.K. Health and Safety at Work Act or any other health and safety legislation. This would apply to dangerous practices started or continued with the director’s consent, or illness or accident attributable to a director’s negligence.

Other potential liability

Directors can also be sued personally for unfair dismissal, discrimination or unfair work practices.  In addition, liability to a third party may arise because the director (either acting independently or when representing the company as its “mind or will”) does something (or refrains from doing something) which harms the interest of a third party with whom the company has a relationship; this would include suppliers and customers as well as employees and other directors.

Director liability can be covered by D&O insurance but many D&O policies in the U.K. have an “insured vs. insured” exclusion that may exclude from cover any claims brought by the company against its directors.  Some policies also exclude losses arising from the “fraud or dishonesty” of the director.

Not surprisingly, U.K. corporations have a much harder time finding independent directors than U.S. corporations.  It is also not surprising that the corporate secretary (there called “company secretary”) function is commonly outsourced in the U.K. to ensure that administrative matters are handled properly.

 

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“Doing Business” in a State?

The question of whether a corporation is “doing business” in a particular state is very difficult to answer because it depends on all the facts of a specific situation, the laws and court decisions of the state in question, and purpose for which the question is being asked. There are three different reasons for asking the question. First, to determine whether the courts of a state have jurisdiction over the corporation if a lawsuit is filed (or, conversely, whether the corporation can bring a lawsuit in the state). Second, to determine if the company is required to qualify as a “foreign corporation” in the state in addition to its incorporation in its home state. And third, to determine whether the corporation is required to pay taxes in a state. Most of the court cases relate to the first issue. Those cases might or might not be dispositive in a case arising under the second or third issues. This uncertainty is unfortunate because the consequences of being found to be “doing business” in a state can be quite serious if a corporation has not qualified as “foreign corporation” or has not paid the required taxes.

Several states impose monetary penalties on corporations that “do business” in the state without qualifying as a foreign corporation in the state. Some of these states not only allow for penalties to be imposed on the corporation but also on individuals acting on behalf of the corporation. These states that provide for personal liability are California, Delaware, Louisiana, Maryland, North Dakota, Ohio, Oklahoma, Utah, Virginia and Washington.

With regard to taxes, states are becoming more aggressive about finding sources of revenue. One potential source is income tax on the portion of business done in the state by foreign corporations if the contacts with the state are significant enough to subject the corporation to the state’s tax laws. It is not sufficient to say that if the corporation is not qualified in the state, the state will never know about the corporation’s income that isn’t taxing. State tax authorities are much more sophisticated in collecting information than is commonly assumed. Moreover, seven states now have laws allowing individuals to act as “tax whistleblowers” and collect a reward. These states are California, Delaware, Florida, Nevada, Illinois, Indiana, and Rhode Island, although the last three do not apply the law to incomes taxes but only other forms of tax, such as sales taxes. This is a growing trend and other states are likely to pass similar tax whistleblower laws. The problem with failure to pay taxes is not just the tax itself but also the penalties and interest. Interest on unpaid taxes is 1% per month in many states. If a foreign corporation is found to have failed to pay state income taxes for several years on a portion of the income earned in a state, the total tax bill can be huge.

To answer the question of whether a corporation must qualify in a state as a foreign corporation, the first step is to examine the state’s corporation law.   The problem here is that some of these state laws provide a list of activities that, taken in isolation, do not require qualification in the state. What if more than one item on the list applies? Two items? Five items? How many are too many? Similarly, the Model Business Corporation Act provides that “…a foreign corporation shall not be considered to be transacting business in this State, for the purposes of [qualification], by reason of…[c]onducting an isolated transaction completed within a period of thirty days and not in the course of a number of repeated transactions of like nature.” Over two-thirds of the states have adopted this Model Business Corporation Act or the Revised Model Business Corporation Act, which is substantially the same in this provision. Again, how many transactions constitutes a “number of repeated transactions”? The available court cases are not very helpful because they generally dealt with situations where the transactions were either rather clearly isolated or, on the other hand, part of a regular course of business. The real question is where those two opposites meet.

Is there any guidance to be drawn from this complex web? Yes, three points. First, it may not be enough to merely select a state of incorporation, file articles of incorporation, and ignore the other states where business might be conducted. (Many new corporations are formed in Delaware and no thought is given to the state in which the corporation is actually located.) Second, ignorance is not bliss. And third, if there is any doubt about whether qualification as a foreign corporation is necessary in a particular state, it is a good idea to get written advice from a lawyer or tax adviser. If the advice is that qualification is not necessary, this will show the state authorities, if they should inquire, that the corporation acted in good faith. The defense of “Gee, I didn’t know” does not carry much weight.

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Piercing the Corporate Veil in Minnesota

Here is a link to an informative post by Attorney Jack P. Roberts at his Minnesota Business & Real Estate Law Blog:

Piercing the Corporate Veil in Minnesota

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